The Hindu Business Line : KLG Systel: Pare exposures

SHAREHOLDERS may consider cutting their exposures in the KLG Systel stock, which has more than doubled in the past two months. Nearly 50 per cent of the sharp rise in the stock price has been in the last fortnight. The stock trades at a price-earnings multiple of 15 times the annualised per share earnings of 2004-05.

Since Corporate India is in an investment mode, KLG Systel, as one of the players focussed on power, steel and FMCG sectors, may turn out to be one of the indirect beneficiaries of order flows for software engineering and development. That, however, will hinge on the sustained pace of order flows and operating margins from domestic business.

Given its relatively small revenue base, past earnings performance and the competitive domestic market, fluctuations in revenue and earnings growth remain a downside risk.

Earnings trend

A review of the earnings performance of KLG Systel in the latest quarter and half year ended September 30, 2004 compared with the four previous quarters throws up a few key elements:

The revenues in the first half of 2004-05 were similar to the same period last year at Rs 16.14 crore and Rs 14.27 crore respectively. Clearly, the sharp jump in revenues of Rs 23.7 crore was recorded in the second half of 2003-04.

The operating profit margins have exhibited a fluctuating trend over this period. The margins, which had touched nearly 17 per cent in the fourth quarter of 2003-04, dipped by over four percentage points to 12.6 per cent in the first quarter of 2004-05. In the latest quarter, it improved to 14.5 per cent. This was aided to a large extent by lower staff costs and stable cost of sales in percentage terms.

Despite a sharp rise in revenues in the second half of 2003-04, the post-tax earnings were evenly spread between the first and second half of the year. In the latest half year, the company recorded post-tax earnings of Rs 1.16 crore.

On a sequential basis (quarter-on-quarter), this improved to Rs 0.69 crore from Rs 0.47 crore in the previous quarter, partly on account of lower tax provision. Based on the latest quarter's performance, the per share earnings works out to Rs 1.80.

Business segments

KLG Systel operates across two segments — Plant Enterprise Applications and Enterprise Integrated Applications.

In the half-year ended September 30, 2004, the Plant Enterprise Applications segment accounted for over 80 per cent of the revenues of Rs 16.14 crore.

The segment caters primarily to CAD/CAE (Computer Aided Design and Engineering), project management, power systems solutions and automation and manufacturing execution systems.

In the domestic market, this segment has a strong presence, having serviced the software engineering and application requirement of companies in the power, steel and FMCG sectors, both in the public and private sectors.

Some of its clientele in the past have been ABB, BHEL, Engineers India, Punj Lloyd, Tata Steel, among others.

By their very nature, these projects tend to be lumpy and, therefore, the revenue flows can fluctuate on a quarterly basis.

Second, since some of these contracts may be slices of systems integration contracts bagged by bigger players, the margins on these may also remain volatile.

Finally, the company is now positioned to bag only small contracts executable over a short time-frame. The combination of small contract sizes and short timespan for execution calls for greater efforts on the part of the company to keep the revenue flows on a predictable basis. Also, considering the company's revenue base, its ability to scale-up and undertake large sized contracts remains untested.

Apart from this, KLG Systel also operates a training segment, with specially designed training courses in project management related areas. It has entered into partnerships with global players in the project management field.

The other segment — Enterprise Integration Applications — accounts for the remaining 20 per cent of revenues.

Since practically all mid-sized players are focussed on this segment, scaling-up revenues will remain a difficult proposition.

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