Prime Broking : Buy Indo Tech Transformers Limited

(BSE: 532717 | NSE: INDOTECH | ISIN: INE332H01014)

Indo Tech currently manufactures power and distribution transformers upto 100 MVA/220 KV, which are customer & Industry specific . The company has three manufacturing facilities – two in Tamil Nadu and one at Palakkad, Kerala. The total installed capacity of Indo Tech currently stands at 3,450 Mega Volt Ampere (MVA) per annum.

The company made an Initial Public Offer in February 2006, raising Rs513 MM. The funds were primarily raised to enhance the company’s capacity. With its new plant getting commissioned in December 2007, the total capacity will go upto 7,450 MVA.

Indo Tech has witnessed very robust growth for the past 3 years as revenues grew by 34.8% CAGR and the ever improving margins magnified the PAT CAGR to 90.1%. The company enjoys one of the best margins in its sector. For Q2FY08, it recorded an EBITDA margin of 28.8%.

Investment Rationale Banking of Power complex Under the government’s initiative of "Power for all by 2012" power generation capacity is targeted to increase from 134,000 MW to 212,000 MW in the XIth five year plan. This aggregates to more than 78,000 MW power generating capacity under the XIth Five Year Plan. Each MW is estimated to witness an investment of Rs80 MM, out of which one fourth is expected to flow in for Transmission & Distribution sector. This aggregates to an investment of Rs1,560 Bn (Rs20 MM x 78,000 MW) in T&D in next 5 years. We believe this will enable organised players like Indo Tech grab a good business opportunity by servicing state electricity boards (SEBs) and other customers. We feel Indo Tech is already well placed to

benefit from the government’s "power for all by 2012" programme, as it has built a strong relationship with the various SEBs in the south over the years. The per capita consumption of electricity in India has increased from 15.6 kwh/yr in 1950 to 408 kwh/yr in 2001, which the Ministry of Power expects to increase to 932 kwh/yr by 2012. However, India is way below the world average which stands at 2,326 kwh/yr. This underlines the latent opportunity for players like Indo Tech.

Transformer sector: Opportunities aplenty Transformer is an equipment which enables to step up or down the voltage of the electricity. Electricity has to be at a high voltage in order to transmit it from one place to another. Since electricity is produced at 11KV, in order for transmission to take place, the transformers are used to step up the electricity from 11KV to 440KV. Later on, before the point of use, the electricity is again stepped down using transformers from 440 KV to 11 KV. As shown in the table below, theoretically every single Mega Watt (MW) generated should be supported with 10 MVA. However, that is not the case because there are transformers which can directly step up the voltage from 11 KV to a higher than 33 KV electric current and vice versa. In some cases the electricity need not travel far, as the power generation plants are near to the area of power utilization. Thus the entire step up and step down process need not take place. Due to such reasons, on an average 1 MW is supported by 7 MVA of transformer capacity. We expect the ratio to improve further because the new power generation plants are coming up at places which are near raw material like coal, but far away from actual user states. Thus the need of transmission at high voltage will come into play.

The Demand Potential India plans to add 78,000 MW by 2012 (134,000 MW currently). However, historically the government has not implemented more than 50% of the planned capacity.

During the XIth five year plan we expect the government to add around 60,000 MW of generation capacity, which will require around 420,000 MW of transformer capacity to service this extra production. Additional demand is expected to flow in from replacement market of transformers which were installed in 1970s & 1980s, as the usual life of a transformer is around 20 to 30 years. The replacement demand is expected to be around 15,000 MVA per annum. On conservative terms, this translates to at least 99,000 MVA transformer capacities to be added annually till 2012, which provides a huge business opportunity to organised players in the transformer manufacturing business.

Transformer players: Ready to fire In anticipation of the huge demand flowing in, the transformer companies have geared up by expanding there own capacities. As shown in the table, the total expanded transformer capacity of the sector would be 130,850 MVA by FY09-FY10. Transformer companies operate at 75% of the total capacity, which comes to around 98,138 MVA (130,850 x 75%) for the sector. As estimated above, on a conservative basis, we expect an annual demand of 99,000 MVA for transformers. Thus, we do not foresee the sector capacities remaining idle for the next 3 years atleast. This is good indication for the sector and for Indo Tech in particular, whose capacities will kick in soon by Jan’08.

Indo Tech: Well placed Indo Tech currently has an unexecuted order book of Rs2.1 Bn (1.35x FY07 revenues). We expect the order flow to remain robust, as the demand for transformers is on an upswing on the back of aggressive implementation of XIth five year plan by the government. The Indo Tech management expects the ratio between SEBs and Corporate clients to settle down at 75:25. Indo Tech has three manufacturing facilities – two of which are in Chennai and one at Pallakad , Kerala . The three plants are capable of manufacturing 500-600 transformers of assorted sizes every month. The company’s up coming plant at Tamil Nadu is an automated plant, manufacturing transformers up to 100MVA / 230KV class. Various technologies have been imported as well as developed by the company to keep abreast withthe ever-changing international scenario. With a variety of product range, Indo Tech seems to be well placed to take advantage of the opportunities to come in T&D sector.

Capacity Expansion Plans A lot of software technology parks, hotels, hospitals and high-rise buildings are coming up in the major Indian cities where there is not sufficient space for setting up substations for oil-filled transformers. A lot of these projects require dry-type transformers, which can be placed indoors as they consume less of space. The rise in real estate prices has forced corporate and real estate developers to prefer dry type transformers to oil transformers. In anticipation of the demand, Indo Tech has commissioned a dry type 100MVA transformer plant in July 2007. The company has signed a Memorandum of Understanding (MOU) with DuPont (USA) for the same. The company will also be adding 4,000 MVA production capacity by December 2007 for manufacturing transformers up to 400KV. With the new capacity on track, the companies total production capacity will increase to 7,450 MVA by Jan’08.

Improving Margins Historically, the company has commanded one of the best margins in the transformer business. In FY07, Indo Tech reported EBITDA margins at 25.1% (highest amongst the transformer sector). The EBITDA margins for Q2FY08 stood at an impressive 28.8% (improvement of 782 basis points y-o- y). The lower price of copper in the quarter and favourable product mix has led to the improvement in the margins. For the full year of FY08, we expect the operating margins to remain around 27%. The realisations for FY07 stood at Rs0.68 MM/MVA. We expect similar realisations for the full year FY08. However, with the company planning to foray in transformers with higher MVA capacities, per MVA realisation is expected to come down to Rs0.6 MM/MVA by FY10.

More than 75% of the total orders are with an escalation clause. However, any abnormal rise in prices of major raw materials like CRGO, copper and transformer oil will affect the profitability. Currently, State Electricity Boards constitutes around 85% of the total order book. Any delay of payment from them may affect Indo Tech adversely. However, the company has not experienced such delays in the past.

Indo Tech is a play on government power sector reforms, which we are bullish on. However, any reduction in planned capacity addition for XIth five year plan may adversely impact the order inflows for Indo Tech and vice versa. In Xth five year plan around 50% of the planned capacity was implemented. We expect a better ratio for XIth five year plan. Any delay in the implementation of the planned capacity may postpone the implementation of Transmission projects, hence delaying the order inflows for transformer sector. We have used valuation methods like P/E, Peer comparison and DCF to arrive at a value for Indo Tech.

It is clear from the above table that Indo Tech is currently trading at a discount to its peers on the basis of P/E, EV/EBITDA and P/BV. The discounted valuations among the transformer pack can be attributed to the fact that Indo Tech has a lower capacity as compared to others. With strong outlays planned in the power transmission space, the return ratios of the company are slated to improve and the earnings are likely to witness a 33.9% CAGR for next 3 years as per our estimates. Based on the above peer group comparison, we believe that Indo Tech should command a P/E in the range of 17x-20x FY09E earnings (as is the case with Voltamp, Emco and Bharat Bijlee currently).

On the Rolling P/E basis, the stock has witnessed a continuous re-rating from a P/E of 4x to P/E of 15x. The power equipment companies enjoy high P/E multiples, primarily due to high visibility on the back government capex in power. We see no reason why Indo Tech (a power equipment company) should trade at a discount to others when it enjoys the similar visibility. With the company well placed to take advantage of the gaining traction in the sector, we expect further re-rating in the stock. A PEG of 0.5x for Indo Tech translates to a P/E of 17x based on 33.9% earnings CAGR. Thus, at a P/E of 17x on our FY09E EPS of Rs 52.3, the Indo Tech valuation comes to Rs889 per share.

DCF Analysis Our DCF analysis is based on assumptions of 13.6% WACC, second stage terminal growth (till FY17) of 8% and a perpetual growth rate thereafter at 3%. Based on this the DCF value of Indo Tech translates to Rs1,004 per share.

At the current stock price of Rs598, Indo Tech’s FY08E EPS of Rs39.8 is discounted 15.1x and FY09E EPS of Rs52.3 is discounted 11.4x. In light of the strong sectoral positives and Indo Tech’s readiness in leveraging this opportunity, we rate the stock as a STRONG BUY with a target price of Rs889 (upside of 49%) by Sept’08, based on P/E of 17x FY09E EPS of Rs52.3.

Other Info: Corporate Announcements | Board Meetings | Financial Results | Corporate Actions
Company Address | Shareholding Pattern | Results Comparison | Annual Reports

This document has been prepared by Prime Broking Company ( India ) Limited (“Prime”). The information, analysis and estimates contained herein are based on Prime’s assessment and have been obtained from sources believed to be reliable. This document is meant for the use of the intended recipient only. This document, at best, represents Prime’s opinion and is meant for general information only.

Investment in equity shares has its own risks. Sincere efforts have been made to present the right investment perspective.The information contained herein is based on analysis and up on sources that we consider reliable. I, however, do not vouch for the accuracy or the completeness thereof. This material is for personal information and I am not responsible for any loss incurred based upon it.& take no responsibility whatsoever for any financial profits or loss which may arise from the recommendations given in this blog.