BEML: Invest

Investors with a three/four-year investment horizon can subscribe to the follow-on public offer of Bharat Earth Movers (BEML), being made in the price band of Rs 1,020-1,090 per share. At the price band, the offer is priced at 21-22 times its FY-07 per share earnings on a post-issue equity base. The rise in industrial capex, increasing Defence outlay, and proposals to introduce metro rail projects in major cities, lend visibility to BEML's future earnings. This apart, BEML's well-diversified product portfolio, established presence in the domestic market, strategic tie-ups with global players and a planned approach towards marking a global presence, are positives. However, short-term investors, despite these positives, can stay away, given the possibility of better entry points to the stock in the short term after the issue closes.

Business

Operating in three segments — construction and mining equipment division, Defence products division and railway and metro division — BEML's strength stems from its business straddling a variety of user industries. In the construction and mining equipment space, BEML enjoys market leadership, thanks to its well-diversified product portfolio. The division's performance can also be attributed to BEML's competitive pricing and on-time availability of spare components. While this trend is likely to continue given the ongoing industrial capex boom, the revenues are likely to get a boost from BEML's upcoming contract mining operations.

To leverage on opportunities in contract mining, BEML has formed a joint venture with Midwest Granites and the Indonesia-based Sumber Mitra Jaya. This venture, apart from giving BEML a 45 per share in earnings, will also serve as an alternative source of revenue; BEML is expected to provide for about 40 per cent of the mining equipment needs. However, effective contributions from this venture are likely to be derived from FY-09 only. While the construction and mining equipment division is likely to enjoy a robust revenue growth, increase in outsourcing of components and rising competition in this space could curtail pricing power.

Having established itself as the country's leading metro coach manufacturer, BEML is well-placed to benefit from the upcoming metro rail projects in major Indian cities. While concerns on the delay in the execution of such projects cannot be ignored, the inevitability of the roll-out of such projects, given the increasing congestion in major cities, points to sound long-term prospects for the business. Further, the Railways' proposal to introduce enhanced passenger capacity coaches, increase the production of electric motor units (EMU) and introduce air-conditioned EMU coaches in suburban trains in Mumbai, Chennai and Kolkata, are also opportunities.

BEML has planned an investment of about Rs 210 crore from the offer proceeds towards expanding its capacity to 190 coaches per annum from the present 150 coaches. Given the cost-advantage BEML enjoys over international players (partly because of a five-year sales-tax exemption), it is likely to garner a chunk of the metro project business. Nevertheless, the possibility of BEML losing out a few orders to other players cannot be completely ruled out.

BEML's Defence products division, which supplies Tatra Vehicles, armoured vehicles and ammunition loader vehicles to the Government, is likely to sustain its revenue growth. Given the 11.6 per cent increase in Defence budget for FY-08 over the previous year, the division is likely to sustain its growth levels. Also, the new Defence procurement procedure, which stipulates a 30 per cent offset for contracts exceeding Rs 300 crore, augurs well for domestic Defence contractors such as BEML.

Brazilian foray

BEML has proposed to form a joint venture with Companhia Comercio E Construcoes, a Brazil-based railroad equipment provider. It plans to utilise about Rs 100 crore from the offer proceeds towards this venture and has proposed to acquire a local manufacturing unit. Given the growing demand for coal mining in Brazil and other South American countries, the joint venture, when it takes off, is likely to help BEML consolidate its position in these new markets. While it is certain to face stiff competition from the already established international players in the region such as Caterpillar, Terex and Komatsu, there is enough room for growth for BEML. Nevertheless, the first couple of years could be crucial.

BEML's tie-up with Apollo Tyres and MRF Tyres for the manufacture of Off The Road (OTR) tyres, apart from meeting the increasing demand for such tyres from earth moving equipment companies, is also likely to help it reduce the delay in orders and production cycles.

Financials

For the year-ended FY-07, the earnings grew 10 per cent on the back of an 18 per cent increase in revenues. Operating profits grew 17 per cent, while the margins remained flat. However, with the introduction of the voluntary retirement schemes and setting up of windmill for captive power consumption, the pressure on margins is likely to reduce. For the year, while the mining and construction equipment division and the Defence products division contributed to about 63 per cent and 32 per cent of the total turnover respectively, the Railways division made only a 5 per cent contribution. The metro coaches division is loss-making, but with the roll out of metro rail projects in the light of BEML's increase in capacities, the division is likely to see better contributions.

Concerns

Given that the Government contributes to a major share of BEML's revenues, any unfavourable changes in policy with regard to Defence or the Railways procurement and any constraints in their budget could affect its earnings negatively. This apart, any unprecedented changes in the price of steel could also dent its earnings.

Offer details

The offer is open from June 27-July 3. The company seeks to raise Rs 534 crore through this offer. ICICI Securities is the book running lead manager and Karvy is the registrar to the issue. The offer would constitute about 11.7 per cent of the fully diluted post-issue paid-up equity capital of the company.