The Hindu Business Line : Greaves Cotton: Buy

Restructuring process close to completion.
Reduction in financial risk
A sharply focussed business profile
Broader range of products
Set to benefit from infrastructure/rural thrust.

There has been a transformation in the profile and fundamentals of the company over the past three years. It has left behind difficult years and is now poised for steady growth.

The Greaves Cotton stock can deliver above-market returns over a one/two-year period. At Rs 384, the stock trades at 22 times its expected FY-06 per share earnings. The three-year-long restructuring is almost coming to an end.

The benefits may be reflected over the next year or so in terms of expanded margin, reduced debt and interest cost, and improved return on equity.

The focus on two-core business segments — engines and infrastructure equipment, both growing at a scorching pace — could keep up the earnings growth momentum.

Focus on core businesses

Greaves has hived of all its non-core businesses and now concentrates only on two key segments — engines and infrastructure equipment. Both businesses have recorded solid growth in FY-06 so far and margins have improved too.

In the engines segment, Greaves makes engines for agricultural, automotive and industrial applications. Of late, the offtake of engines in the 25kVA- 500kVA range, which find applications for industrial purposes and automobiles, have been rising sharply. In the automobile segment, Greaves caters mainly to the two- and three-wheeler segments, both of which have recorded 25-30 per cent growth.

The prospects appear bright, given the capacity expansion plans of two- and three-wheeler makers such as Bajaj Auto and Piaggio.

Greaves is the market leader in light diesel engines, predominantly used in three-wheelers and is the sole supplier to Piaggio.

It recently increased its capacity for this product from 1.5-lakh to 2.5-lakh units. With Piaggio planning to make India a manufacturing hub, Greaves can look forward to good pick-up in volumes.

The bright demand outlook for both construction machinery and automobiles — the primary end-user segments for middle-range engines — increases the revenue visibility over the medium term.

The lower range engines may be in for better times as the Government's rural thrust may lead to a pick up in rural demand over a year.

Despite lower margins and tough competition, this segment may maintain volume growth.

In the infrastructure segment, despite the sale of drilling equipment business, the company has recoded an 8 per cent growth in revenues and a 300 basis point increase in margins. This reflects the strong demand for the construction equipment business. Greaves has expanded its product range and now has a complete portfolio for concrete mixing and road-making equipment. It has tied-up with international players such as Bomag of Germany and CIFA of Italy for new products. With a broader portfolio, Greaves could garner a better share of the market.

Restructuring benefits

The restructuring is almost complete and the benefits may continue to flow in for one more year. The company has reduced the cost of borrowing from 12 per cent to 8 per cent. Funds from the sale of its stake in Greaves Morganite Cubicle and the transfer of transmission business could be used to reduce debt further.

A number of cost-cutting initiatives are under implementation.

Further, the channelling of resources into two core product segments and the reduction in interest costs could improve margins. The total debt may decline to less than 50 per cent of the shareholder funds and interest costs less than 5 per cent of the operating profit in FY-06, lending comfort to shareholders.

With the return on equity touching the 40 per cent mark and expected to improve in the next couple of years, the stock appears attractively valued at the current levels.

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