At Rs 81 a share, Tube Investments will pay 23.5 times the per share earnings of Shanthi Gears for FY-12. This is at a good premium to the 18.3 times that the stock trades at in the market (based on trailing 12-month earnings).

While these numbers may suggest that Tube Investments is paying a stiff price for the deal, the buyout may not necessarily be expensive if a few financial and business factors are considered. For one, Shanthi Gears enjoys high operating profit margins of 25 per cent. This is almost twice that of comparable players like Elecon Engineering.

Owning an in-house foundry is one key reason for the company’s superior profit margins. The foundry has also helped the company retain better control over the quality of its products. A higher proportion of customised gears in its offering also aid Shanthi Gears’ profitability.

Two, at a time when most capital goods players are reeling under high debt, Shanthi Gears has nil debt.

Three, in an effort to reduce low-end standardised products, the company has declined orders with poor margins since FY-10. This in fact has led to under-utilisation of capacities and moderate revenue growth. But this also means that the current sales or earnings may not reflect its full production potential. Sales of Rs 173 crore for FY-12 was only two-thirds of the FY-08 revenue.

Four, the company had plans to manufacture products where gears play a predominant role. This included products like compressors or mining equipment. If Tube Investments takes these initiatives forward, this provides scope for higher margins besides commanding superior valuations in the market.

(This article was published on July 13, 2012)
XThese are links to The Hindu Business Line suggested by Outbrain, which may or may not be relevant to the other content on this page. You can read Outbrain's privacy and cookie policy here.