The Hindu Business Line : Kovilpatti Lakshmi Roller Flour Mills: Invest

The income from the foundry business is likely to contribute effectively from FY-08 only; investors may need to consider a long-term investment horizon.

Offer priced at a discount to the market
Eltex to contribute to earnings over the long term
Wheat and textile division contribution likely

Mr Suresh Jagannathan, Managing Director, Kovilpatti Lakshmi Roller Flour Mills Ltd. - Paul Noronh

Investors can consider investing in the seasoned offer of Kovilpatti Lakshmi Roller Flour Mills (KLRF), a diversified player in wheat flour mills, cotton yarn and sheet metal fabrication business. Our recommendation is underscored by the company's decision to expand its activity in metal sheet operations with the acquisition of a controlling stake in Eltex Super Castings of Coimbatore, combined with an already-established market for its flour and cotton products.

The engineering sector boom is an added fillip to the growth prospects of the company's business. Its expansion in this space involves the risk of entering a new area (foundry) and losing focus on its present core businesses. However, if the company is successful , it should enjoy a better valuation.

At an offer price of Rs 55, the price-earnings multiple works out to eight times the trailing 12-month earnings on an expanded equity base. The offer is at a discount of 32 per cent to the current market price.

Business overview

KLRF markets its wheat and cotton products under the trademark of `Kuthuvillaku,' an established brand in southern Tamil Nadu and Kerala. It also enjoys a well-knit network of dealers for its wheat division, while the cotton yarn produced is sold through both company-owned depots and dealers. Both wheat and cotton contribute equally to its revenue. Given that the scope for growth in these two segments is limited due to market size and increased competition from local and national players, the company's decision to venture into engineering through a controlling stake is likely to open up a new revenue. This could offset a slowdown in its wheat or cotton business.

KLRF's sheet metal fabrication facility at Coimbatore caters to the needs of original equipment manufacturers (OEMs) such as LMW and Elgi, but the operations are on a small scale and are not on the scale of its food and textile division. A major part of the proceeds from the issue will beinvested in Eltex for the revival of its foundry operations.

Before being declared sick, Eltex Super Castings manufactured grey iron, Spheroidal Graphite (SG) iron and alloy iron castings. It became non-operational in June 2002 due to labour problems and lack of working capital. As the unit is already equipped with good infrastructure and manufacturing facilities, KRLF plans to begin commercial production in Eltex by January 2007. KRLF has also begun talks with clients of Eltex (L&T, Audco India, BHEL, BEML and TVS group, among others) to revive its business. The turnaround through fresh capital infusion, if successful, will expand KLRF's earnings; this is likely, however, to accrue over the long term.

KRLF's operating margin levels in FY-06 rose on investments to improve infrastructure for storage and handling of wheat, and augmented spinning productivity. It has an installed capacity of 6.25 MW of power generation through windmills for captive consumption, which contributes to about 70 per cent of the power cost and is a positive. KRLF plans to increase the windmill capacity as it envisages a higher demand for power from its engineering division. This is likely to lead to lower power cost and hence better margins, apart from tax savings.

However, since the company's core business is commodity driven, any unfavourable event in the segment can significantly affect margins. Hardening of wheat prices owing to global shortage is a matter of concern. Further, the near-term earnings may not be commensurate with the proposed doubling of equity, and may well lead to muted growth in the bottom line in the short term. Moreover, KLRF is a small-cap stock and can pose liquidity constraints.

Offer details: The offer is open from November 27 to December 1. KLRF is offering 26-lakh shares (face value of Rs 10) and seeks to raise Rs 14.3 crore through this offer. Keynote Corporate Services is the lead manager to the issue.

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