For 2QFY2016, Elecon Engineering Company (Elecon) reported standalone
numbers broadly below our estimates, except at the operating level. The top-line
for the quarter declined by 5.5% yoy to `111cr. However, the operating
performance improved significantly, led by a 1,516bp yoy decline in raw material
cost to 43.9% of sales. Although, this benefit was partially offset by a 394bp yoy
and 236bp yoy increase in employee and other expenses to 12.4% and 18.9% of
sales, respectively; overall, the EBITDA margin expanded by 859bp yoy to 24.9%.
Led by the favorable operating performance, the standalone net profit increased
by 158.9% yoy to Rs7cr.
Recovery in capex taking longer than expected, long term prospects intact: The
Material Handling Equipment (MHE) business of the company continued to
remain under pressure on account of delay in capex in core sectors and due to
slower execution at the customer level. On the other hand, the Power
Transmission Equipment (PTE) business, which had been holding its ground, has
now been facing some pressure (in 1HFY2016). However, the margins have
improved considerably, which is a positive sign for the business. Although the
recovery in capex in core sectors has been slower than expected, the long term
prospects for the MHE business remain intact. Additionally, the underperforming
European subsidiary has now turned profitable post restructuring and reported a
PAT of `6cr for 1HFY2016.
Outlook and Valuation: We expect Elecon’s consolidated revenues to post a
CAGR of 7.4% over FY2105E-17E to Rs1,533cr. Recovery in the MHE business’
margins will result in EBITDA margins expanding by 214bp over FY2015E-17E to
14.9%. Consequently, the net profit is expected to improve to Rs66cr in FY2017E.
At the current market price, the stock is trading at 13.0x its FY2017E earnings.
We believe that these valuations are attractive considering its 5-year and 3-year
median P/E of 18.7x and 20.7x, respectively. We have an Accumulate rating on the
stock with a revised target price of Rs85 based on a target PE of 14.0x for FY2017E.

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