April 4, 2012

ELGI EQUIPMENTS LTD (ELGI)

DOWNGRADING TO ACCUMULATE

Analyst Rajiv Bharati

rajiv.bharati@destimoney.com

ELGI Downgrading to ACCUMULATE

ACCUMULATE
TARGET : `89 CMP : `79

Key Data Ticker (Bloomberg) NSE Code BSE Code Sector Industry Face Value (`) Book Value per share (`) Dividend Yield (%) 52 Week Range (`) Market Cap. (` mn.) ELEQ ELGIEQUIP 522074 Capital Goods Compressor / Pumps 1 21 1.3% 63-102 12,549

(In ` m n) - C o ns o lida te d Net Sales EBITDA EBITDA Margin EPS (`) EV/Sales EV/EBITDA P/E (x) (` 79.2) Price Performance Absolute Relative

FY10 6,770 1048 15.5% 3.7 1.6 10.6 21.7 CY09 206.7% 131.0%

FY11 9,390 1391 14.8% 5.6 1.2 7.9 14.1 CY10 114.3% 96.3%

FY12E 9,711 1141 11.7% 4.8 1.1 9.7 16.6 CY11 -27.7% -3.0%

FY13E 11,092 1380 12.4% 5.9 1.0 8.0 13.4 YTD 20.8% 5.7%

Shareholding Pattern (as on 31 Dec 2011)

109 Others 3% Promoters 33% MF/UTI/FIs 7% 98 87 Bodies Corporate 14% FIIs 4% Individuals 39% 76 65 Apr-11

Relative Stock Performance (Apr'11=100)

Jun-11

Aug-11

Oct-11

Dec-11 NIFTY

Jan-12

Mar-12

Source: Company, Bloomberg, Destimoney Research

Elgi Equipments

Negative surprises in non-waterwell business bespeak rating downgrade

We had initiated coverage on Elgi Equipments in May 2011 with a BUY rating based on the successful indigenization of imported compressor technologies and growth in after market segment. Based on the 9MFY12 performance we cut out estimates of over 15% revenue growth in non-waterwell business to about 10-%11%. Overall we expect a flat FY12, with mere 3.4% growth in topline and 15.3% drop in PAT on account of reduced contribution from waterwell segment owing to seasonality. Elgis french subsidiary, Belair, is expected to record 22% topline growth in FY12 to `500 mn. The management expects the same to grow by another 34% to `670 mn in FY13. Still in the nascent stage the Belair vertical has broken even in FY12. The company has commissioned a separate production line for oil free compressors and targets to sell 200 units in 2 years at a price point of `6 mn internationally and `2-3.5 mn domestically. Initial response as per the management has been encouraging. Strong auto sales post supply disruption in mid 2011 bodes well for Elgis automotive segment. We expect a 20% growth in Automotive segment in FY13. The seemingly under penetrated after market segment is expected to retain its 10% clip in FY13 as well. Operating margins are expected to hover in the healthy band of 12%-14% in the absence of waterwell business. Growth in exports and further in roads in international business will give boost to topline growth. Though, ELGI EQUIPMENTS LTD is positioned to get immediate impact of change in capex cycle owing to lower lead time product portfolio, we remain cautious over the prevailing macroeconomic situation and hence cut our rating on the stock to ACCUMULATE and a target price of `89 per share. 3

We expect slower growth in dominant domestic compressor business to continue in FY13 as well

Segment-wise Revenue Contribution (`mn) `

10000 7500 5000 2500 0 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E Others Compressor Automotive Equipments

Segment-wise revenue growth over the years

54% 36% 18% 0% -18% FY06 FY07 FY08 FY09 FY10 FY11 FY12E Compressors Automotive Equipments 3% 34% 26% 12% 8% 12% -8% 21% 28% 12% 2% 39% 24% 37%

Domestic business excluding exports comprise ~80% of Elgis topline. Compressor segment is expected to grow by 13.5%, while we expect smarter growth in Automotive equipments segment of 20%, owing to growing auto sector which got marred by supply disruptions in FY12.

Segment-wise PBIT margins over the years

20% 15% 10% 5% 0% FY06 FY07 FY08 FY09 FY10 FY11 FY12E 18% 17% 18% 11% 13% 15% 12% 11% 12% 12% 10% 4%

15% 14%

Compressors Source: Company, Destimoney Research

Automotive Equipments

owing to persistent sluggishness in industrial output which reflects delayed capex by corporates

Industrial output trend (2004-05 base)

44% 22% 0% -22% -44% Jun'11 Jan'11 Sep'11 Mar'11 Oct'11 Feb'11 Nov'11 May'11 Aug'11 Dec'11 Apr'11 Jan'12 Jul'11

IIP Index Source: CSO

Capital Goods

Industrial output has remained sluggish during the FY12 with apparent slowdown in Capital goods sector As Elgi operates in book and ship kind of segment with typical leadtime of 4-6 weeks, any revival in new orders placed will have immediate impact on FY13 financials.

Higher infrastructure spending in 12th five year plan is expected to drive the growth in domestic market

Twelfth plan target infrastructure spending ($ bn)

1200 1025 900 600 300 0 2002-2007 Source: Planning Commission 2008-2012 2013-2017 227 514 9.0% 6.0% 3.0% 0.0% 12.0%

Infrastructure spending as % of GDP

9.95% 7.55% 5.08%

2002-2007

2008-2012

2013-2017

Infrastructure spending in governments 12th five year plan is estimated to be 4.5 times spent in the 10th plan. Allocation to infrastructure spending will increase from 5% of GDP in 10th five year plan to ~10% of GDP in the 12th five year plan

 and smart growth in overseas subsidiaries will pave road for future acquisitions, in order to achieve $0.5 bn dollar topline vision by FY15

Belair acquisition is gathering pace

720 540 360 180 0 FY11 FY12E FY13E

Belair France Revenue (`mn)

Source: Company, Destimoney Research

Still at nascent stage, Belair contributed to 4.3% of FY11 revenue. Management indicated to reap `670 mn in FY13. Losses in companys China subsidiary, Elgi Equipment Zhejiang Ltd, are reducing with rationalization of operations. Elgis growth in coming years will strongly be determined by growth in international business including exports. Management expects 25%-30% growth in the segment in years to come. Management intends to scale up the contribution from International business to 40% of total revenue in 3 years time, from current 20%. 7

Margins are expected to be better in Q4FY12

Positive impact of Steel price correction in Q4FY12

40000 38000 36000 34000 32000 Apr-11 Jun-11 Aug-11 Oct-11 Jan-12 Mar-12 54 53 51 50 48 Oct-11

Rupee strengthened in Q4FY12

Nov-11

Dec-11

Jan-12

Feb-12

Mar-12

Hot Rollled Steel Prices (Rs. per tonne) Source: Bloomberg

INRUSD Currency

Correction in Steel prices since Jan 2012 has come as welcome change. Though the kicker in the form of forex gain till 9MFY12 receded as currency cooled down marginally in Q4FY12.

and we expect it to stabilize between 12% - 14% levels attributing to cyclicality of waterwell business

Quarterly performance
2800 24%

2100

18%

1400

12%

700

6%

0 Jun-09 Sep-08 Sep-09 Jun-10 Dec-07 Dec-08 Dec-10 Sep-11 Mar-09 Mar-08 Mar-10 Mar-11 Dec-11 Sep-07 Jun-08 Dec-09 Sep-10 Jun-11

0%

Net Sales (`mn)-LHS

EBITDA Margin-RHS

Higher material cost in production of oil free compressors will result in a little squeeze in margins as contribution of oil free compressors grow.

Source: Company

Working capital days are largely in control

Working Capital Management

100 85 70 55 40 FY05 FY06 FY07 Debtors Days Source: Company, Destimoney Research FY08 FY09 FY10 Inventory Days FY11 FY12E

Elgi has largely maintained working capital well. Marginal increment is due to growing international business and change in product mix towards oil free compressors.

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We downgrade our rating to ACCUMULATE and a target price of `89 per share

Relative Stock Performance (Apr'11=100) Elgis long term growth is strongly hinged to increasing infrastructure spend by the government and success in penetrating overseas market. We believe the $500 mn topline target by 2015 is in sight as the macroeconomic situation improves. With zero debt and `1200 mn cash, company is suitably placed to expand inorganically in new geographies. The stock is trading at 16.6 and 13.4 times its FY12E and FY13E earnings. We remain watchful towards improvement in macroeconomic situation and hence cut our rating on the stock to ACCUMULATE and a target price of `89 per share.
109 98 87 76 65 Apr-11 Jun-11 Aug-11 Oct-11 Dec-11 NIFTY Jan-12 Mar-12

Elgi Equipments

Consolidated EPS (`) CEPS (`) P/E (x) P/B (x) ROE ROCE EV/EBIDTA (x)

FY10 3.7 4.8 21.7 4.8 25.1% 35.1% 10.6

FY11 5.6 6.6 14.1 3.7 27.7% 36.9% 7.9

FY12E 4.8 5.6 16.6 3.2 19.1% 25.3% 9.7

FY13E 5.9 6.9 13.4 2.7 20.0% 26.0% 8.0

Source: Destimoney Research, Bloomberg

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Financial Summary

Income Statement
(In ` m n) - C o ns o lida te d Net Sales Operating expense EBIDTA Depreciation EBIT Interest EBT Other Income PBT FY10 6,770 5,722 1,048 108 940 940 82 1,022 FY11 9,390 7,999 1,391 115 1,276 1,276 134 1,410 FY12E 9,711 8,570 1,141 132 1,009 1,009 116 FY13E 11,092 9,712 1,380 150 1,229 1,229 172

Balance Sheet
(In ` m n) - C o ns o lida te d Liabilities Equity Share Capital Reserves & Surplus Loans Deferred Tax Liability Current Liabilities (CL) Provisions Total Assets Gross Block + CWIP Accumulated Depreciation 1,831 1,100 731 143 30 4,270 5,174 2,080 1,202 878 173 27 5,580 6,657 2,396 1,334 1,062 173 27 6,022 7,284 2,736 1,484 1,252 173 27 7,058 8,509 79 2,553 28 17 1,366 1,131 5,174 158 3,225 50 31 1,502 1,691 6,657 158 3,793 31 1,553 1,749 7,284 158 4,548 31 1,774 1,998 8,509 FY10 FY11 FY12E FY13E

1,125 371 754

1,402 463 939

Tax PAT Margins Sales Growth % Operating Margin % Net Margin %

361 660

472 939

22.4% 15.5% 9.8%

38.7% 14.8% 10.0%

3.4% 11.7% 7.8%

14.2% 12.4% 8.5%

Fixed Assets Investments Misc Current Assets (CA) Total

Source: Company, Destimoney Research

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Key risks

Policy changes like lowering custom duty could intensify the pricing pressure domestically. Foreign exchange fluctuation risk for the products with higher import content. Capex deferment by customers leads to severe competition for Elgi, resulting in the risk of margin erosion. Validation of equipments norms in different countries is a time consuming process, resulting in potential loss of business opportunity.

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