Stock Review: Crompton Greaves Limited (CGL)

 

Crompton Greaves Limited (CGL) designs, manufactures and markets electrical products and services related to power generation, transmission and distribution. The company has three primary businesses: power systems, industrial systems and consumer products.

 

Strengths

Leadership position: Currently it is India's leading manufacturer of power transformers, distribution transformers, extra high-voltage and medium-voltage circuit breakers, and gas insulated switchgear.

High domestic growth: CGL reported good growth numbers in Q3FY11. Growth in the domestic business was led by the consumer products segment, which grew 30 per cent y-o-y while the industrial segment grew 23 per cent y-o-y.

According to a report by Angel Broking, the company has been able to marginally improve its margins despite heightened competition and rising commodity prices owing to higher operational efficiency that resulted in less raw-material consumption and optimal absorption of overheads. The company has been able to improve its operational efficiency by integrating the design and production technologies acquired from its overseas facilities.

Growth in overseas business: In Q3FY11, the revenue of CGL's overseas business grew by nearly 13 per cent year-on-year (y-o-y) in euro terms. Revival in demand for distribution transformers, particularly in the renewable energy space (both solar and wind), accounted for this growth.

Healthy order book: At the end of Q3FY11, CGL's unexecuted order backlog stood at Rs7,017 crore. Order backlog of the overseas business stood at Rs3,315 crore while that of the domestic business stood at Rs3,702 crore. Currently it has orders worth Rs250 crore from Power Grid Corporation of India Limited (PGCIL) for the supply of 17 transformers and 11 reactors in the 765 kilovolt (KV) segment.

Low debt: In FY10, the company's debt-to-equity ratio stood at 0.03. From Rs53.67 crore in FY09, its total debt fell to Rs26.73 crore in FY10, a reduction of 50 per cent.

Surplus free cash flow: Free cash flow represents the cash that a company is left with after allocating money for maintenance or expansion of its capital assets. CGL is cash-rich: at the end of FY10, its free cash flow stood at Rs517.18 crore, a growth of 43.5 per cent over FY09.

 

Growth drivers

Joint ventures: Recently CGL entered into a joint venture (JV) with Spain's ZIV Aplicaciones for manufacturing substation automation systems in India. It has also entered into a memorandum of understanding (MOU) with Saudi Arabia's EIC group for undertaking engineering, procurement and construction (EPC) projects in the Middle East.

Strong growth in industrial and consumer segments: The company's management expects the consumer products segment to grow at 25 per cent in FY12. The industry segment's revenue is expected to grow 20 per cent with order inflows from sectors such as cement, steel, fertiliser and railway.

Power segment to drive growth: Currently the domestic power systems segment accounts for 48 per cent of the company's standalone revenues. The massive capacity addition planned in the country will lead to large investments in both power generation and distribution. According to Angel's report, the government proposes to upgrade the 765 KV ultra high-voltage transformers. CGL is well poised to benefit from this opportunity.

International opportunities: According to a recent report from Kotak Securities, the management is eyeing opportunities in the international power distribution space.

Capital expenditure: In FY11 the company had allocated a budget of Rs600 crore for capital expenditure of which it spent around Rs400 crore. Its management had indicated in a conference call with analysts that it would allocate an equivalent amount, i.e., Rs600 crore for capital expenditure. According to a report from Angel Broking, the management now intends to defer its FY12 capex plans till greater clarity emerges on order inflows from Power Grid Corporation and other state utilities. It is of the view that its existing capacity is sufficient to cater to the orders that it is likely to receive in FY12.

 

Concerns

Muted past growth in power segment: In Q3FY11, the power systems segment reported a marginal decline of 0.9 per cent. This segment has reported negative growth in five out of last six quarters, with Q2FY11 being the only quarter when it posted positive y-o-y growth of 6.8 per cent.

In particular, order inflows from PGCIL have been muted during the first nine months of FY11.

According to a recent report from Kotak Securities, the current slowdown in real estate activity in the country and continuous delays in placement of order by Power Grid will remain a matter of concern for the company and its peer group in the short term. The report goes on to add that this is likely to be a temporary phenomenon. Between FY10 and FY12, analysts at Kotak Securities expect the company's domestic power business to grow at a compounded annual growth rate (CAGR) of 23 per cent. The company's management has also indicated that it expects order inflows from PGCIL to gather pace from the early part of FY12.

Overseas margins contracting: Margins of the overseas business have been contracting continuously on account of increased competition and rising commodity prices. Despite an improving demand scenario, the industry has not been able to pass on the cost of higher commodity prices to customers on account of overcapacity in global transmission and distribution markets.

Huge competition in 765 KV segment: Competition in 765 KV segment has heated up with a number of Chinese and Korean companies slashing their prices when bidding for tenders. Furthermore, competition has heated up in the transmission and distribution segment as well. The management however believes that it is still getting a reasonable share of orders despite Chinese players bidding at low rates.

Adverse currency movement: As mentioned earlier, it registered a decent 13 per cent growth in revenue in euro terms, while the same in rupee terms amounted to a decline of -2.6 per cent in Q3FY11. This happened owing to the depreciation of the euro.

 

Valuation

The stock is currently trading at a 12-month trailing price-to-earnings (P/E) ratio of 23.5 (as on May 30, 2011), which is below its five-year median P/E of 29.5. Based on the five-year CAGR growth of 33.6 per cent in earnings per share, the stock trades at a price-earnings to growth ratio of 0.70.

Near-term triggers to watch out for would be the listing of Avantha Power Infrastructure Ltd. (APIL). CGL could benefit as the valuation of its 32 per cent stake in that company would improve.

CGL's stock appears to be attractively valued currently. Moreover, with spending on the transmission and distribution segment likely to rise, it enjoys good long-term prospects. Buy this stock with at least a three-year investment horizon.