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Sowmya Sundar

INVESTORS with a medium-term perspective can consider exposures in Kirloskar Oil Engines (KOEL). At Rs 238, the stock trades at seven times its March 2004 sustainable per share earnings.

The three-fold strategy of widening the product portfolio, targeting overseas markets and expanding the services business appear to have paid off.

Wider product portfolio

KOEL has expanded its product portfolio not only in the bread-and-butter engines business but also in such areas as valves and bearings for the automotive segment.

Targeting the overseas market and services business provide the right trigger.

Engines: In the engines segment, KOEL has widened its portfolio in the large engine segment and targeted more OEMs in the mid-range segment. Its dependence on the small engines (below 20 hp) has declined though this segment still contributes 28 per cent of its turnover. This range of engines finds applications in agricultural equipments. This segment is extremely competitive and price-sensitive and, hence, margins are lower. The market for small engines is on a decline. However, KOEL is targeting the genset market in the semi-urban and rural areas, which received good response.

The move towards high power engines provided new markets and also higher margins. As of 2004, KOEL derived 59 per cent of its revenues from the mid-segment. The engines in this segment find applications in construction machinery, tractors and in Defence applications. In the tractor segment, Punjab Tractors is its main customer. The volume growth in the segments that KOEL has a presence appears positive.

The large engine segment primarily caters to the Navy. The business depends on orders from the Navy and is volatile. Orders were good in 2004 and the segment saw 88 per cent growth. This is, however, not sustainable. The segment contributes 13 per cent of the turnover.

Other businesses: KOEL also has a presence in the automotive segment.

Last year, the company started supplying to new OEMs. The automotive segment contributes 10 per cent of the turnover.

Exports: A starter

Exports recently started picking up momentum. KOEL has been exploring new areas and markets. Exports still constitute only 6 per cent of the turnover. KOEL exports both engines and bearings. Orders from new OEMs and the introduction of new products such as gensets for the overseas markets could drive growth. Establishing a services network overseas would further enhance prospects for growth.

In the bearings segment, the company has established tie-ups with eight new customers and has increased its supplies to OEMs. The prospects on the export front appear bright.

Services

Services is a lucrative business and provides steady growth. In 2003-04, services constituted close to one-fifth of the revenues from the engines segment and close to 13 per cent of the total revenues. The margins are better and also provide steady business.

Performance

KOEL's financial performance has been impressive over the past three years. The company used improved cash flows to retire long-term debt and reduce interest costs. Consistent cost-pruning and the shift from small engines to mid- and large-range engines have also improved margins.

Operating margins rose two percentage points to 9.5 per cent in 2003- 04. Given that a 10-12 per cent earnings growth over the next couple of years is likely, valuations appear attractive at the current levels.

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