For 2QFY2016, Kirloskar Oil Engines (KOEL) reported a disappointing set of
numbers. Its top-line for the quarter declined by 6.0% yoy to Rs590cr. The raw
material cost declined by 286bp yoy to 62.3% of sales while employee expense
increased by 79bp yoy to 8.5% of sales, and other expenses increased by
405bp yoy to 21.0% of sales. This resulted in the EBITDA margin contracting by
198bp yoy to 8.2%. Other income increased by 61.1% yoy to Rs20cr and
consequently, the net profit remained flat at Rs36cr.
Outlook to remain subdued in the near term: In the near term, we expect the
company to witness some pressure on account of overall slowdown in the Genset
industry. In addition, the absence of large engines orders has been impacting the
top-line and profitability. KOEL has expanded its capacity in the past and is
positioned to successfully cater to improvement in demand once the operating
environment changes in the longer run. KOEL also has taken measures to
increase its focus on exports which should aid growth.
Cash rich position: KOEL is a debt free company with cash and cash equivalents
of approximately Rs835cr. With ample capacity in place, there is no major capex
expected in the near future. Consequently depreciation expense is also expected to remain
low which will add to the bottom-line. We expect KOELs cash and cash equivalents to be
at ~Rs982cr in FY2017E which is approximately 26% of the current market cap.
Outlook and Valuation: We expect KOELs revenue to recover post FY2016, ie to
Rs2,826cr in FY2017E. With recovery in the top-line, we expect the EBITDA margin
to recover to 10.4% in FY2017E. Consequently the profit is expected to grow to
Rs193cr in FY2017E. We have scaled down our numbers for FY2016E and have
accounted for improvement in the top-line for FY2017E. At the current market price,
the stock trades at 19.7x its FY2017E earnings (vs its 3-year median of 21.7x). At
the current juncture, we have a Neutral rating on the stock as the infrastructure
scenario in the country is expected to remain dampened in the near term.

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