Edelweiss Research has recently initiated coverage on Indian engineering company Kirloskar Brothers with a target price of Rs 300, implying over 18% upside to its Friday’s close of Rs 253.65. The research firm cited increasing contribution of high margin products business to the company’s earnings, and growth in international business from thrust on infrastructure development, among the factors driving attractiveness for Kirloskar Brothers.
Kirloskar Brothers is the largest pump manufacturer in India, with around 14% market share. Under its ‘products’ vertical, Kirloskar Brothers makes small pumps used in irrigation and housing, and manufactures large pumps used in industry, infrastructure, power stations and oil fields. Under its ‘projects’ vertical, the company undertakes EPC (engineering, procurement and construction) orders for building large pump stations. The company undertakes higher margin large package pump orders for industries.
“Over the last seven years, the company has shifted focus from the loss-making projects business to high-margin product business,” Salil Utagi, Research Analyst, Edelweiss Research, said in a video note to clients. “The products business inherently boasts of strong R&D capabilities, higher investment in capacities, large distribution network and high market share,” Utagi added.
Edelweiss expects the product business contribution to the company’s earnings to reach 78% in the next financial year 2018-19. “Even under the projects vertical, the order backlog of Rs 1,100 crore has less civil content, and high package product content,” Utagi said, adding that the package product content will boost the gross margin for the standalone business.
Utagi said that internationally, the company has diversified across products and geographies, to minimise its risk associated with single product, ie, offshore oil pumps. “However, as the oil prices settle over $55 per barrel, we expect high margins spares and services business come back to the company over the next two years,” he said.
Kirloskar Brothers is also expected to benefit from thrust on infrastructure in the US and South East Asia. “In our view, with recovery in growth, the operating leverage is expected to take the operating margin of the international business back to 8% level in FY19,” Utagi said.
Edelweiss expects the company to report net profit of Rs 160 crore in FY19 on a consolidated basis, against a loss of Rs 33 crore in FY16. “Non-recurrence of one-time expenses is expected to substantially improve the profitability of the business,” Utagi said.
Currently, Kirloskar Brothers is trading at a significant discount to its peers in the engineering industry, specially pumps and oil engine manufacturers. Edelweiss target price of Rs 300 values the stock at 15 times price-to-earning multiple on FY19 basis.