| Summary of Contents STOCK IDEAS Greaves Cotton
Cluster: Emerging Star
Recommendation: Buy
Price target: Rs365
Current market price: Rs266
Firing on all cylinders Key points · Strong recovery in demand: Greaves Cotton Ltd (GCL) is benefiting from the revival in demand in both of its business segments: engines and construction equipment. Consequently, we expect a robust growth of 20.5% CAGR in its revenues over FY2009-11. o Engines business to gear up: After two years of stagnation the engines segment (accounting for 85% of its revenues) is likely to turn around with a recovery in automobile engine sales and a steady growth in agro and power engines. With its key clients, Piaggio and Mahindra and Mahindra, reporting a smart pick-up in their three-wheeler sales coupled with the low base effect, GCL?s automobile engines division (accounting for ~60% of its total revenues) is estimated to show an exponential growth in the coming quarters. Further, the supply of engines for Tata Motors? new product, which is expected to be a lower version of ACE, will boost the sales in FY2011.
We expect the agro equipment division (contributes ~15% of total revenues) to grow in excess of 20% in the coming years on the back of the government?s initiatives and the rising prices of agricultural output. Also, with the pick-up in industrial activity and increased expenditure on the marine and defence sectors, the auxiliary power division (contributes ~10% of total revenues) will see a sustained growth. Overall, we expect the engines business to post a revenue CAGR of 17.1% over FY2009-11. o Construction equipment business to ride on revival in construction activity: This business is a direct play on the growth in the construction and road building activity in the country. After reporting revenue CAGR of 54% from FY2005 to FY2008, this division collapsed in FY2009 with its revenues crashing by 59.1% year on year due to a slowdown in its user industries.
We believe with much improved fund availability, low interest rates and pick-up in industrial and real estate sectors, the business is in for a sharp revival. Also, with the bidding and concession norms well established now and the award of road projects having gained traction, the demand from this segment is likely to pick up sharply. Thus, we expect the construction equipment division to post a sharp revenue CAGR of 37.4% over FY2009-11. · Margins to expand on revival of construction equipment business: In FY2009 GCL?s overall operating profit margin declined by 300 basis points. This was due to the losses posted by the construction equipment (infrastructure equipment) segment, which had enjoyed a PBIT margin of ~14% in the previous years. Also, in a scenario of a sharply increasing raw material cost and pressure on sales, the engines segment posted a drop of ~200 basis points in its PBIT margin compared to its past record of profitability.
We believe that with much higher scale of operations (especially for the construction equipment business) and relatively lower raw material cost, the company would sustain its overall operating profit margin at ~15% going forward, which is significantly better than the 11% margin recorded in FY2009. · Excellent financials: GCL has a strong balance sheet and is a zero net debt company. Moreover, the company does not have any major capex plans in the near future. With a hefty increase in its profits and a low capex the company is expected to generate free cash flows in excess of Rs100 crore each in FY2010 and FY2011. The company has generated high returns on capital over the years and for FY2010 and FY2011 we expect it to generate RoCE and RoE of ~35% and ~25% respectively. · Valuation and view: We expect GCL to post a robust CAGR of 20.5% in revenues and that of 59.9% in its net profits respectively over FY2009-11. Moreover, the free cash generation will be substantial. At the current market price of Rs266.4 the stock trades at 12.1x and 9.3x its FY2010E and FY2011E EPS respectively, and appears attractively priced, considering the company?s growth outlook and historical one-year forward average multiple of 10.6x. We initiate coverage on the stock with a Buy recommendation and price target of Rs365, valuing it at 12.8x FY2011E earnings (EV/EBIDTA of 6.5x). The valuation, we believe, is justified given the expected high growth traction. Our price target implies an upside of 37% from the current market price of Rs266.
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