>EMCO Ltd. (KR Choksey)

Too cheap to avoid

EMCO is the third largest transformer manufacturing company in India. It is a leading player in the 132KV, 220KV and 400KV rating transformer market segments with an annual capacity of 20,000 MVA. It also manufactures meters and has a presence in EPC turnkey power T&D projects. Transformer segment contributes about ~65% to the revenues, while rest has been contributed from the transline towers, project business, electronic energy meter and other businesses.

Investment Rationale
Rs 550 crore order from PGCIL
Emco Ltd has received five orders worth Rs 550 crore from the state-run Power Grid Corporation of India Ltd for a 765 kilo volt overhead transmission line. The orders also involve supply of galvanised steel towers.

"Transforming" into a complete T&D EPC player
The Baroda-based Urja Engineers, a transmission-tower manufacturing company, has been merged with EMCO. Previously, it had supplied towers to EMCO for the latter's projects business. Post-expansion the merged entity would have transmission-tower manufacturing capability of 45,000 MT. Urja is qualified to bid for all State Government and PGCIL contracts. This provides EMCO with an edge in terms of providing 400kv transmission lines along with its 400kV transformer manufacturing capability. The focus is to become an end-to-end solutions provider for the EPC business.

Emco plans hybrid model for selling power
The company plans for 540 MW merchant power plant at Warora in Chandrapur district (near Nagpur, Maharashtra). The financial closure for the first phase of 270 MW (135MW X 2 units) of the project is about to be completed. The plant is expected to be operational by March 2010.

Q3FY09 Results
In Q3FY09, company’s witnessed drop of 14.6% & 45.7%(YoY) in net sales & PAT to Rs 207.9 crore & Rs 8.2 crore.

Valuations
In last one year, we have witnessed re-rating of transformers industry on anticipation of surplus capacity & slowdown in economy. Earlier the industry, which used to trade in range of ~12x to 14x is currently trading in range of 3x to 4x (in other words stocks are available at ~70% discount).

We believe on back of EMCO’s diversified business model, high concentration of Government orders, foray in to power generation & coal mining, and the stock looks attractive at current levels. Further, with the kind of order it received from PGCIL, it seems strong demand still exist in the transformer industry. At CMP of Rs 47.7, the stock is trading at 4.8x on TTM earning of Rs 9.96 and 5.3x FY10E earning of Rs 8.9. We maintain our BUY rating on the stock with target price of Rs 55.

Key Developments
JV with Edison Group
EMCO has formed a JV with Edison Group through its wholly owned subsidiary, Emco Overseas Pte Ltd., Singapore by way of 51% participation in the equity of Emco Edison Transformer (Pty) Ltd incorporated in South Africa. This company will manufacture and market Transformers to cater to South Africa and neighboring countries.

The company plans 2,000 MVA transformer capacity at its new facility in South Africa. Initially, the company would be focusing on 20MVA/33KV class transformers and planning to source higher rating (220KV and 400KV) transformers from its Indian facilities. This would facilitate the company to meet its aim of enhancing export business from ~16% to ~30% in coming time. EMCO expects to begin the commercial production of transformers by Q1FY10E. It has planned a capex of ~USD 10 mn (~Rs 45 crore) for its South African venture.

Stake in Coal Mine
EMCO bought 37.35% stake in Singapore-based Rabaan Pte Ltd for ~$18 million (~Rs 76 crore) through its overseas subsidiary Emco Overseas Pte Ltd. The move is to get into coal trading as the demand for coal is quite high. The Singapore based company has a long-term exclusive coal offtake contract with Bina Insan Sukses Mandiri, an Indonesian mining company, which has estimated coal reserves of ~105m tons, 95% of which is extractable. The Indonesian coal mine is in the Kalimantan region with ~5500 kcal/kg calorific value.

Competition can be managed
EMCO management strongly believes that despite rising competition in the business, the company will retain its competitive edge due to prequalification norms for SEB orders and proven quality vis-à-vis newer entrants.

Strong order book position
At end of Q3FY09, Emco order book stands at ~Rs 1300 crore (increased 5.5% YoY). The transformer orders constitute ~56% of the order book (10% export orders), projects contributed ~42%, while the balance 2% being meter orders. Further, order inflow during Q3FY09 fell by 56% (YoY) to Rs 208 crore mainly due to higher base affect.

To see full report: EMCO Ltd.