The Hindu Business Line : Lakshmi Machine Works: Buy

A long-term investment with a two/three-year perspective can be considered in the stock of Lakshmi Machine Works (LMW), the largest maker of spinning machinery in India. An established presence in the market with a strong revenue growth visibility, a hefty order book, and the company's thrust on technological upgradation underscore our recommendation.

At the current market price, the stock trades at about 16 times its FY-08 per share earnings. Market corrections, if any, may also be used as good entry opportunity.

Investment Argument

The company operates in three business segments — textile spinning machinery, CNC (Computer Numerical Control) machine tools, and high precision machine castings (foundry). The textile machine division, which caters to about 60 per cent of the domestic market, provides cost competitive solutions to the spinning industry. The division operates with an 80 per cent capacity utilisation, contributing nearly 91 per cent of revenues. With the upgradation of its existing plants, installation of high-tech mother machines and the merger with erstwhile Jeestex Engineering (JEL), the installed capacity is set to increase from 1.8 million spindles to 2.7 million by the end of March 2007. This would, however, contribute to the earnings from FY-08 only.

The machine tools and foundry division, though not as significant as its textile division, contributed to about 10 per cent of the total sales during the first half of FY-07. Despite the pricing pressure that the CNC machine tools division faces from its competitors, we believe the company's plan to roll out customised products in this segment would pay-off in the future, given the growth in user industries driven by by the manufacturing boom. The foundry division, apart from meeting most of its captive-consumption demands, supplies international companies, such as General Electric, Siemens and Armstrong, with critical castings.

LMW's order-book, which is around Rs 4,500 crore, has recorded a growth of over 65 per cent over the past year.

Despite the higher waiting period for delivery of textile machinery of 22-26 months, demand continues to outstrip supply. This is reflected by LMW's healthy growth in the order book. Moreover, it faces no significant threat from its competitors and given that most of the parts and processes in the industry are patented, the possibility of a new entrant is remote. This again provides further revenue visibility to the company. Further, we have not taken into account the savings due to lower sales tax on VAT implementation in Tamil Nadu from January 1, 2007.

Strategies

LMW charges its clients a 10 per cent advance against booking, irrespective of the order size. Its zero-debt position plus these cash advances have ensured a comfortable cash flow position for the company.

This apart, its thrust on both R&D and plant modernisation has helped de-bottleneck manufacturing capabilities and hence improve overall productivity. During the current fiscal, about 2 per cent of the net turnover was earmarked for R&D expenditure. The introduction of assembly line manufacturing has also augured well for the company.

For the quarter ended September, revenues increased by 43.5 per cent on a year-on-year basis.

The operating profit margins increased by about 350 basis points, largely driven by volume growth in the textile division. The company's efforts to continuously upgrade its technology have also helped it contain cost.

Concerns

Since the nature of its business is cyclical, any recession in the textile sector would affect LMW's business. Moreover, the stretched delivery period can also prompt the mill owners to import second-hand machines (not cost-effective now), leading to a loss in LMW's market share.

In addition to this, the relatively lower liquidity of the stock is likely to be a cause for concern during exit.

Slowdown in capex plans of textile companies, rise in raw material cost and increase in competition from international suppliers of textile machines could also pose a downside risk to our recommendation.

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