Kirloskar Brothers - Multibagger

KBL has recently taken over the management control of TKSL by inducting a majority of directors on the board of the subject company. TKSL, incorporated in 1965, is engaged in manufacturing of alloy steel castings catering to sugar, cement, steel, pumps/valves, marine, earth moving and other general engineering industries sectors.

Investment Rationale

KBL, the flagship company of the Rs 3660 crore Kirloskar Group incorporated in 1920, is the largest manufacturer and exporter of Centrifugal Pumps in India. It manufactures power driven pumps, valves, turbines, electric motors, anti-corrosion products and alloy iron castings at its five manufacturing plants located in the states of Maharashtra and Madhya Pradesh. KBL has five Strategic Business Units (SBUs) namely, Industrial Pumps (IP), Projects & Engineered Pumps (PEP), Agriculture & Domestic Pumps (ADP), Valves and Others of which PEP is the highest contributor to the revenues followed by ADP and IP. Besides, the Company also has strategic tie-ups in form of JVs and subsidiaries either specializing in niche categories or in their geography. KBL is transforming itself into a total water solution company from a mere product company by spreading its wings in the domestic and global markets. KBL has reputed companies and state & Central governments of various countries as its customers. All the five SBUs of KBL have witnessed strong double-digit growth ranging from 30% to 130% and pending orders in FY2007. Robust construction & infrastructure development in the economy has been the major growth driver for KBL’s businesses. High pending orders and a buoyant outlook for the user industries makes us confident of the sustainability of the high growth rates in future. An unexciting quarterly performance in Q1 and Q2FY2008 marked by aberration has beaten the stock substantially on the bourses. We however, consider this a good buying opportunity considering the bullish outlook for the company’s performance going ahead on the back of strong order book position and a buoyant outlook for the user industries.

Key Developments and Impact:

Capacity Expansion

KBL is undertaking major capacity expansion in the current year by investing to the tune of Rs 150 crore for setting up a greenfield facility for manufacturing hydel turbines as also increasing its capacity of manufacturing large capacity pumps. The new Capex is almost entirely for building new capacities resulting in a 60% increase in its Gross Fixed Assets.

Management control of The Kolhapur Steel Ltd (TKSL)

KBL has recently taken over the management control of TKSL by inducting a majority of directors on the board of the subject company. TKSL, incorporated in 1965, is engaged in manufacturing of alloy steel castings catering to sugar, cement, steel, pumps/valves, marine, earth moving and other general engineering industries sectors. TKSL’s steel casting manufacturing capacity will be utilized for KBL’s captive consumption as well as for selling in the external market.

Financials:

Net sales during Q2FY2008 grew by 14% to Rs 318.12 crore from Rs 279.07 crore in Q2FY2007. Domestic sales grew by 28% due to robust demand scenario. However, Export sales declined by 66% due to high base year effect. Exports during the year-ago quarter were higher on account of spill over of FY2006 order into Q1FY2007. Lower Other Income restricted the Total Income growth to 8.9%. Operating Profit declined by 24.2% to Rs 22.6 crore due to sharp rise in RM and Staff cost. EBITDA declined at a sharper rate, 30.5% to Rs 42.6 crore due to lower Operating Profit coupled with lower Other Income. Higher depreciation charge, steep rise in interest cost and higher tax rate affected the already low profits. Profit After Tax was also affected by absence of extraordinary income (profit on sale of & dividend from investment in Kirloskar Copeland Limited) which was present in the year ago quarter. PAT thus declined by 88.2% to Rs 27 crore. Despite an unexciting quarterly performance in Q2FY2008, we remain bullish on the company’s performance going ahead due to strong order book position and a buoyant outlook for the user industries.

Industry Scenario:

The domestic pump market valued at Rs 3500 crore can be categorized into: agricultural, industrial, utilities and services. Being fragmented in nature, the unorganized segment accounts for 30% of market. The fortune of pumps industry depends on the performance of and outlook for its user industries namely, refining, petrochemical, fertilizer, drugs & pharmaceutical, agriculture, cement, etc. There are various types of pumps like centrifugal pumps, reciprocating pumps, diaphragm pumps, gear pumps and dosing pumps. Indian pump and valves industry is on upswing with all its industry majors registering impressive double-digit growth rate. Major demand drivers for this industry are as follows:

• Investment and thrust on agriculture, development of drinking water supply & drainage system
• Performance of the fluid handling industries like petrochemicals, etc
• Investment in infrastructure development and construction activities

Financial Analysis:

Profits affected due to higher Operating Expenses, reduced Other Income & absence of Extraordinary Income as in year-ago quarter. Net sales during Q2FY2008 grew by 14% to Rs 318.12 crore from Rs 279.07 crore in Q2FY2007. Domestic sales grew by 28% due to robust demand scenario. However, Export sales declined by 66% due to high base year effect. Exports during the year-ago quarter were higher on account of spill over of FY2006 order into Q1FY2007. Lower Other Income restricted the Total Income growth to 8.9%. Operating Profit declined by 24.2% to Rs 22.6 crore due to sharp rise in RM and Staff cost. EBITDA declined at a sharper rate, 30.5% to Rs 42.6 crore due to lower Operating Profit coupled with lower Other Income. Higher depreciation charge, steep rise in interest cost and higher tax rate affected the already low profits. Profit After Tax was also affected by absence of extraordinary income (profit on sale of & dividend from investment in Kirloskar Copeland Limited) which was present in the year ago quarter. PAT thus declined by 88.2% to Rs 27 crore.

Valuations:

At the CMP of Rs 385.95, KBL is trading at about 2.9x MCap/Sales, 3x EV/Sales and 21.7x EV/EBITDA on TTM basis.

Risks:

Financial and integration risk arising from inorganic growth initiatives: KBL in order to achieve its target of becoming one of the top 15 companies in the world is considering acquisitions in the domestic and international markets. However, acquisitions could lead to integration risk to a certain extent and financial distortion for some time.

Growth:

Healthy industrial growth, boom in construction & infrastructure development, rapid urbanization leading to escalating need of drinking & waste water management, Government’s thrust on agricultural development & irrigation and its target of “Power for all by 2012” ensures strong revenue visibility from domestic market.

KBL is one of the only three manufactures of primary moderator circulation Canned Motor Pump over 200 kW. The Indo-US nuclear treaty would open up huge opportunity for KBL. Besides, its association with Bechtel, USA will be an added advantage to win new global power projects.

KBL is expanding its global presence (70 countries at present) by focusing on countries like Africa. Thus, geographical expansion would ensure additional revenue stream and hence would further boost the topline of the pumps major.

The stock is moving downwards. The support for the stock exists at around 369 levels. The MACD indicator for the stock is moving sideways in negative zone. Investors can buy the stock at declines.