Stock Review: Mcnally Bharat Engg

 

Mcnally Bharat Engg is an engineering company that provides turnkey solutions to core industries like power, steel, and aluminium. It is part of Kolkata's Williamson Magor Group. The company has 49 years of experience in setting up plants on turnkey basis across India.

 

The company's business is divided among three broad divisions: products division, engineering turnkey business, and infrastructure business. After restructuring, the product business is conducted through Mcnally Sayaji Engineering (MSE) in which MBE holds 87 per cent stake. This 60-year old company manufactures heavy equipment required in core industries.

 

The engineering turnkey business can be divided project-wise into steel, mining, ports, power plants, material handling and non-ferrous metals. This division is the major contributor to the company's overall revenue. Currently a large proportion of this division's revenue comes from material handling and non-ferrous metals projects, but in future power projects are likely to gain prominence, given the pace of orders flows from this sector.

 

The infrastructure business is managed by two of its subsidiaries: Mcnally Bharat Infrastructure and Mcnally Bharat Equipment. They undertake projects in the civilian infrastructure space. Last year Mcnally Bharat Infrastructure acquired a 100 per cent state in Buildmet Ltd, which specialises in construction techniques for silos and chimneys required by cement and power plants. Thus, MBE is now well placed to cater to these two sectors.

 

Strengths

One-stop shop: MBE has a wide range of products and technology solutions, which give it a unique advantage over its peers. For example, MSE, its subsidiary, manufactures heavy equipment, which is in turn required by MBE in the execution of various projects. Moreover, through its subsidiaries and strategic tie-ups MBE has access to various technologies required for balance of plant.

In future, opportunities for companies in the engineering space will go up exponentially: it is estimated that orders worth Rs51,600 crore will be placed between FY10 and FY15. Moreover, the government's focus on the power sector also bodes well for the prospects of this company.

MBE's reputation and its relationship with both public and private sector players like NTPC, SAIL, BHEL, TISCO, Jindal, etc. ensures that it will get its due share of the order pie.

Technical collaborations: MBE has got technical collaborations with firms that are world leaders in different technologies. It has struck partnership agreements with companies in Germany, France, Finland, Poland, Russia and China. It has inked an exclusive agreement with Hiflux (HL) of Singapore for constructing sea water desalination plants and water and waste water treatment plants in India. There is strong demand for water desalinations solutions in India and this tie-up with HL, a leading player in this space, makes MBE eligible for projects that require setting up of these plants.

Large order book: MBE's order book stood at Rs406 crore in FY05; it is expected to end FY11 with an order book of about Rs5,000 crore. Being a diversified player, MBE was able to withstand the downturn better: its sales went up 101 per cent in FY09 at the height of the crisis.

At the end of Q3FY11 the company's outstanding order book stood at Rs3,920 crore (on a standalone basis). The company has placed bids for orders worth another Rs13,000 crore and is the preferred bidder for orders amounting to Rs470 crore. According to the company's management, it will be able to add orders worth another Rs1,000 crore by the end of Q4FY11.
Aggressive expansion plans: MBE is preparing a restructuring plan to consolidate its presence globally and to enter new segments. It has already transferred its product manufacturing division to MSE. It plans to undertake capital expenditure worth Rs106 crore in the next couple of years.

It has already acquired a German engineering company, KHD Humboldt Wedag, including both the latter's manufacturing and coal and mineral facilities, for Rs78 crore.

 

Weaknesses

Execution-related challenges: In the last few years, both the size of MBE's business and its order book have grown at a spectacular rate. The company has diversified into a number of fields. Managing such a diversified business will become complicated in future. The management's ability to execute a number of projects simultaneously will also be tested.

Also challenging will be managing the company's burgeoning debts. Its outstanding debt has jumped over 400 per cent in the last two years to Rs348.4 crore (FY10).

Higher working capital requirement: Material handling and balance of plant are both capital-intensive segments. Hence in future the company will have to set aside more money to meet its working capital needs.

 

Financials

Between FY08 and FY10, MBE's revenue expanded 43.34 per cent annually, driven by strong order inflows. The company's average execution period for projects is now 24 months. Currently the order book stands at 2.6 times its net sales for FY10, which provides strong revenue visibility for the company.
According to analysts' estimates, the company is expected to post an annual growth in sales of 32 per cent between FY10 and FY12. Between FY08 and FY10, its net profit grew at the rate of 25 per cent annually. It is expected to grow at the same rate in future (between FY10 and FY12).

Another positive about MBE is that it has been able to maintain healthy return ratios. Its return on equity for FY10 stood at 22.1 per cent, while the five-year average stands at 18.09 per cent — an impressive figure for a company in the infrastructure-engineering space (industry average is 11.73 per cent). The company's return on capital employed stood at 22.7 per cent for FY10, which indicates that the company is utilising its capital productively.

The company's debt-equity ratio stands at 1.35 (consolidated), while its interest-coverage ratio is 2.39. This is not a comfortable situation to be in, since the interest payments to cash flow ratio suggests that most of the company's cash flow is being spent on servicing its debt.

 

Valuation

Over the last one year (ending May 25, 2011), the stock has corrected over 38 per cent, steep fall compared to the 11 per cent rise in the value of the Sensex. The stock is currently trading at a price level of around Rs 175. Its price-earnings ratio (P/E) is 11.13, 50 per cent below its five-year historic P/E median of 21.90. This implies that the stock is trading at a discount to its own historic levels.

Considering its competitive positioning in the engineering sector, and the upcoming opportunities in this segment, this is an attractive level for accumulating MBE's stock.