Reasonable valuation makes TD Power's public offer a case for investment

Investors with a three-year perspective can consider allocating a small sum to the initial public offering of generator maker TD Power Systems. Besides manufacture of alternating current (AC) generators, the company also has a growing presence in the Engineering Procurement and Construction (EPC) segment. This has helped integrate operations, thus generating superior profit margins. The issue closes on Friday.

A sound balance sheet with low debt, positive operating cash flows in the last three years, stable operating profit margins and superior return on equity are all positive factors given the market's current aversion for leverage and poor cash flow generation.

The offer price of Rs 256-261 discounts its expected consolidated per share earnings for FY-13 by 9.8 times; sufficiently lower than large players such as BHEL. While the offer appears reasonably priced, investors may have to tone down expectations of listing gains. Any downside in the short-term cannot be ruled out given the stock's small cap status.

Background and offer

TD Power Systems has three operational segments. One, it manufactures AC generators of up to 52 MW, mainly steam generators used by captive power plants of sugar, cement and steel. It makes generators used in wind, geo thermal, hydro and solar thermal applications. Two, it executes thermal turbine generator projects, where it source turbines and uses its own generators. Three, it executes EPC contracts for boiler–turbine-generators (BTG) with capacity of 52-150 MW, sourced from original equipment manufacturers. This segment is housed in a subsidiary.

The offer seeks to raise Rs 227 crore to expand capacities in Karnataka besides repaying debt. The offer would expand equity by 35 per cent. At the offer price, the company's market cap on listing would be Rs 850-860 crore.

Right place right time

TD Power Systems stands out in the power-related product and engineering space for few reasons. One, at a time when most players have been busy supplying equipment to large independent power utilities, TD Power Systems has stuck to its focus area of captive power plants. Though a serious competitor, BHEL, for instance, has little focus on the smaller capacities given its increasing focus on mega power projects. Two, import data on generators suggest that overseas presence is limited as low value orders may not make up for margins, given the import costs involved. Three, unorganised players in the space focus more on portable genset market. Four, the company is largely immune to issues faced by power equipment makers and power developers on account of delays in clearances or environmental issues.

These factors have evidently helped the company in its sales of AC generators; volumes growing at 14 per cent per annum over the last three years, including years of downturn.

TD Power Systems has kept pace with technological changes through well-timed collaborations. The company now owns technology for manufacture of AC generators that it had initially licensed from a Japanese electric maker. Besides similar licensing agreements it also has tie-ups to be a contract manufacturer/supplier for major global players such as Toshiba Mitsubishi Electrical and Siemens for motors/generators. We believe these licensing agreements not only secure technology but also provide some stable business from the technology partner. EBITDA margin at close to 12 per cent has not only been stable but also above industry average.

TD Power Systems has been growing its EPC business rapidly with the segment now contributing well over 40 per cent to sales. While this segment has so far completed 2 large contracts, it accounts for close to 50 per cent of order book. This together with the project business can be expected to drives top line in the next couple of years, given its part-backward integration.

The company's order book of Rs 1,094 crore, at 1.2 times sales is healthy, as its execution cycle for manufactured products is 3-6 months.

TD Systems expanded sales at 32 per cent compounded annually over the last two years to Rs 863 crore, while net profits expanded 22 per cent; the newly added EPC subsidiary drove top line more than it did profits. TD Power Systems enjoyed a high 33 per cent return on equity as of March 2011. The current infusion could lower returns in the medium term. The company's debt equity would reduce to about 0.2 times post offer.

Enam Securities is among the book running lead managers.