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Trading Below Book Value

Transformers and Rectifiers India Ltd is a compelling pick despite the capital goods sector being under stress…

This is not the best of times for capital goods companies, particularly those in the power transformer business. Most of the players within the sector are finding the going tough. BHEL’s incremental order flow is not growing fast enough. BGR Energy saw revenue fall 19 per cent (y-o-y) in Q1FY12 due to lower order book. Voltamp Transformers reported a revenue decline of 21 per cent (y-o-y) during the quarter due to lower transformer volumes. Voltas saw its revenue decline by 4 per cent while the Crompton Greaves stock got battered for not living up to market expectations.
Out of favour among investors, the BSE Capital Goods Index has fallen 30 per cent over the past 12 months. This is a much steeper decline than that of the Sensex, which has fallen 20 per cent. As a consequence of this lack of interest in the sector, valuations have come down dramatically. Stocks in this sector can be found trading below their five-year averages. Some profit making companies can even be found trading below their book values.
One such company in the power transformer space is Transformers and Rectifiers (India) Ltd (TRIL). TRIL has reported revenue growth of 23 per cent per annum since 2007 (consolidated numbers available since FY07). PAT has grown at a higher rate of 25 per cent annually over the same period.
TRIL was established in 1994 as Triveni Electric Company Ltd. The company started off manufacturing transformers of up to 220 KV. With the commencement of its Moraiya plant, the company now manufactures transformers of up to 765 KV. TRIL now has three plants — at Odhav, Changodar and Moraiya, all located in Ahmedabad, Gujarat.

Strengths and opportunities
Small is beautiful. So what works in favour of TRIL? One, it has growth prospects. With a revenue of Rs 547 crore (FY11), TRIL is an undersized entity compared to its larger peers. How small? Take the example of BHEL. The industry heavyweight’s revenue for FY11 was 78 times that of TRIL. Its small size gives TRIL the growth prospects that the larger players cannot aspire to maintain. BHEL, for instance, reported a revenue growth of 10 per cent (y-o-y) in the first quarter of the current financial year. TRIL reported a better-than-industry revenue growth of 60.5 per cent (y-o-y) in the same quarter.
Power investments still alive. The power sector has not been moving fast enough. The requirement is real, the Plans are laid out, but execution lacks the desired speed. This is the primary reason why the sector’s order book has not been growing. The 11th Plan (2007-12) envisages total power capacity addition of 62,000 MW by the end of the Plan period. So far, around 40,000 MW has been added, leaving 22,000 MW to be added in the remaining period of the current Plan.
The 13th Plan has an even more ambitious target of adding 90,000 MW. A part of that target may end up unexecuted (due to delays). But given the huge amount of capacity addition that is envisaged, the demand for transformers should keep buzzing in the near future.
Building higher capacity. TRIL has commissioned its new transformer plant at Moraiya, Ahmedabad, for producing 220 kV and higher kV transformers. With the addition of this plant, TRIL’s capacity has bumped up to 23,200 MVA. What makes this plant vital to TRIL’s fortunes is that the government will focus on the 220+ kV segment in its forthcoming Plans (specifically the 400/765 kV). Currently the company has `117.55 crore worth of orders constituting 34 per cent of the order book in the 220+ kV category.
Entry into the big league. TRIL has partnered with ZTR of Ukraine for manufacture and supply of transformers to Power Grid Corporation (PGCIL), the country’s largest power distribution company and one of the biggest buyers of transformers. TRIL recently supplied a 400 kV transformer to a state electricity board.
TRIL has jointly bid with ZTR for 14 transformers of which the company is at L1 (lowest cost) status for seven transformers. If the JV does manage to bag all the orders, eight transformers will be manufactured by TRIL while the rest will go to its partner. Delivery of these transformers will automatically qualify the company for 400 Kv orders from PGCIL.
Robust steel demand. Even as international demand for steel is expected to cool down in the near term, demand from domestic shores is expected to remain firm. Recent estimates by a Steel Ministry panel sees demand jump by 70 per cent to 113 million tonnes (MT) by the end of the 13th Five-Year Plan. The resulting capacity addition by steel companies is expected to fuel demand for industrial transformers.

Weaknesses and threats
Weak business environment. TRIL’s current sector outperformance notwithstanding, the company’s growth rate will eventually fall in line with overall sector demand. And the capital goods sector is not showing any signs of improving just yet. The most recent August 2011 numbers saw capital goods output grow by only 3.9 per cent compared to a 4.7 per cent growth last year.
Besides private sector investments, even government orders — the government is the biggest customer for capital goods manufacturers — are moving at a snail’s pace. Delays in project clearance, high cost of borrowing, and an uncertain global environment that threatens to get worse have taken their toll. To compound problems, fluctuating stock markets will mean that the government will find it hard to raise as much through disinvestment this year as it would have liked, thereby further tightening the resources it has at its disposal to spur growth through expenditure. Till some clarity emerges, the sector could remain embroiled in this morass — something which will eventually affect TRIL’s revenues.
Other concerns. Indian manufacturers have to contend with several other concerns as well. Lack of coal linkage and problems in land acquisition have stalled several large power projects. Inflation and higher cost of borrowing have started hurting. Higher input prices, including that of copper and other raw materials, too have begun to have an impact. TRIL saw increased expenditure eat away its margins. Raw materials consumed, as a percentage of sales, jumped by 930 basis points (y-o-y) in the June 2011 quarter.
Growth at what price? There is a price that TRIL has to pay to play in the big league. Entry into the 400+ Kv has resulted in lower margins in an intensely competitive segment catered to by industry biggies. Coupled with higher input costs, realisation per MVA of transformers declined by around 19 per cent (y-o-y) to `4.4 lakh during the June 2011 quarter.
Decline in margins. For the above reasons, TRIL saw its EBITDA margin decline 710 basis points to 10.1 per cent in the June 2011 quarter. At Rs 13.8 crore, EBITDA was lower by 6.1 per cent (y-o-y) while PAT was down 8.5 per cent (y-o-y) at Rs 8.5 crore.

Valuation
TRIL is trading at a P/E of 7.10. That is at a significant discount to its five-year median P/E of 9.50. The stock, trading 53 per cent below its 52-week high, is now available below its book value at a P/B of 0.68x.
Though the capital goods sector may remain under stress for some quarters ahead, TRIL’s distressed valuations (and lower than book valuation) for a company that is not mired in excessive debt (current debt-equity at 0.2) and one that has growth prospects, provide compelling reasons to take a look at this company. Investors may buy into TRIL for long-term capital gains.