Stock Review: Diamond Power

 

Considering Diamond Power's strong earnings growth of the past 12 months and growth potential on the back of completed capex plan, it deserves a better valuation

 

GUJARAT-BASED Diamond Power Infrastructure is an integrated turnkey contractor in the power transmission and distribution business and manufactures entire set of equipment needed in transmitting power from point of generation to the end user. This includes transformers, conductors, cables and towers of various capacities. The company manufactures all types of conductors and has a total capacity of 50,500 million tonne. Similarly, it has a wide range of low-tension and high-tension cables with a total capacity of 39,500 km. The company has also forayed into manufacturing of transmission tower business with a capex of 65 crore adding to 48,000 MT capacity. It is present in the transformer business through its two subsidiaries — Apex Electricals and Diamond Power Transformers — and has 4,000 megavolt ampere (mVa) capacity for distribution transformers and 10,000 mVa capacity for power transformers.

   Its manufacturing capacity and expertise in the power T&D business allowed the company to start EPC operations in 2006 which now account for a third of its total revenues.

FINANCIALS:

From FY08 to FY10, its net sales grew at a compounded annual growth rate (CAGR) of 26% to 860 crore. In FY10, conductors business contributed 35% to revenues, one-third by EPC, 18% from cables and 13% from transformers segment. Among these, conductor and transformer business enjoy the highest margins of around 13.5%, while EPC business and power cable businesses have margins of 10.7% and 8.4%, respectively. In the first three quarters of FY11, the overall margins have improved due to integration in the EPC and tower business. However, the company has been repeatedly diluting equity in the past to fund its expansion drive, which has resulted in the per share earnings (EPS) growing at a slower rate than the company's bottom line.

   At present, the company appears nearing its capital expenditure cycle, which is expected to limit its requirement to raise funds in future. Similarly, its current debt-equity ratio is low at 0.67, which leaves some room for it to raise debt, if needed. However, considering the company's history, a future equity dilution will continue to remain a concern.

   The 375-crore capital expenditure in the past couple of years was funded by 150 crore long-term debt at cost of 10.3% to be repaid in nine years and the remaining through equity. Out of the total capex, 65 crore were spent on tower facilities, 205 crore for extra high voltage cables and remaining 105 crore for transformers. In future, the operating margins are expected to improve due to introduction of extra high voltage cables and integration of EPC and tower business.

GROWTH DRIVERS:

Significant power generation capacity addition in India would lead to higher investment in the transmission and distribution sector. With the government aiming to reduce the transmission losses, significant investments are expected in the T&D sector resulting in large opportunities for companies in this sector.

   Increase in urbanisation is leading to underground cabling for power transmission. Recent addition of low tension cable capacity from 8,800 km to 33,000 km and high-tension cable capacity from 2,800 km to 5,600 km will enable the company capitalise on this opportunity in the cable business.

   Diamond Power recently became qualified for bidding for Power Grid projects, which is an important achievement for the company. Power Grid has a huge capex plans going ahead and has recently increased the pace of awarding contracts, which is good for the company.

   In the first nine months of FY11, the company bid for projects worth 3,500 crore and has already bagged projects worth 1,400 crore. Its outstanding order book at the end of December 2010 stood at 1,500 crore, which gives revenue visibility of one year ahead considering revenues of trailing 12 months.
   
VALUATION:

Being a fully-integrated EPC contractor in power T&D, Diamond Power has no direct peer. But the company has competitors in various segments. The average valuation for conductor companies is 7.7, EPC companies 10.2, cable companies 20 and transformer companies 10.4.

   The company has given a growth guidance of a CAGR of 30% for another two years. Given this, the company deserves a price-earning valuation of 8-9 on the conservative side as against the current price to earning of 4.5.