The Hindu Business Line : Shanthi Gears: Invest

An upsurge in the industrial capex across its user segments such as steel, earth-moving equipment, thermal stations, paper, aviation and cement, should scale up the revenues of Shanthi Gears, which makes gearboxes, gear wheels and gear motors used in various industrial applications.

This, combined with the company's ability to deliver high quality products, is likely to help it sustain the earnings growth.

Shanthi Gear's ability to capitalise on the strong demand for gears has made it the market leader, helping it command a premium for its products in the domestic market. It has a wide product portfolio consisting of both standard and custom-made gears.

The revenue contribution from such custom-made products has risen to about 55 per cent.

Given that the capex across various industrial segments is on the rise, the demand for such custom-made products is set to increase. Moreover, since the margins from these products are higher, it adds further visibility to its earnings growth.

At current price levels, the stock trades at a price-earnings multiple of 14 times its likely per-share earnings for 2007-08 on a conservative basis.

Strategy

The company's strategy to regularly invest in capacity and technological upgradation has helped it increase its production in line with demand.

To gain better control over its production, Shanthi Gears has also set up its own foundry and forging plant.

It has partnered with the likes of Atlas Copco and GE Electric for outsourcing orders to establish a strong foothold in the export market.

Additionally, it is in talks with other overseas OEMs to set up similar businesses.

These orders enjoy better margins. Since the company caters to the needs of various industries, none of the user industries enjoys a dominant position in its portfolio, which is a positive as a diversified user base mitigates business risks.

For the half-year ended September 2006, the company's net sales rose 26 per cent.

The company is expanding its presence in the international market. This is reflected in the export contribution, which has risen to about 7.5 per cent of the total turnover.

Owing to shorter delivery schedule of the orders, not extending beyond four months, the company is better positioned to factor in the volatility in material price.

This would help it contain the effect of a huge swing, if any, in the material cost.

Also, pruning of staff and other expenses have helped it improve its operating profit margin. New production lines, have however, increased the depreciation cost.

As Shanthi Gears' business depends directly on the industrial activity, it tends to be cyclical. Furthermore, being a small cap, the stock is subject to more volatility.

Any slow down in the growth of the economy, rise in steel prices and the failure to pass on the input cost hikes fully to customers would pose a downside risk to our recommendation.

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