Technological Expanse | Value Research Attractive valuations, rich growth history & a solid legacy make Kirloskar Pneumatic a tempting buy…
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Technological Expanse

Attractive valuations, rich growth history & a solid legacy make Kirloskar Pneumatic a tempting buy…

Kirloskar Pneumatic Company (KPCL) is a subsidiary of the Kirloskar Brothers Investment (KBIL), the flagship company of the $1.2 billion conglomerate Kirloskar Group. The word 'pneumatic' means the section of the technology that deals with the study and application of pressurised gas to effect mechanical motion. Thus, the company is into twin lines of manufacturing and selling business which includes compression systems and transmission products. Compression system contributes 89 per cent to the revenue and comprises air compressors, refrigerators, air-conditioners and gas compressor packages. Remaining 11 per cent comes from transmission products segment which manufactures locomotive transmission units, hydraulic marine gear boxes and industrial and windmill gear boxes.

KPCL also designs systems and manufactures customised products as per the needs and requirements of the industries it caters to: oil and gas, food, power, railways and marine. KPCL got merged into an associate company KG Khosla in 2001 and thus operates under two brand names: Kirloskar and Khosla.

Its core strength lies in the management and the holding company KBIL which has experience and expertise spanning over 120 years. It's a technology-driven company, developed on own over the years and through strategic tie ups abroad. It has been successful in becoming self-reliant in the system technology and now has tie-ups, such as those with Man Group, GE and Howden, only for the specialised products.
* The company is the largest player in packaging and distribution of CNG in India and has a market share of 40 to 45 per cent.
* It has made a landmark in the wind power segment by producing and commissioning 1MW gearboxes, making it the only company to do so. Its client base includes NEPC and Pioneer Wind Energy.
* The company manufactures, assembles and implements air-conditioning systems and air-compressors on a customised basis and is leader in supply to Indian Navy. It has implemented projects in majority of refitted or manufactured Indian submarines, surface ships, frigates, destroyers and the lone aircraft carrier. Over the next decade the Indian Navy is going to spend a hefty amount on defenses.
* It also manufactures rail traction gears for Indian Railways. The estimated market share in this segment is 75 to 80 per cent.

Growth Drivers
The company entered into an agreement with Railways last year to launch road railer trains between Delhi and Chennai. The road railer is a bimodal transport system under which the same vehicle can ply not only on railway tracks but roads too. The company has already made capital expenditure for the project and the factory in Nashik is ready to manufacture first rake of 50 units, under licence from US-based Wabash Corporation. The rakes are expected to be rolled out in first quarter of the current fiscal year. These rakes will be leased or sold out to a service company in which it will have a majority stake. This service company in turn will pay the Railways for using the track lines and will operate as a logistic company.
* Major clients come from sectors like power and gas, both of which are on a growing spree in India. The growth of these sectors will be advantageous to the compression system segment of the company.
* Railways is still investing on its rolling stock on continuous basis which can lead to a healthy growth in the transmission business. The transmission business, which was in a loss in the FY2011, now has had a turnaround and has started giving profits in current financial year. This has also happened partly due to the revamp of the transmission division last year.
* The existing number of CNG stations in India is around 724 and the requirement is pegged at around 5,000. With the growth of CNG stations the gas compressor system for CNG packaging business of KPCL is going to excel.

The business nature of KPCL is directly related to the performance of the Indian economy and unfortunately the current economic uncertainties are not expected to fade away anytime soon given the macro crisis that we are witnessing. This may bring the compressor system business on a fighting mode as it is currently utilising only 43 per cent of its installed capacity. This means the company is not leveraging on its capacity and is spending on the fixed expenses. But this may also prove to be beneficial if the demand picks up as they could produce more units without any additional capex.
* It is also facing strong competition from multinationals venturing into the India market due to the growth in compression industry.
* Its CNG packaging system is being challenged by the second-largest Argentinian company, Atlas Corp Co and Burkhdrt.
* Windmill market has been slowing down despite a tag of clean energy and global support, thus affecting the transmission segment of the company.
* The company has contingent liabilities of `28.7 crore and a pending case of $10 million claims against the company. The case is going on in the International Court of Arbitration.

The company grew at an exceptionally high pace in the first half of the last decade at the rate of 30 per cent CAGR. Now the revenue growth has stabilised somewhat at a decent rate of 14 per cent CAGR in the last 5 years ending December 2011. Average return on capital employed in the last 5 years is 45 per cent and return on net worth is 40 per cent, signifying that the management is efficiently churning earnings out of available resources. Debt has also been reducing consistently over the years and it is expected to become a debt-free company by the end of half-year in current financial year. It raised $5.5 (`27.5 crore) million through external commercial borrowings (ECB) which will mature in December 2013. The company has cash and short-term investments of `128 crores which comes out to be `100 per share as against the current share price of `470.

The stock price of KPCL is trading at 9.8 times the earnings as against its 23 per cent discount to 5-year median price to earnings of 12.75. Also, the current price to book value is 2.63 which is again at 37 per cent discount to 5-year average of 4.2. At a PEG of 0.29, KPCL is a value buy and a reasonably-priced growth stock. Once the industrial numbers, i.e IIP, comes on track, the stock will realise its potential. BUY. WI

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