Sunday, June 12, 2011

Engineers India Buy on declines

The company's dominant market position, through its unique mix of consultancy and turnkey projects, and the ability to tap new business opportunities are positives.

Investors with a three-year perspective can consider buying the stock of Engineers India. Catering to the entire hydrocarbon value chain, dominant market position through its unique business mix of high-end engineering consultancy and turnkey projects, and the ability to quickly tap new business opportunities make Engineers India a superior play in the engineering and infrastructure space.

At the current market price of Rs 280, the share trades at 11 times its expected per share earnings for FY-13. The price is close to the follow-on offer price in July 2010. A marginal premium to peers is justified on account of superior profit margins, return on equity as well as zero-debt status. Investors can consider accumulating the stock on any steep declines linked to broad markets.

UNIQUE PLAY

Engineers India is a play on the technology and engineering segments in the oil and gas and other infrastructure industries. The company's presence in the lucrative hydrocarbon industry spanning commissioning of refinery and petrochemical units, consultancy services for offshore and onshore oil and gas and laying of pipelines have provided it a market leadership in the local arena. Besides, it has emerged as a sound competitor for overseas projects.

This has led to the company enjoying high EBITDA margins hovering over 20 per cent; such profitability is uncommon in the infrastructure space. With hardly any peers with similar skill sets in the domestic arena, Engineers India can be expected to be a beneficiary of upgradation and capacity additions in the refinery space under the Plans. Such activity is set to increase by 25 per cent (capacity) in the 12th Plan.

CHANGING MIX

Engineers India is known to have lumpy revenues across quarters as a result of its consultancy division accounting for a chunk of revenues compared with lump sum turnkey (called LSTK or engineering procurement and construction) projects. In FY-07, for instance, consultancy accounted for as much as 85 per cent of the revenues. This has now shrunk to 40 per cent in FY-11. There are both benefits and disadvantages to such a change in mix.

For one, consultancy jobs offer high margins in the range of 30-40 per cent, this explains why the company has so far enjoyed superior operating margins. This shift towards EPC would mean a reduction in profit margins. EBITDA margins for FY-11, in fact, fell 2 percentage points to 23 per cent over a year ago.

On the positive side, focus on EPC projects provides a wider universe and larger opportunity for Engineers India to participate in projects that it was only advising earlier. It has also helped the company to diversify in infrastructure and water and waste management projects.

SURGE IN ORDER FLOWS

A faster increase in top line growth could, perhaps, ensure that margins do not suffer much. The EPC segment's contribution to revenue would also be relatively steady, based on the proportion of work completed. Revenue has, in fact, grown at a compounded annual rate of 55 per cent to Rs 2823 crore in FY-11, since EPC contracts saw a gradual increase in sales contribution over the last four years. Revenues remained volatile over 2005-08 when consultancy dominated income flow.

The above shift in focus also resulted in a surge in order flows by 166 per cent in FY-11, taking the order book to Rs 7,500 crore or 2.6 times sales in the latest ended fiscal. The mix of 65:35 in favour of EPC and consultancy can be expected to provide sound top line growth and support to margins as well.

Engineers India, interestingly, has a slightly varied approach to its EPC/LSTK contracts. Called Open Book Estimate convertible to LSTK, the contracts entail a quick preliminary design that would suffice for entering into a contract.

This is said to reduce the bidding period, after which prices governed by market conditions are decided. Design too is left open to change. This is a key positive as contractors often reach a deadlock with owners of projects due to freezing of designs and any changes required at a later stage. This often leads to cost-overruns and delays; an issue prevalent in projects awarded by the likes of ONGC or refineries.

The OBE-LSTK combination, therefore, balances the requirements of owners of the project as well as the contractor. Such a strategy has helped the company deal with high-end projects without major disputes.

Engineers India has re-entered the fertiliser space, bagging a brown-field project and has also plans to tap in to opportunities in the nuclear and gas distribution space. With sufficient accruals and debt-free status, an approach of taking strategic stakes in the above businesses may help the company

Our Recommendation :

The scrip has 52 week high / low of 372 and 258 giving enough opportunities both for long term investors and traders. Buy on dips for a intermediate target of 325


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Ingenious Investor

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