EQUITY RESEARCH Elgi Equipmentsbreport.myiris.com/ENAMSDPL/ELGEQUIP_20110117.pdfElgi is a leading...

Elgi Equipments

ENAM Securities Direct 17th January 2011

ENAM DIRECT EQUITY RESEARCH

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For private circulation only

Proxy to Industrial capex Company Background Elgi is a leading manufacturer of compressors catering to industries like construction and mining, water well, railways, power, engineering, transport and textiles. It is also engaged in manufacturing of automobile service station equipments and provides manufacturing and engineering solutions for compressors and automotive equipments. Investment Argument

An oligopoly industry with high industry barrier: The domestic industry is an oligopoly industry with only 4 players- Elgi, Kirloskar Pneumatic, Atlas Copco and Ingersoll-Rand. Furthermore, the industry has high entry barriers in the form of technology.

Strong product portfolio coupled with steady domestic demand: Elgi manufactures a wide range of compressors catering to large number of industries thus insulating it from downturn in a single industry. Elgi is a key beneficiary of higher industrial capex. With domestic demand on an up-tick, we have estimated revenue and PAT (consol.) to increase at a CAGR of ~32% and ~36%, respectively, through FY10-FY12E.

Increasing International presence: Elgi is focusing on increasing its international presence by the way of organic and inorganic route. It has presence in large number of countries and is further expanding. As a result, Elgi’s exports have also got a fillip and management expects the international business to contribute meaningfully to its business, going ahead. Elgi has established subsidiary in China to produce large screw compressors and also acquired Belair (which has 3% market share in France). It has also established a company in Brazil to enter S.American market.

An Asset light business model with improving ROCE: A virtually debt free company with steadily increasing revenue and profit. It has maintained average ROCE and ROE of 37% and 25% over the last four years. It has a strong balance sheet with cash of Rs.139 cr. as on Sep’10. It has been able to manage its working capital efficiently with working capital to sales reducing to 8.6% in FY10 from 22% in FY06. The business has high asset turn at nearly 4x.

Factors to monitor Slowdown in industrial capex: Lack of fresh investments across all

market segments could dampen the growth of the company. Valuation We believe that with India’s GDP on a high growth trajectory, Elgi should continue its strong performance. Elgi has a scalable business model with strong balance sheet, stable ROCE and has generated FCF of Rs. 89 crores as on FY10. We initiate BUY on the company with a target price of Rs. 124 (based on 16x FY12E consol. EPS of Rs. 7.8).

CMP (Rs) 84 Target price (Rs) 124 Potential upside 48%

Stock data

No. of shares (cr) 15.7

FV (Rs) 1

Market cap (Rs cr) 1,320

52 week high/low (Rs) 107/ 39

Avg. daily vol.* (shares) 101,338

BSE Code 522074

NSE Code ELGIEQUIP

Bloomberg code ELEQ IN

Reuters Code ELGE.BO

* BSE & NSE 6 monthly

Shareholding (%)

Dec-10 QoQ Chg

Promoter 33.33 0.40

FIIs 3.12 0.20

MFs / UTI 7.26 0.14

Banks / FIs .15 (0.01)

Others 56.14 (0.73)

Price performance

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Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11

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BSE_SENSEX Elgi Equipments Source: Cline, ENAM Direct Research

Financial summary (Consolidated)

Y/E March Sales (Rs cr)

Adj. PAT (Rs cr)

EPS* (Rs.)

Change (YoY %)

P/E (x)

RoE (%)

RoCE (%)

EV/EBITDA (x)

DPS (Rs)

2009 551 38 2.4 (12) - 20.8 34.4 3.5 1.3 2010 677 66 4.2 74 - 28.9 44.4 5.6 1.8 2011E 954 100 6.4 52 13.2 33.2 49.1 7.3 0.9 2012E 1,185 122 7.8 22 10.8 30.7 45.5 5.6 0.9

Source: * Adj. for bonus for FY09 & FY10; Company and ENAM estimates

BUY

17th January 2011 ENAM Securities Direct 2

Elgi Equipments

COMPANY BACKGROUND

Elgi is a leading manufacturer of air compressors and automobile service station

equipment. ELGI's products are used in a wide range of applications in areas ranging from

mining, transport, pharmaceuticals, power, oil, railways, chemicals, textiles, printing to

ship building, paper, electronics, telecommunications, medical, food & beverages and

plastics. No sector contributes more than 10% to the topline of the company thereby

hedging it from downturn in a single industry. Hence, it is a play on India’s GDP growth

which would in-turn fuel the growth in industrial capex.

Compressor Technology can be classified as reciprocating compressors, screw

compressors, centrifugal compressors and oil-free compressors. Elgi is largely into rotary

screw and reciprocating compressors. The Automotive Service Equipment Division

manufactures lubrication equipment, two-wheeler and four-wheeler hoists, paint booths,

AC recovery units, crash repair systems, wheel balancers etc.

Elgi has a vision of becoming a $1 bn. company in terms of topline by 2015 by resorting to

organic and inorganic growth routes.

Product profile

Source: Company, ENAM Research.


Elgi Equipments

Company Structure

Elgi includes Elgi equipment Standalone Company and its subsidiaries. ATS Elgi, is yet, in the growth phase as auto sales have picked up over the last few years and are growing strong. This, inturn, is leading to investment in new and existing garages. The compressor subsidiaries are still in their nascent stage of growth. However, they hold an area of promise since the management’s vision is to touch $1 bn topline which would entail increasing international exposure through the subsidiaries- organically or inorganically.

Subsidiaries

Holding as on Mar-10

Total Assets (Rs cr)

FY10 Revenue

(Rs cr)

FY10 PAT

(Rs cr)

ATS ELGI Limited 100% 27.2 89.2 5.1

Adisons Precision Instruments Manufacturing Company Limited 100% 1.1 0.0 0.0

ELGI GULF (FZE) 100% 0.9 5.9 0.7

Elgi Equipments (ZHEJIANG) Limited 100% 2.8 2.1 (3.8)

Elgi Compressor Trading (Shangai) Ltd. 100% 1.6 1.5 (0.5)

SA Belair-France* 100% 6.9 3.1 0.0

Source: Company and ENAM Direct Research; the revenue and PAT nos.are only for one month as Elgi acquired Belair in Mar’2010

Business Mix

Compressors contribute lion’s share of revenue (86%) which stands at Rs. 582 cr. for FY10.

It accounts for 92% of EBIT of the company. Automobile Equipments contribute 13% to

revenue at Rs. 89 cr. It accounts for 10% of EBIT.

Revenue Break-up EBIT Break-up

86%

13% 1%

Compressors Automotive Equipments Others

90.1

9.8

(2.1)(20.0)

0.0

20.0

40.0

60.0

80.0

100.0

Compressors AutomotiveEquipments

Others

(Rs C

r)

Source: Company and ENAM Direct Research; All nos. are on consolidated basis


Elgi Equipments

BUSINESS OVERVIEW Compressor Segment

Elgi is Asia's largest manufacturer of air compressors. Elgi has a strong product portfolio.

It manufactures a wide range of rotary and reciprocating compressors which cater to large

number of industries like mining, transport, pharmaceuticals, power, oil, railways,

chemicals, textiles etc. This diversifies its customer base and protects it from downturn in a

single industry. Spares and services business accounts for nearly 20% of the compressor

business. Elgi has a huge nationwide network of over 114 dealers with service team of over

250 engineers and technicians. Elgi manufactures airends in-house. It caters to large no. of

esteemed customers.

Rotary Compressor Customers Reciprocating Compressor Customers

Source: Company and ENAM Direct Research

The size of domestic industry is around Rs. 3,000 cr. Furthermore, the domestic industry is

an oligopoly industry with only 4 players- Elgi, Kirloskar Pneumatic, Atlas Copco and

Ingersoll-Rand. The industry has huge entry barriers in the form of technology. Compressor Technology can be classified as reciprocating compressors, screw

compressors, centrifugal compressors and oil-free compressors. Amongst these, Kirloskar

is mainly into gas based compressors. Demand for spares constitutes for a large part of

demand for compressors. This ensures a minimum level of demand even in downturn.


Elgi Equipments

Elgi is focusing on increasing its international presence by the way of organic and

inorganic route. ELGI has a presence in all the major markets across the world including

Europe, North America, Latin America, Africa, Australia, Middle East, South East Asia,

West Asia and the Far East. It has more than 50 dealers overseas. As a result Elgi’s exports

have also got a fillip and management expects the international business to contribute

more than 50% to its business, going ahead.

Elgi’s major focus is on European and Chinese market. The Chinese market is more than

double the size of Indian market. Elgi has established subsidiary in China to produce large

screw compressors which faces little competition from domestic Chinese market. It is also

looking at multiple acquisitions in China to capture small size rotary screw compressor

market. In March 2010, Elgi acquired Belair of France. Belair is a leading supplier of

industrial compressors with 3% market share in France. It has also established a company

in Brazil to enter S.American market.

The compressor business contributes 86% to the total consol. revenue. The compressor

segment revenue (consol.) has increased at a CAGR of 25% over FY06-10. The EBIT margin

has averaged 16% over the last five years. The segment ROCE has averaged over 50%

during the last five years. We have estimated revenue in compressor segment to increase

at 35% CAGR over FY10-12E.

Compressor segment Revenue and EBIT Margin Compressor segment ROCE (%)

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Compressors Revenue EBIT(%)

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ROCE(%)

Source: Company and ENAM Direct Research; All nos. are on consolidated basis


Elgi Equipments

ATS- Elgi

The Automotive Equipment Division manufactures lubrication equipment, two-wheeler and four-wheeler hoists, paint booths, AC recovery units, crash repair systems, wheel balancers etc. This segment is expected to perform in line with auto sales and investment in new and existing garages. It accounts for 13% of sales (consol.) and 10% of the profits of the company.

Key Customers

Source: Company and ENAM Direct Research ATS- Elgi, is yet, in the growth phase as auto sales have picked up over the last few years and are growing strong. This, inturn, is leading to investment in new and existing garages. We have estimated revenue to increase at 21% CAGR for FY10-12E.

Automotive Equipment Revenue and EBIT Margin ATS segment ROCE (%)

020406080

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(Rs

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Automotive Equipment RevenueEBIT(%)

0%10%20%30%40%50%60%


ROCE(%)



Elgi Equipments

INVESTMENT ARGUMENT

Strong product portfolio coupled with steady demand domestically: Elgi

manufactures a wide range of air compressors of both rotary and reciprocating

technology in various powers and capacity. It caters to large number of industries

like construction, mining, railways, power etc. This insulates it from downturn in a

single industry as no industry contributes more than 10% to its sales. Elgi is a key

beneficiary of higher domestic industrial capex. The size of domestic industry is

around Rs. 3,000 cr. Furthermore, the domestic industry is an oligopoly industry

with only 4 players- Elgi, Kirloskar Pneumatic, Atlas Copco and Ingersoll-Rand.

Additionally, the industry has huge entry barriers in the form of technology.

Demonstrated growth in sales and EBITDA margin: Elgi has been able to increase

sales at a CAGR of 21% over FY06-10. In the same period EBITDA has grown from

Rs. 39 cr. in FY06 to Rs. 108cr. in FY10 (CAGR of 29%). Ebitda margin has

improved largely due to favourable product mix. We have estimated revenue to

increase at a CAGR of 32% and PAT to increase at CAGR of 36% over FY10-12E.

Increasing Net Sales and sustainable EBITDA margin

0200400600800

100012001400

FY2006 FY2007 FY2008 FY2009 FY2010 FY2011E FY2012E

(Rs

Cr)

0%5%10%15%20%25%30%35%40%

Net salesEBITDA Margin



Elgi Equipments

A virtually debt free company with improving ROCE and ROE in the compressor business: A debt free company which has maintained average ROE of

25% and ROCE of 37% over the last four years. Cash flow from operation (CFO)

has increased at a CAGR of 51% between FY07-FY10 (CFO increasing to Rs. 105 cr.

in FY10 from Rs.31 cr. in FY07).

Improving ROCE and ROE profile Multifold increase in Cash flow from operations

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(Rs

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CAGR = 51%


Working capital- ‘A cash generator’: Elgi has consistently been able to decrease its

working requirement. Elgi has been able to reduce its working capital as percent of

sales from 22% in FY06 to 9% in FY10.

Working capital requirement falling with increasing sales

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Elgi Equipments

Quarterly sales trend is encouraging- Sales have been rising consistently from

Mar’09 onwards. In the last three quarters the company has posted an average

revenue growth of over 50% YoY.

Consistently rising quarterly sales

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Net Sales Sales Growth Y-o-Y

Growth of over 50% YoY over the last three quarters


RISKS TO VALUATION

Slowdown in industrial capex: Lack of fresh investments across all market

segments could dampen the growth of the company. Hence, if GDP growth slows

down for a sustained period of time it can hamper Elgi’s growth.

Adverse exchange rate movements- Around 15% of company’s revenue (st.) comes

from export, rupee appreciation could have a negative impact on revenue.

Recovery of global economy- Elgi has exposure to international markets some of

which are still under recessionary trends especially Europe. Recovery of Europe will

be key to Elgi’s growth.

Rise in input costs- Sharp rise in commodity prices such as steel and copper and

company’s inability to pass on the increase in prices could hamper the margin of the

company.


Elgi Equipments

VALUATION Revenue growth of ~32% CAGR during FY10-FY12E

EPS growth at ~36% CAGR over next two years

Scalable business model and stable earnings growth

Strong Corporate governance

Asset light business with virtually no debt

Our 1-yr. target price of Rs. 124 is based on 16x consol. EPS of Rs. 7.8


Elgi Equipments

FINANCIALS Income statement (Rs Cr)

Y/E March (Consol.) 2009 2010 2011E 2012E Net sales 551 677 954 1,185 Other operating income 2 3 3 3 Total income 553 680 957 1,188 Material Cost 344 409 576 717 Employee Cost 53 64 90 111 Other Manufacturing Cost 21 25 36 45 Contribution (%) 25 27 27 27

Advt/Sales/Distrn O/H 67 74 100 124 Operating Profit 69 108 156 190 Other income 2 5 8 8 PBIDT 71 113 163 198 Depreciation 8 11 13 16 Interest 0 0 0 0 Other pretax 0 0 0 0 Pre-tax profit 63 102 150 182 Tax provision 25 36 49 60 (-) Minority Interests 0 0 0 0 Associates 0 0 0 0 Adjusted PAT 38 66 100 122 E/o income / (Expense) 3 (8) (0) 0 Reported PAT 40 58 100 122

Balance sheet (Rs. Cr)

Y/E March (Consol.) 2009 2010 2011E 2012E

Total assets 197 265 350 456

Gross block 158 173 203 243

Net fixed assets 66 69 86 110

CWIP 1 2 0 0

Investments 14 14 14 14

Wkg. cap. (excl cash) 91 58 66 72

Cash / Bank balance 25 119 183 259

Others/Def tax assets 0 2 2 2

Capital employed 197 265 350 456

Equity capital 6 8 16 16

Reserves 190 252 328 433

Borrowings 0 3 4 4

Others 0 2 3 4



Elgi Equipments

Key ratios (%)

Y/E March (Consol.) 2009 2010 2011E 2012E Sales growth 9.3 22.9 41.0 24.2

OPM 12.6 15.9 16.3 16.1

Oper. profit growth 6.3 55.7 44.1 22.5

COGS / Net sales 75.4 73.3 73.3 73.5

Overheads/Net sales 12.1 10.9 10.4 10.4

Depreciation / G. block 5.2 6.2 6.5 6.5

Effective interest rate n.a. n.a. n.a. n.a.

Net wkg.cap / Net sales (x) 0.2 0.1 0.1 0.1

Net sales / Gr block (x) 3.7 4.1 5.1 5.3

RoCE 34.4 44.4 49.1 45.5

Debt / equity (x) 0.0 0.0 0.0 0.0

Effective tax rate 39.5 35.4 33.0 33.0

RoE 20.8 28.9 33.2 30.7

Payout ratio (Div/NP) 20.1 25.0 14.4 11.8

EPS (Rs.)* 2.4 4.2 6.4 7.8

EPS Growth (11.6) 74.1 52.0 21.6

CEPS (Rs.) - - 7.2 8.8

DPS (Rs.) 1.3 1.8 0.9 0.9

* EPS adjusted for bonus in FY09 & FY10

Cash flow (Rs Cr)

Y/E March (Consol.) 2009 2010 2011E 2012E Sources 60 75 118 146

Cash profit 55 69 107 131

(-) Dividends 4 15 17 17

Retained earnings 50 54 90 115

Issue of equity 0 23 0 0

Borrowings 0 3 1 0

Others 9 (5) 26 31

Applications 60 75 118 146

Capital expenditure 23 16 28 40

Investments (0) 0 0 0

Net current assets 24 (36) 26 30

Change in cash 13 95 64 76



Elgi Equipments

CONFLICT OF INTEREST DISCLOSURE

We, at ENAM, are committed to providing the most honest and transparent advice to our clients. However, given thenature of the capital markets, from time to time we are faced with situations that could give rise to potential conflict ofinterest. In order to provide complete transparency to our clients, before we make any recommendations, we arecommitted to making a disclosure of our interest and any potential conflict IN ADVANCE so that the interests of ourclients are safe- guarded at all times. In light of this policy, we have instituted what we believe to be the mostcomprehensive disclosure policy among leading investment banks/brokerages in the world so that our clients may make an informed judgment about our recommendations. Thefollowing disclosures are intended to keep you informed before you make any decision- in addition, we will be happyto provide information in response to specific queries that our clients may seek from us. Disclosure of interest statement (As of 14th December 2010) 1. Analyst ownership of the stock No 2. Firm ownership of the stock No 3. Directors ownership of the stock Yes 4. MBD Relationship No 5. Broking relationship No We are committed to providing completely independent and transparent recommendations to help our clients reach a better decision.

This document has been prepared by Enam Securities Direct Private Limited – Privileged Client Group. Affiliates of Enam Securities Direct Private Limited focused on Institutional Equities may have issued other reports that are inconsistent with and reach different conclusion from the information presented in this report. The views and opinions expressed in this document may or may not match or may be contrary with the views, estimates, rating and target price of the Affiliates research report. The report and information contained herein is strictly confidential and meant solely for the selected recipient and may not be altered in any way, transmitted to, copied or distributed, in part or in whole, to any other person or to the media or reproduced in any form, without prior written consent. This report and information herein is solely for informational purpose and may not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial instruments. Nothing in this report constitutes investment, legal, accounting and tax advice or a representation that any investment or strategy is suitable or appropriate to your specific circumstances. The securities discussed and opinions expressed in this report may not be suitable for all investors, who must make their own investment decisions, based on their own investment objectives, financial positions and needs of specific recipient. This may not be taken in substitution for the exercise of independent judgement by any recipient. Each recipient of this document should make such investigations as it deems necessary to arrive at an independent evaluation of an investment in the securities of companies referred to in this document (including the merits and risks involved), and should consult its own advisors to determine the merits and risks of such an investment. The investment discussed or views expressed may not be suitable for all investors. Certain transactions -including those involving futures, options and other derivatives as well as non investment grade securities - involve substantial risk and are not suitable for all investors. Enam Securities Direct Private Limited has not independently verified all the information given in this document. Accordingly, no representation or warranty, express or implied, is made as to the accuracy, completeness or fairness of the information and opinions contained in this document. The Disclosures of Interest Statement incorporated in this document is provided solely to enhance the transparency and should not be treated as endorsement of the views expressed in the report. This information is subject to change without any prior notice. The Company reserves the right to make modifications and alternations to this statement as may be required from time to time without any prior approval. Enam Securities Direct Private Limited, its affiliates, their directors and the employees may from time to time, effect or have effected an own account transaction in, or deal as principal or agent in or for the securities mentioned in this document. They may perform or seek to perform investment banking or other services for, or solicit investment banking or other business from, any company referred to in this report. Each of these entities functions as a separate, distinct and independent of each other. The recipient should take this into account before interpreting the document. This report has been prepared on the basis of information that is already available in publicly accessible media or developed through analysis of ENAM Securities Direct Private Limited. The views expressed are those of the analyst and the Company may or may not subscribe to all the views expressed therein. This document is being supplied to you solely for your information and may not be reproduced, redistributed or passed on, directly or indirectly, to any other person or published, copied, in whole or in part, for any purpose. Neither this document nor any copy of it may be taken or transmitted into the United State (to U.S. Persons), Canada, or Japan or distributed, directly or indirectly, in the United States or Canada or distributed or redistributed in Japan or to any resident thereof. This report is not directed or intended for distribution to, or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction, where such distribution, publication, availability or use would be contrary to law, regulation or which would subject Enam Securities Direct Private Limited to any registration or licensing requirement within such jurisdiction. The securities described herein may or may not be eligible for sale in all jurisdictions or to certain category of investors. Persons in whose possession this document may come are required to inform themselves of and to observe such restriction. Neither the Firm, not its directors, employees, agents or representatives shall be liable for any damages whether direct or indirect, incidental, special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information.

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ENAM Securities Direct Pvt. Ltd.

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Website: www.enam.com / www.enamdirect.in Email: [email protected]

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