Fresh investments can be considered in the stock of Everest Kanto Cylinders, a leading manufacturer of high-pressure CNG (compressed natural gas) and industrial cylinders. At the current market price of Rs 288, the stock trades at about 14 times its likely FY-10 per share earnings on a diluted equity base.
While prima facie the valuation may appear pricey, it is supported by the growing demand for EKC's products. At a time when many engineering and capital goods companies are battling with a slowing demand, EKC's prospects are stable.
Driven by high oil prices, most countries, including India, have been on the lookout for cheaper energy options and CNG fits this bill well. Cheap and viable, the demand for CNG-based applications is likely to remain buoyant over the next couple of years, irrespective of short-term blips in oil prices. This bodes well for EKC, which enjoys over 80 per cent market share in India and derives close to 57 per cent of its consolidated revenues from exports.
Investors, nevertheless, should accumulate the stock in lots to take advantage of volatility in the broad markets.
Expansion in capacities
In the last two years, the company has, on a consolidated basis, reported a compounded sales and earnings growth of 50 per cent and 77 per cent respectively. This may well continue over the next couple of years as EKC has put in place expanded capacities that would help it cater to most of the incremental demand in the coming years.
The company has four manufacturing facilities (three in Gujarat, India and one in Dubai) that together have a capacity to manufacture over one million cylinders per year. Further, it has recently commenced production at its new facility in China (capacity of 200,000 cylinders per year) and proposes to expand it further.
Having a manufacturing presence in China will not only help EKC leverage on the demand-supply mismatch in that region, but also help it build on its relationship with Chinese suppliers of seamless tubes — the key raw material.
Besides this, EKC has also undertaken addition in capacities for the manufacture of industrial cylinders to its existing facility at Gandhidham, Guajrat. It further plans to introduce a product line — Jumbo cylinders — offering higher margins, at this facility. In total, this would imply an addition of over 200,000 cylinders per annum capacity; commissioning of these plants is expected by the third quarter of this year.
That EKC's existing facilities are running at full capacity and the company has its order book full for the next year reduces concerns on its ability to optimally utilise additional capacities.
However, given the high gestation period in this segment, it may take a couple of years for the company to reap the full benefits of its expanded capacities, which reiterates the need for a two-year holding period on this stock.
CP Industries, key to growth
In February 2008, EKC had sealed its entry into the US market through the acquisition of CP Industries, a division of Reunion Industries for a consideration of about $67 million (about 1.7 times CPI's reported revenues last year).
Being the world leader in the manufacture of very large, seamless, high-pressure vessels, CPI's acquisition will be a strategic fit, bringing in a complementary product portfolio. It will also bring to the table CPI's design capabilities, which are in compliance with the US and Chinese standards and its well-established set of clientele, which includes makers of alternative fuel vehicles, NASA, the US Navy and others in the transportation and aerospace industries. Funded primarily through debt, this acquisition may burden EKC's books with interest cost in the near-term, but will be a long-term positive.
Funding growth
Another factor that lends comfort to the company's growth prospects is the fact that a significant portion of the funds required for its expansion plans — be it for its existing facilities or for setting up new facilities at Kandla SEZ and China — has already been raised. Last year, the company had raised about Rs 236 crore through a combination of private equity and FCCBs (due for conversion in 2012 at Rs 303). This assumes significance since the recent bouts of interest rate hikes have made money dearer.
Among other factors that lend strength to the EKC's business prospects is its ability to pass on input price hikes to its customers. Despite there being pressure on the input cost front, the company has not only been able to maintain its margins (at about 29 per cent last quarter); it has also bettered its average realisation in recent times. This was also achieved partly by tilting the product mix in favour of CNG cylinders (which enjoy higher margins). In the coming quarters, even if there were no respite on the raw material cost front, better capacity utilisation and economies of scale may give it sufficient leeway to sustain margins at the current levels.
On this score, EKC's strategy of broad-basing its raw material supplier base to include Chinese and Japanese suppliers (low cost) besides Tenaris, a global manufacturer and supplier of seamless tubes, would also help. That said, domestic growth would, to a great extent, depend on the improvement in CNG infrastructure in the country.
While the government is certainly inclined towards improving CNG infrastructure, in the midst of an economic slowdown, this may not figure in its priority list. Delays in the expansion of EKC's capacities may also pose a risk to the company's earnings.
While prima facie the valuation may appear pricey, it is supported by the growing demand for EKC's products. At a time when many engineering and capital goods companies are battling with a slowing demand, EKC's prospects are stable.
Driven by high oil prices, most countries, including India, have been on the lookout for cheaper energy options and CNG fits this bill well. Cheap and viable, the demand for CNG-based applications is likely to remain buoyant over the next couple of years, irrespective of short-term blips in oil prices. This bodes well for EKC, which enjoys over 80 per cent market share in India and derives close to 57 per cent of its consolidated revenues from exports.
Investors, nevertheless, should accumulate the stock in lots to take advantage of volatility in the broad markets.
Expansion in capacities
In the last two years, the company has, on a consolidated basis, reported a compounded sales and earnings growth of 50 per cent and 77 per cent respectively. This may well continue over the next couple of years as EKC has put in place expanded capacities that would help it cater to most of the incremental demand in the coming years.
The company has four manufacturing facilities (three in Gujarat, India and one in Dubai) that together have a capacity to manufacture over one million cylinders per year. Further, it has recently commenced production at its new facility in China (capacity of 200,000 cylinders per year) and proposes to expand it further.
Having a manufacturing presence in China will not only help EKC leverage on the demand-supply mismatch in that region, but also help it build on its relationship with Chinese suppliers of seamless tubes — the key raw material.
Besides this, EKC has also undertaken addition in capacities for the manufacture of industrial cylinders to its existing facility at Gandhidham, Guajrat. It further plans to introduce a product line — Jumbo cylinders — offering higher margins, at this facility. In total, this would imply an addition of over 200,000 cylinders per annum capacity; commissioning of these plants is expected by the third quarter of this year.
That EKC's existing facilities are running at full capacity and the company has its order book full for the next year reduces concerns on its ability to optimally utilise additional capacities.
However, given the high gestation period in this segment, it may take a couple of years for the company to reap the full benefits of its expanded capacities, which reiterates the need for a two-year holding period on this stock.
CP Industries, key to growth
In February 2008, EKC had sealed its entry into the US market through the acquisition of CP Industries, a division of Reunion Industries for a consideration of about $67 million (about 1.7 times CPI's reported revenues last year).
Being the world leader in the manufacture of very large, seamless, high-pressure vessels, CPI's acquisition will be a strategic fit, bringing in a complementary product portfolio. It will also bring to the table CPI's design capabilities, which are in compliance with the US and Chinese standards and its well-established set of clientele, which includes makers of alternative fuel vehicles, NASA, the US Navy and others in the transportation and aerospace industries. Funded primarily through debt, this acquisition may burden EKC's books with interest cost in the near-term, but will be a long-term positive.
Funding growth
Another factor that lends comfort to the company's growth prospects is the fact that a significant portion of the funds required for its expansion plans — be it for its existing facilities or for setting up new facilities at Kandla SEZ and China — has already been raised. Last year, the company had raised about Rs 236 crore through a combination of private equity and FCCBs (due for conversion in 2012 at Rs 303). This assumes significance since the recent bouts of interest rate hikes have made money dearer.
Among other factors that lend strength to the EKC's business prospects is its ability to pass on input price hikes to its customers. Despite there being pressure on the input cost front, the company has not only been able to maintain its margins (at about 29 per cent last quarter); it has also bettered its average realisation in recent times. This was also achieved partly by tilting the product mix in favour of CNG cylinders (which enjoy higher margins). In the coming quarters, even if there were no respite on the raw material cost front, better capacity utilisation and economies of scale may give it sufficient leeway to sustain margins at the current levels.
On this score, EKC's strategy of broad-basing its raw material supplier base to include Chinese and Japanese suppliers (low cost) besides Tenaris, a global manufacturer and supplier of seamless tubes, would also help. That said, domestic growth would, to a great extent, depend on the improvement in CNG infrastructure in the country.
While the government is certainly inclined towards improving CNG infrastructure, in the midst of an economic slowdown, this may not figure in its priority list. Delays in the expansion of EKC's capacities may also pose a risk to the company's earnings.
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