Report Date

October 23, 2008

Company Name

Kirloskar Brothers Limited (KBL)

Recommendation

BUY

CMP – Rs. 84/-

Target Price – Rs. 118/-

Mkt. Cap. - Rs. 888.4 crore

Investment Rationale

Ø      KBL, market leader in pumps & valves, reported not so encouraging performance for Q2 FY 09. Net Sales grew @ 32.2% to Rs. 420.4 crore. However, OPM% dropped to 5% because of sharp rise in raw material cost to 76.1% (74.5%) of sales and other expenditures to 13.1% of sales (11.8%). Further impacted by substantially higher finance cost of Rs. 6.29 crore, PBT declined by 18.4% to Rs. 28.24 crore and PAT by 13.2% to Rs. 23.42 crore. 

Ø      For H1 FY 2009, company’s performance was dismal. Sales rose by 24.8% to Rs. 790.78 crore. However, OPM% plunged to 2.8% (9.2%) owing to shooting up of raw material cost to 78.6% (70.7%) of sales. This is because company could not pass on all the input cost hikes (which rose sharply in relatively shorter time of a few months) in fixed price contracts (had aggressively gone for these), where besides longer gestation period for execution, time of 8-9 months elapses between submitting tender and final receipt of order, which made it difficult for the company to build-in suitable price escalations in tender driven business. Besides, delay in capacity expansion resulted in capacity constraints and delay in execution of projects. As many contracts could not reach prorate revenue / profit recognition norm of 35% set by the company, reported profits were lower. Delay in execution of high margin export order due to non-receipt of letter of credit also impacted profitability. Consequently, PAT dwindled to Rs. 18.94 crore, fall of 64.1%.

Ø      However, going ahead, things are set to change. Company has taken several corrective measures to see that EBIDTA margin springs back to normal level of low double-digit in the shortest possible time:

1. Become more selective in taking new orders and all contracts to have price variation clause.

2. Increased prices of products in April and July 2008.

3. Expedited expansion projects to reduce execution time by 1/3^rd .

4. Revamped organization structure changing all SBUs tuned to user segments and each plant being made a profit centre.

5. Has also started negotiating with customers to pass on some cost increases in balance 40% fixed price contracts and hopes to get some success.

Ø      KBL is set to become a proxy of agrarian & water resources revolution underway in India. Company has a wide range of pumps from 0.1 KW to 16,000 KW to cater to diversified market segments including irrigation, power, water distribution & management, industry, building & construction, oil & gas, marine & defence, etc., all of which need to move water and other fluids where pumps & valves are required; and all these user segments offer high growth potential. KBL is moving from product to project to total solution and from local to global in water management business.

Ø      KBL has global footprint in the business of fire fighting pumping system thru its 100% subsidiary SPP Pump -UK, also undertakes EPC contracts for water treatment & sewerage systems / water management thru its other subsidiaries, JVs and associate companies like Ebara, Corrocoat, Gondwana Engineers, Aban Constructions, etc.

Ø      Barring temporary hiccups, company is on very strong wicket catering to growing market of water pumps and number of projects are underway in areas of irrigation, water & sewage management, industries, oil & gas, power plants, etc., all of which provide exciting growth prospects to the company.

Ø      Its vision to expand operations globally and focus on providing total solutions in water management & water sewerage systems, are providing exciting opportunities to KBL like Africa Irrigation Project, on which African government is planning to spend US $ 5.5 billion over next 5 years and KBL is the first company there doing water management projects; getting into big-league international EPC contractors and power equipment suppliers like Alstom, Bechtel, Doosan, etc. for supplying cooling water pumping systems, etc.

Ø      Company had very healthy order book on June 30, 2008 of Rs 4,138 crore (fixed price contracts almost 40%), providing good visibility for the next few years.

Ø      It has set an ambitious target of growth of > 25% CAGR for next 3 years to become US $ 1 billion company by FY 2011 and want to be among global top 5 companies by 2015.

Valuation

Ø      At CMP, share (Rs.2 /- paid up) is trading at 7. 9 times estimated consolidated FY 09 EPS of Rs 10.6 and at 4.9 times estimated consolidated FY 10 EPS of Rs 17. 3. With softening of commodities prices (which will substantially reduce risk of lower profitability on balance 40% un-executed orders) and exciting business opportunities, company’s bottom line is likely to grow @ CAGR of ~ 24% and at CMP, KBL is attractive BUY

FY 2009

FY 2008

%

FY 2009

FY 2008

%

FY 2008

Q2

change

H1

change

12 mths

Net Sales

420.43

318.12

32.2%

790.78

633.64

24.8%

1,525.15

Other Operating Income

2.38

7.88

-69.8%

2.96

10.68

-72.3%

14.08

Total Expenses

399.33

295.53

35.1%

768.70

575.12

33.7%

1,382.96

Operating Profit

23.48

30.48

-22.9%

25.04

69.21

-63.8%

156.26

EBITDA (%)

5.02%

7.10%

2.79%

9.24%

9.32%

Interest Expenses / (Income)

6.29

3.65

72.2%

10.53

6.78

55.4%

16.89

Depreciation

5.18

4.29

20.8%

9.83

8.34

17.9%

18.21

Other Income

16.23

12.08

34.4%

19.46

15.18

28.2%

28.87

P.B.T.

28.24

34.61

-18.4%

24.14

69.28

-65.2%

150.04

Net Profit

23.42

27.00

-13.2%

18.94

52.71

-64.1%

110.14

Equity Capital (Rs 2/-)

21.15

21.15

21.15

21.15

21.15

EPS for the period (Rs)

11.07

12.76

-13.2%

8.95

24.92

-64.1%

52.07