>GUJARAT APOLLO LIMITED (GAL)

■ Gujarat Apollo has been observing sluggish demand across Mobile Equipment Group (MEG) divisions. Public spending in new road construction and maintenance has slowed down due to 1) increase in interest rates 2) issues related to land acquisition and environmental clearances continues to affect execution 3) elections in five states including Uttar Pradesh led to a halt in government spending in respective areas.


■ Margins are expected to remain subdued in short and medium term for the company on account of higher input prices. Company has taken few price hikes in the past to partly pass on the raw material pressure to its customers.


■ Unlike TIL (that operates in North and East India), GAL has not been observing significant increase in receivables. Company continues to enjoy strong balance sheet at the end of 9MFY12. We highlight that company's stock has outperformed the BSE MIDCAP index in past one year. 


■ We believe that the company is well positioned to benefit from the likely recovery in road construction and maintenance activity in India over FY13. We maintain our 'BUY' recommendation with a one year DCF based unchanged price target of Rs 170.



Company Highlights
We recently interacted with the management of GAL to get perspective on the overall business environment unfolding mainly in the domestic markets. Below are the key highlights of our interaction.


■ Company has been experiencing moderate pick up in the Industrial Product Group (IPG) segment which includes Asphalt Batch-mix plants, Asphalt Drum-mix plant and Crushing and Screening plants. However, the pickup in demand in still significantly lower than expected.


■ Order flows from NHAI have expedited in 9MFY12 and we believe that this is likely to benefit the company and its peer group (TIL, Greaves Cotton) with a lag of 2-3 quarters.


■ Concerns regarding muted public spending on road construction and maintenance continue to exist. Road sector has been observing sluggish growth due to 1) YoY increase in interest rates 2) issues related to land acquisition and environmental clearances continues to interrupt execution 3) elections in five states including Uttar Pradesh led to a temporary halt in government spending in respective areas.


■ Company has been observing slowdown primarily in the MEG segment. Demand for Asphalt Paver and Hydraulic paver has significantly declined vis-à-vis last year.


■  In 9MFY12, GAL has reported muted YoY revenue growth in IPG segment to Rs.1.2 bn. However, revenues in MEG segment at Rs 409 mn were significantly lower vis-à-vis last year at Rs 542 mn. We highlight that in last quarter, MEG segment was negatively impacted by inability of BSII and BSIII compliant engines for Hydraulic Pavers. This has led to the production halt of over one month in the quarter.



■ Managements expects operating margins to remain under pressure over the next few quarters due to 1) volatility in raw material prices and 2) inability of the company to take price hike effectively (it has taken marginal hike in Q1FY12) across key product categories.
n IPG segment reported EBITDA margins at 12.2% for 9MFY12 vis-à-vis 16.7% in 9MFY11. For MEG segment operating margins stood at 11.7% which is far lower than the historical average of over 20%.


■ Management has stated that it is difficult to take price hike in the current situation where its key customers are facing headwinds from increasing interest rates and sluggish public spending. However company has taken moderate price hikes in certain product categories earlier.


■ Company has been experiencing a slight pickup in the business after sluggish 1HFY12. However, the pickup in demand in still significantly lower than expected. 


■ Our interaction with the other industry players highlights that the major part of the new demand is driven by the small and medium size road contractors. Demand from larger players like IRB, IVRCL etc. has been broadly stagnant.


■ Interest charges have gone up significantly over 9MFY12 at Rs 33 mn vis-à-vis Rs 18 mn for the company due to increase in working capital requirement. However company has effectively managed its debtors and inventories at close to 45 days and 50 days respectively.


■ We highlight that road contractors have been experiencing significant amount of delays in payment from various government bodies. Therefore construction equipment companies have been observing substantial increase in debtor days leading to an increase in working capital requirement. TIL, which operates mainly in North and East India in the same space has reported debtors at 70 days in 9MFY12 vis-à-vis 52 days last year.


■ Management expects to maintain its leadership position in key product categories. Company enjoys nearly 30-35% market share in key product categories with over 50% market share in Asphalt pavers.


■ Going ahead, company's revenue mix is expected to remain more or less same with 35% contribution from BMP (Batch mix plants) and 30% from Pavers (both Hydraulic and Mechanical). Company has been observing a slight pick-up in demand for Drum mix plants.



Financial Outlook
■ In 9MFY11 NHAI has awarded approximately 4382 Kms of new road orders visà- vis 5000 kms in FY11. We believe that this augers well for the company and peer group viz. TIL, Greaves Cotton etc.
■ We believe that execution of these orders remains the key challenge for the industry as bottlenecks exists w.r.t. land acquisition and environment clearances.
■ We believe that company is likely to report meaningful growth in FY13E on back of 1) investments from NHAI in new road projects and 2) lower base of FY12. We project 15% revenue growth in FY13E at Rs. 2.7 bn.
■ We opine that the company would continue to prudently manage its overhead expenses and mitigate the impact of increasing commodity prices to some extent. We build an EBITDA margin of 16.2% for FY13 in our forecasts.


Valuation and recommendations
■ At current price of Rs.136, stock is trading at 9.5x P/E and 5.3x EV/EBITDA on FY13E respectively.
■ We maintain BUY rating and a DCF based unchanged target price of Rs.170, over a 12-month horizon.

RISH TRADER