elgi compressors

8/19/2019 ELGI Compressors

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One-year performance (Rel to Sensex)

Source: ACE Equity

Registered Office: Kotak Securities Limited, Bakhtawar, 1st floor, 229 Nariman Point, Mumbai 400021 India.

Elgi Equipment Ltd (EEL)

PRICE : RS.79 RECOMMENDATION : BUY

TARGET PRICE : RS.98 FY13E P/E: 13.2X

Elgi Equipment Ltd (EEL) is Asia's leading manufacturer of air compressorsand automobile service station equipment. The company enjoys a healthymarket share of over 30% in Indian market and its products find applica-tion across industries ranging from mining, transport pharmaceuticals,power, hydrocarbons, ship building, textiles etc. Driven by gradual pick upin global industrial capex outlook, we believe that the company is wellpoised for 23% growth in net profits in FY13E.

We project 14.1% growth in revenues from Rs. 9.8 bn in FY12 to Rs.11.2bn in FY13E. Within the revenue streams, we expect compressor businessthat accounts for nearly 80% of company's business to grow by 15% and

automotive to grow by 7% in FY13E mainly driven by 1) pick up in thedomestic infrastructure spending viz. hydrocarbons, mining, constructionand water segments 2) revival in international demand for compressorsand 3) increased contribution from company's key overseas subsidiaries.

At the current price, company's stock looks attractively valued on a dis-counted cash flow basis. We therefore initiate coverage on EEL stock witha BUY rating and one year DCF based target price of Rs.98.

Key Investment Rationale

Leadership position in the domestic air compressor market; one of thefew end to end player catering to numerous industries. Elgi is one of

the prominent players which enjoys 30% market share in Indian compressormanufacturing segment on back of 1) strong brand in medium rangecompressors 2) robust distribution network offering pan India presence 3)efficient cost controls providing price advantage to the end user and 4)effective after sales services. Over the past few decades, it has emerged as amarket leader in the domestic market and has developed strong relationshipwith key players like Tata Motors, Sony, M&M, ESAB, BHEL, Bosch, HP, Bayer,Crompton Greaves etc.

International presence offers geographical diversification; favorableJoint ventures and strategic domestic/overseas tie ups strengthenscompany's offering. In order to widen the spectrum of offerings andexploring new geographies for growth, EEL has envisaged a strategy of

entering into strategic alliances through joint ventures and acquiringcompanies overseas that offer strategic fitment. Company through itssubsidiaries is present in all major markets across the globe which includesEurope, North America, Latin America, Africa, Australia, Middle East, SouthEast Asia, West Asia and the Far East. It will likely report meaningful growthin export revenues from current 20% of consolidated revenues to nearly 35-40% over next two to three years.

Sustained emphasis on research & development initiatives providescompetitive edge to the company. EEL is a technologically driven companyand pays invariable emphasis on the research and development capabilities. Itconstantly ventures into new initiative related to technological advancement.It consistently deploys resources for adding and modifying current product

specifications making it valuable to the end users.

Stock details

BSE code : 522074

NSE code : ELGIEQUIP

Market cap (Rs mn) : 12,518

Free float (%) : 68.2

52-wk Hi/Lo (Rs) : 83.45 / 62.75

Avg. Daily Volume BSE+NSE : 51,760

Shares o/s (mn) : 158

Summary table

(Rs mn) FY11 FY12E FY13E

Sales 9,390 9,897 11,267

Growth (%) 39.8 4.8 14.1

EBITDA 1,411 1,083 1,484

EBITDA margin (%) 15.0 10.9 13.2

PBT 1362 1106 1417

Net profit 890 756 949

EPS (Rs) 5.6 4.8 6.0

Growth (%) 34.8 (15.1) 25.5

CEPS (Rs) 6.3 5.6 6.9

BV (Rs/share) 21.4 24.9 29.6

DPS (Rs) 1.0 1.0 1.1

ROE (%) 29.6 20.6 22.0

ROCE (%) 32.7 23.7 24.8

Net cash (debt) 1,349 1,486 1,652

NW Capital (Days) 36.1 39.9 45.1

EV/Sales (x) 1.2 1.1 1.0

EV/EBITDA (x) 7.9 10.3 7.5

P/E (x) 14.1 16.6 13.2

P/Cash Earnings (x) 12.5 14.1 11.4

P/BV (x) 3.7 3.2 2.7

Source: Company,

Kotak Securities - Private Client Research

INITIATING COVERAGEJUNE 18, 2012

PRIVATE CLIENT RESEARCH

Ruchir [email protected]+91 22 6621 6448

One-year performance (Rel to Sensex)

Source: ACE Equity



Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 2

INITIATING COVERAGE June 18, 2012

Company to maintain high growth in financials; higher operatingmargins and shorter cash conversion cycle likely to aid to free cashflow generation. We project 14.1% growth in revenues from Rs. 9.8 bn inFY12 to Rs. 11.2 bn in FY13E on back of 1) pick up in the domesticinfrastructure spending viz. hydrocarbons, mining, construction and watersegments 2) revival in international demand for compressors and 3) increased

contribution from company's key overseas subsidiaries.

We expect that the company will likely maintain its revenue mix at currentlevels with compressor business contributing to nearly 80% of revenue pie. Weopine that the company would continue to prudently manage its overheadsmitigating any increase in input prices. In our projected financials we build 13%EBITDA margins for FY13.

Current valuations appear favorable vis-à-vis the potential growth in revenues.At current price of Rs.79, stock is trading at 13.2x P/E and 7.5x EV/EBITDAmultiples on FY13E earnings. We believe that stock is attractively valued at thecurrent price. We therefore initiate coverage on EEL stock with a BUY ratingand one year DCF based target price of Rs.98.

Key Concerns

Sharp increase in raw material prices. Sharp increase in the raw materialprices especially steel and aluminum would negatively affect company'sprofitability. In our estimates, we build a moderate increase in key raw materialcosts which is likely to get absorbed by the company achieving economies ofscale going ahead.

Increasing competition. Low HP (< 20 HP) compressor segment is highlyfragmented and there exists stiff competition between various players bothfrom unorganized sector and organized players. In large HP category, companyfaces competition mainly from multi-national players. We believe that thecompany has grown commendably in the past amidst higher competitive

intensity in the industry and is likely to maintain meaningful growth goingahead.

Slowdown in domestic industrial activity. Compressor segment growth ishighly correlated with the overall economic activity mainly mining,hydrocarbon, transport, power, oil, railways etc. Any slowdown in the industrialcapex program would imply lower off take of company's products.

We initiate coverage on EEL witha BUY rating and one year DCF

based target price of Rs 98





COMPANY OVERVIEW

Incorporated in year 1960, Elgi Equipment Limited (EEL) is one of India’s leadingmanufacturers of air compressors with nearly 30% market share in the domesticmarket. It is engaged in the manufacturing of borewell, reciprocating, centrifugaland screw compressors. Company also manufactures automotive garage equipment

that includes lifting equipment, body shop equipment, wheel servicing equipmentetc.

Company’s business is aligned into two major segments 1) Compressors businessthat accounts for over 80% of the total revenue pie and 2) Automotive Equipment(AE). Over the past few decades, it has emerged as a market leader in thedomestic compressor market and has developed strong relationship with key playerslike Tata Motors, Sony, M&M, ESAB, BHEL, Bosch etc. It has two state of the artmanufacturing plants in Coimbatore with combined installed capacity of 32500compressors per annum.

Key Revenue Streams

Source: Company, Kotak Securities - Private Client Research

AutomotiveEquipment

Elgi Equipment Ltd

AirCompressors

Rotary Screw AirCompressors

Reciprocating AirCompressors

Railway Compressorsand OE

Electric powered ScrewAir Compressor

Airends

World’s smallest ScrewAir Compressor

Oil-Free Screw Air

Compressor

Centrifugal AirCompressor

Portable Screw AirCompressor

Single stage (SS)/ Twostage (TS) Horizonseries

Borewell Compressors

High pressure/ Volumereciprocating Aircompressors

High Volume Tankmounted AirCompressors

LG Series Reciprocating

Air Compressor

Electrical Locomotives

Diesel Locomotives

Expressors

Auxiliary Compressors

Exhausters

Wind Screen Wipers

Water raisingapparatus

Lifting Equipment

Wheel ServiceEquipment

Diasgnostic Equipment

Lube Equipment

Body Shop Equipment

Flume ExhaustExtraction Systems

Washing Equipment

Pneumatic Tools

Benefitting from the low cost operating model, company has effectively leveragedits strong foothold in India to expand its operations into the overseas markets. Todifferentiate EEL has envisaged a strategy of entering into strategic alliancesthrough joint ventures and acquiring companies overseas that offer strategicfitment. Company through its subsidiaries is present in all major markets across theglobe which includes Europe, North America, Latin America, Africa, Australia,Middle East, South East Asia, West Asia and the Far East.

EEL is a technologically driven company and pays adequate emphasis on theresearch and development capabilities. It constantly ventures into new initiative

related to technological advancement.

EEL is one of India’s leadingmanufacturers of air compressorswith nearly 30% market share in

the domestic market





Over the last five years, EEL has grown consolidated revenues and profits by 22%and 38% CAGR respectively mainly boosted by the compressor business growth indomestic as well as overseas markets. It has commendably gained market share indomestic market competing with some of the multinational players like AtlasCopco, Ingersoll rand etc.

Company has a strong balance sheet and its major capex programs have beenfunded through internal accruals. With an extensive distribution network and highlyqualified and motivated personnel base, ELGI aims at establishing itself asmeaningful global player in its core products.





INDUSTRY OVERVIEW

The global market for compressed air equipment and aftermarket is characterizedby a diversified customer base. Air compressors are used in wide spectrum ofapplications in which compressed air is used as a source of power or as anintegrated part of industrial process. Gas compressors find use in any industry where

gases are handled as part of the manufacturing process, such as vanaspati,fertilizers, refineries, etc. apart from usage in gas purification and bottling plantsincluding LPG bottling.

Some of the applications of air compressors other than mining and construction arestated below:

Application of air compressors

Industry Applications Utility for Compressed Air

Textile Spinning, Weaving, Processing etc. Pneumatic operations

Chemicals Dyes & Intermediates Filter pres, Spray driers,

Material transfer

Pharmaceuticals Blister pack machines Pneumatic operations

Plastics Blow Moulding Machines, Pneumatic operations, Blowing

Injection Moulding Machines

Dairy FFS Machines Pneumatic operations

Automobiles pneumatic operations, tyre/tubes

Railways Electrical locomotives, dieseal Tap changers, contactors,

locomotoves, auxiliary compressors brakes etc.

Source: Kotak PCG-Research

Availability of technically skilled manpower, coupled with cheap un-skilled labor has been drawing many multinational companies to ei-

ther establish manufacturing facilities into the country directly orthrough joint ventures with indigenous suppliers. Also, given theeconomic downturn in the Western countries, several global compa-nies are looking at India as a viable destination for business.

Since the beginning of the establishment of the compressor industry in India, Airand Gas compressors have been manufactured with foreign technical collaboration.Most of the established manufacturers continue to enter into foreign collaborationsfor producing new types of compressors or for updating and expanding the presentrange. The industry has huge entry barrier with respect to technology and initialcapital outlay.

Indian compressor industry size is estimated at Rs 30 bn currently. Compressors ofpower rating up to 5 hp have been dominated by small scale sector. It is estimated

that there are around 35 – 40 manufacturers of these small compressors spread allover the country. These small compressors are mainly used for garage typeapplications and the technology involved is very simple and does not requiresophisticated machinery.

Government initiatives on infrastructure have led to a healthy growth in heavyindustries in India. Considering the possibility of over 6.5-7% percent economicgrowth over the coming years, high growth can be anticipated in the majority of theheavy industries like metals and mining, hydrocarbons, cement and power. Theplanning commission’s infrastructure-related investment projection for the 12th five-year plan of USD 1025 billion and its impact on the growth of heavy industries isexpected to spur the growth of pumps, valves and compressors over the next coupleof years.

XII five-year plan projectedinvestments of USD 1025 billionand its impact on the growth ofheavy industries is expected to

spur the growth for compressors





Planning commission’s five year plan projections (US$ bn)

Source: Planning Commision

We believe that buyer preference for compressors has also witnessed a shift overthe last few years. End user emphasis on efficiency and energy saving has resultedin preference for integrated solution providers who offer equipment along withnecessary spares, services and support.

Only a few indigenous suppliers like EEL along with multinational companies areable to offer desired cost-effective solutions to the customers. We believe that this isone of the major challenges for most of the small and medium-scale manufacturerswho lack the required capital and technical expertise. As a consequence, webelieve that this is likely to reduce growth prospects for small participants andeventually will lead to consolidation in the industry.

Indian Oil & Gas Industry

According to Ministry of Petroleum and Natural Gas (MoPNG), domestic crude oilrefining sector currently has combined annual installed capacity of 185.40 mmt per

annum and capacity additions of 23.88 mmt per annum has been planned under XIIFive Year Plan in the existing refineries. Additionally, during the XII Five Year Plan,54.00 mmt p.a. capacity additions is planned under new refineries to be set up bycompanies such as IOCL, Essar Oil Limited, and HPCL-Mittal Energy Limited.According to the MoPNG, XII year plan would entail total investment of Rs 1.2trillion.

Indian infrastructure sector

India has been witnessing meaningful growth in the infrastructure spends, both fromGovernment and the private sector. The primary growth in the infrastructure isdriven by power, transportation, petroleum and urban infrastructure.

According the Planning Commission’s report on Projections of Investment inInfrastructure, the Twelfth Five Year Plan envisages a total investment of US$ 1trillion in the infrastructure sector to bridge the infrastructure deficit and sustain agrowth momentum of 9% per annum. This will lead to commissioning of largenumber of construction projects and is likely to auger well for company’s operations.

Indian Mining and Metallurgy sector

India is one of the leading countries possessing mineral resources like mica, bauxite,iron ore, manganese ore, zinc and aluminum.

Growing global demand for minerals and metals, particularly in Asia is expected toresult in new opportunities for Indian mining companies. This is expected toincrease demand for compressors in the Indian mining and metallurgy sector

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X Plan XI Plan XII Plan

End user emphasis on efficiencyhas resulted in preference forintegrated solution providers

who offer equipment along withnecessary spares, services and

support





Water

According to the Planning Commission, India accounts for 16% of the world’spopulation and has only 4.0% of the total available fresh water. 85-89% of theusable water is consumed for irrigation in India. The increasing population alongwith the demand for crops like wheat and rice that require a greater quantity ofwater is likely to put increasing pressure on the available water resources in nearfuture.

Recently government has increased its budgetary allocations on various projectsrelated to the availability of fresh water that includes desalination, preserving waterbodies, sewerage treatment and strengthening distribution channels.

A committee appointed by the government, led by Dr Ahluwalia has envisaged aspending of USD 174 bn over next 20 years across water purification, storage andsupply projects.

Overseas Markets: While US markets witnesses some signsof revival, resurrection in European demand remains aconcern

Leveraging on the low cost and skilled manpower base in India domestic compressor manufacturers have started to focus on export markets. EEL, Ingersoll-Rand (I) and Atlas Copco have been very successful in their export efforts. USA, UK,USSR, Belgium and Italy are the major countries to which compressors are exportedfrom India.

Currently US markets have been witnessing revival in the infrastructure spendinggenerating significant demand for compressors. Europe along with emergingmarkets such as China, Brazil, India etc are likely to witness pick-up in demandthrough FY13 driven mainly by 1) continued momentum in mining segment and 2)pick up in construction sector.

EEL has been positioning itself as a service oriented company in the overseas

market especially in geographies like China where it faces stiff competition frommultinational players like Atlas Copco, Ingersoll Rand, Sullair compare etc alongwith host of local manufacturers.

Leveraging on the low cost andskilled manpower base domesticcompressor manufacturers have

started to focus on exportmarkets





Competitive landscape

The Indian market for compressors has traditionally been oligopolic in nature. Beingcapital intensive, industry has been dominated by international companies like AtlasCopco and Ingersoll Rand. Apart from players like BHEL, ELGI, KPCL and fewothers, there are no major indigenous manufacturers of compressors in India.

Competition in the industry has been intensifying, with many multinationalcompanies setting up operations in India. Existing multinationals are also makingadditional investments to aggressively target the expanding Indian markets.

The major international players in the field of Air & Gas compressors are:

Company Country of origin

Ingersoll-Rand USA

Atlas Copco Sweden

Kobe Steels Japan

Hitachi Japan

Joy Compressors USA

MAN GHH Sterkrade GermanySundyne Compressors USA

Hokuetsu Industries Japan

Fives Cail Babcock France

Elliot USA

Nuovo Pignone Italy

Dresser-Rand USA

Demag Germany

MHI, Japan Ebara Japan

Borsig Germany

Sullair Corporation USA

Sulzer Germany

Burckhardt Compression Switzerland

Source: Kotak Securities - Private Client Research

Bharat Heavy Electricals Limited (BHEL) and Bharat Pumps and Compressors Ltd aretwo public sector units in the field of Centrifugal compressors in domestic market.They manufacture large heavy duty compressors for customized/tailor-madeapplications. Kirloskar Pneumatic has also been bidding aggressively for expandingits market share.

EEL with its extensive distribution network and direct sales channel enjoys marketshare of nearly 30% in the domestic market. It has also been increasing itspresence in the overseas markets through organic and inorganic route. It is mainly

present in medium segment compressor ranging from 0.75 to 1500 HP andcompetes mainly on price and service with its competitors.

EEL faces competition fromdomestic as well as international

players across segments





KEY INVESTMENT ARGUMENTS

Leadership position in the domestic air compressor market; one ofthe few end to end player catering to numerous industries

EEL’s business is aligned into two principal segments 1) Compressors and 2)

Automotive Equipment (AE).

Compressor segment; price leadership and service differentiate Elgi fromcompetition

Elgi is one of the prominent players which enjoys 30% market share in Indiancompressor manufacturing segment on back of 1) strong brand in medium rangecompressors 2) robust distribution network offering pan India presence 3) efficientcost controls providing price advantage to the end user and 4) effective after salesservices. Established as a reciprocating compressor manufacturing company in1960, it has grown several folds to become a multi-product, multi-market companymanufacturing high value added products.

Over the past few decades, it has emerged as a market leader in the domestic

market and has developed strong relationship with key players like Tata Motors,Sony, M&M, ESAB, BHEL, Bosch, HP, Bayer, Crompton Greaves etc. Companyproduct line consists of Rotary Compressors, Reciprocating Compressors, CentrifugalCompressors, Automotive Equipment, Diesel Engines and Manufacturing andengineering services.

Company’s domain knowledge and effective overseas alliances with players like J.PSauer & Sohn, Germany has enabled the company to provide global standardsproducts to its end customer. By earning the tag of one stop garage solutionprovider, company has steadily grown to capture a large market share in India.

ELGI manufactures compressors covering a range from 0.75HP to 1500HP forvolumes from 1.8 cfm (cubic feet per minute) to 80000 cfm. ELGI’s has envisaged

its marketing strategy which involves partnering with customers to providecustomized solutions for their operations.

Company manufactures almost all of its products in house and sources keycomponents domestically. This facilitates company in producing superior products atnearly 10-12% discounts vis-à-vis competitors. EEL also has the license tomanufacture SDS series of Hitachi compressors. These are marketed as Elgi NHSeries Compressors in India.

Compressor segment consists of following major sub-divisions

Division Core Competencies

Rotary Compressor Division (ROCD) Design, development and manufacture of

electric and diesel powered screw aircompressors.

Reciprocating Compressors, Design, development and manufacture of single

Railway Compressors and Original and two stage reciprocating compressors, railway

Equipment Division (RCD) compressors and a variety of compressor

solutions for railway applications.

Company’s competence also lies in customized

packages for applications like circuit breakers,

engine starting etc.Bottom of Form

Source: Company, Kotak PCG-Research

EEL derives a major part of its revenue pie (nearly 80%) from the compressorbusiness catering to a wide range of end user industry including mining, transport

pharmaceuticals, power, hydrocarbons etc. It has two state of the art manufacturingplants in Coimbatore with combined installed capacity of 32500 compressors p.a.

EEL’s business is aligned into two

principal segments 1)Compressors and 2) Automotive

Equipment (AE)

Company has emerged as a

market leader in the domesticmarket and has developed strong

relationship with key customers

EEL derives nearly 80% of itsrevenue from the compressor

business and caters to a widerange of end user industry





Competition in domestic in medium HP segment arises from MNC players like AtlasCopco and Ingersoll Rand. Kirloskar Pneumatic and EEL are among the domesticplayers having meaningful market presence. We believe that cost effectiveness andefficient aftersales are the key for success for any player. We highlight that EELhas commendably established its strong positioning in the market amidststiff competition from various established players and new entrants. It has

grown its revenues at a much faster pace (approximately 23% CAGR in last6 years) than several established players.

Major players growth trend

FY05 FY06 FY07 FY08 FY09 FY10 FY11 CAGR (%)

EEL 2,316.10 2,374.10 2,999.50 4,180.70 4,711.50 5828 7964 22.9

Ingersoll Rand 2,537 2,828 3,326 4,222 4,046 3,717 4,790 11.2

Atlas Copco (Industrial division) 3,356 4,614 6,344 7,982 7,759 10,888 N.A N.A

Kirloskar Pneumatic 2,404 2,635 3,081 3,231 4,269 3,904 4,353 10.4

Source: Kotak Securities - Private Client Research

From historical perspective, water-well segment has been an important driver forthe domestic compressor demand in India. Over the last few years, company hassuccessfully increased market share in other segments such as mining, construction,cement, power, transport etc. We highlight that despite the fact that the water wellsegment has been experiencing cyclical slowdown since past three years, companyhas commendably managed to derive and grow its revenues from other segmentsacross geographies. In future, company focus would continue on industrialapplications and high potential oriented international markets.

Consolidated revenue and margin trend

Source: Company

Automotive segment

EEL through its fully owned subsidiary ATS ELGI, caters to the automotive segment.ATS Elgi is a leading manufacturer and distributor of automotive service equipmentin India. Automotive segment thrives mainly on the passenger car sales andconstitutes to nearly 12% of the overall revenue pie.

It manufactures nearly 35 equipment and 150 tools and accessories includinglubrication equipment, two-wheeler and four-wheeler hoists, paint booths, AC

recovery units, crash repair systems, wheel balancers and other diagnosticequipment.

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FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11

EBITDA (Rs mn ‐LHS) Sales (Rs mn ‐ LHS)

EBITDA(% ‐ RHS)

Slowdown inwaterwellsegment

Diversified revenuestreams counters

slowdown inwaterwell industry

EEL has commendablyestablished its strong

positioning in the marketamidst stiff competition from

various established players

Water-well segment has been animportant driver for the domestic

compressor demand in India andis currently observing cyclical

slowdown





ATS ELGI manufactures or deals in garage equipment under the following eightverticals:

Product profile

Category Key products

Lifting Equipment Two post lifts, Four post lifts, Inground lifts,Washing hoist etc.

Body Shop Equipment Paint booths, Spot Welders, MIG Welders, Panel repair

systems etc.

Wheel Servicing Equipment Wheel aligner, Wheel balancer, Tyre changer, Tyre

Inflation air, etc.

Washing Equipment Car washer, Auto car washer

Lube Equipment Grease pumps, Oil pumps, Lube management systems

Diagnostic Equipment Gas analyzer, AC recovery Semi-Automatic, AC recovery

fully automatic

Pneumatic Tools Impact wrench, Ratchet wrenchers, Drills, Disc Grinders etc.

Special Products Mobile service unit, Effluent Treatment plant.


This segment is highly fragmented and the company has established itself as amajor organized player on back of new product inclusions and superior serviceofferings. Company has grown at 15% CAGR between FY06-12 in the segment.We believe that the company is well poised to grow in the Automotive segment onaccount of 1) Indian passenger car segment growing at an average rate of 12-15%per annum and 2) launching of new passenger car models in India that is bound tofuel the demand for strengthened service network.

Automotive segment sales trend

Source: Company

International presence offers geographical diversification; favor-able Joint ventures and strategic domestic/overseas tie upsstrengthens company’s offering

In order to widen the spectrum of offerings and explore new geographies forgrowth, EEL has envisaged a strategy of entering into strategic alliances through joint ventures and acquiring companies overseas that offer strategic fitment. InEurope, company follows the strategy of acquiring multi-local companies of small tomedium size with strong brand names and market access.

Company through its subsidiaries is present in all major markets across the globewhich includes Europe, North America, Latin America, Africa, Australia, Middle

East, South East Asia, West Asia and the Far East. It has been positioning itself as aservice oriented player in order to differentiate itself in highly competitiveinternational markets.

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Automotive segment thrivesmainly on the passenger car salesand constitutes to nearly 12% of

the overall revenue pie.

For expanding inorganicallycompany has envisaged the

strategy of acquiring multi-localcompanies of small to mediumsize with strong brand names

and market access.





EEL’s Key Subsidiaries and JVs

Entity Relationship % Ownership Geography Focus Area Rationale Current Status

SAS Belair Subsidiary 100 France Assembly sales and Adding to the Company expected

service of industrial current product to grow better than

compressors, piping, range of Belair industry and break even

fittings and accessories and leveraging in next few quarters

upon its 25 yearsold presence in

European region

Elgi Equipment Subsidiary 100 China large screw compressors Highly competitive Continue investing over

Zhejiang Limited and rotary screw region, capture market next two to three years

(China)/ Elgi compressor market share in local market for long term strategic

Compressors over next two to three gains. Expected to break

Trading (Shanghai) years. Also start even in FY14.

Co. Ltd. (China) exporting to other

regions from China

in longer run.

Elgi-Gulf (FZE) Subsidiary 100 Middle East Medium range Several Indian Company has been able to

compressors finding organizations are establish itself as a

application construction engaged in the successful player and

activity construction activity earns reasonable

and they offer profits from the

reasonable opportunity middle east market.

to the company.

Elgi Sauer Joint Venture 26 India Defense, shipping, Consolidating the JV has been successful

Compressors industrial and engineering, since inception in the

Limited offshore market indigenization and year 2008.

product support Achievements in the

capabil it ies of both defense sector include

the entities building aircraft carrier

fitted with JVs state of

the art high pressure and

low pressure compressors

Adisons Precision Subsidiary 100 India

Instruments

Manufacturing

Company Limited


EEL has acquired Belair S.A – France in the year 2010 at the EV of EUR 0.7 mn.Belair S.A is engaged in assembly, sales and service of industrial compressors,piping, fittings and accessories for over 25 years. It enjoys nearly 3% share inFrench market. Management aims at adding to the current product range of Belairand has already started the complete units of Air compressors from India.

In china, EEL operates through its subsidiary Elgi Equipment (Zhejiang) Limited,Jiaxing, China. Company has been focusing on large screw compressors and rotaryscrew compressor market and expects to break even in FY14. However,management eyes Chinese market as a long term strategic investment and plans tokeep investing for over the next two to three years before it starts generatingmeaningful profits.

Company has also entered into highly attractive Brazilian market in the year 2008to tap the local market growing at meaningful rate and also to use it as a base totap neighbouring countries such as Chile, Columbia and Argentina.

EEL’s success in overseas markets in evident from the fact that a large proportion ofits international business comes from repeat sales and established customer base.Its expertise in compressed air technology, backed by an efficient manufacturingbase and competent distribution network provides competitive edge to thecompany.

A large proportion of itsinternational business comes

from repeat sales and establishedcustomer base





Currently exports constitutes to nearly 20% of company’s total revenue pie.However, given company’s new initiative in Europe, China, Brazil and Australiamarkets and eventual global economic recovery, we believe that the share ofexports is likely to increase substantially and reach 40% of total revenue pie by2015.

Sustained emphasis on research & development initiatives providescompetitive edge to the company

EEL is a technologically driven company and pays considerable amount of emphasison the research and development initiatives. It constantly ventures into newinitiative related to technological advancement. It consistently deploys resources foradding and modifying current product specifications making it valuable to the endusers.

We highlight that R&D efforts become extremely important in the highlycompetitive mid- range compressor segment where profitability is determined bythe product’s cost effectiveness.

Recently, company has launched lower end compressors ranging from 3-20 hp. The

reception of these machines have been extremely satisfactory in Indian as well as inFrance and United States.

EEL takes pride in launching world’s smallest industrial screw compressor. Lot ofdesigning and engineering excellence has gone into building an air compressor ofsuch small dimensions which is capable of supplying compressed air for industrialapplications. Also in FY12, company has successfully launched oil free screwcompressor in Indian and Chinese market. Company aims at substantially rampingup the production of these Equipment and expects to deliver over 200 units of thesame over FY13.

Company to maintain high growth in financials; higher operatingmargins and shorter cash conversion cycle likely to aid to free cash

flow generation We project 14.1% growth in revenues from Rs. 9.8 bn in FY12 to Rs. 11.2 bn in

FY13E on back of 1) pick up in the domestic infrastructure spending viz. hydro-carbons, mining, construction and water segments 2) revival in internationaldemand for compressors and 3) increased contribution from company's keyoverseas subsidiaries.

We highlight that stationary industrial air compressors and associated air treat-ment products and after market represents 60-70% of sales. Large gas and pro-cess compressors represents almost 10% and the balance is represented by por-table compressors, generators.

Revenue Trend


Within the revenue streams, we expect compressor business to grow by 15%and Automotive to grow by 7% in FY13E.

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FY10 FY11 FY12E FY13E

Revenues (Rs mn ‐ LHS) Asset Turnover (x ‐ RHS)

We project 14.1% growth inrevenues from Rs. 9.8 bn in FY12

to Rs. 11.2 bn in FY13E





Segment Revenues (Rs mn)


We expect the company to leverage its effective track record in India to expandits operations internationally. We believe that being stationed in India, companyis likely to immensely benefit from its low cost operating model providing com-petitive edge vis-à-vis peer group.

In the past few years company has recorded growth in geographies like MiddleEast, Europe, Australia and Brazil. Company is likely to break even in China inFY13E where it is present through its subsidiary.

We believe that over FY13-15E, company is likely to report significant growth inits overseas business on back of 1) increased contribution from newly addedmarkets like Brazil 2) likely inorganic initiatives, 3) expected economic recoveryin European region and 4) current lower base of exports in the overall revenuepie. However we also highlight that the company is likely to continue incur sunkcosts in overseas geographies mainly China for setting up and expanding itspresence through FY13.

We highlight that currently exports constitutes to nearly 20% of the consolidatedrevenue pie. Over the next 3-4 years, we believe that the share of exports islikely to increase to 35-40% of total revenues of the company.

We expect that the company is likely to maintain its revenue mix at current lev-els with compressor business contributing to nearly 80% of revenue pie. Weopine that the company would continue to prudently manage its overheads miti-gating any increase in input prices.

The major raw-materials used for the manufacture of compressors are castings,aluminum and steel. The major finished and semi-finished components used arebearings, crankshafts, switches, gauges, rotors and housings. The major bought-out items are motors, starters, control panels, inter and after coolers and filters.

Operating margins have contracted sharply in FY12 due to increase in inputprice and employee expense. We believe that the margins would bottom out incurrent year and build 13% EBITDA margins for FY13.

0

3000

6000

9000

12000


Compressors Auto Equip

Over the next 3-4 years, webelieve that the share of exportsis likely to increase to 35-40% of

total revenues of the company





Steel US$/t FOB Price

Source: Bloomberg

Consolidated Margin Trend


Segment EBIT Margin Trend (%)

Revenues FY11 FY12E FY13E

Compressors 7964 8287 9529

YoY % 36.6 7.5 15.0

Auto Equip 1135 1300 1391

YoY % 28.1 3.0 7.0

EBIT

Compressors 1191 790 1277

YoY % 34 (33.6) 61.6Auto Equip 127 151 181

YoY % 29.6 19.2 19.6

EBIT %

Compressors 15.0 12.1 13.4

Auto Equip 11.2 12.7 13.0


400

600

800

1000

1200

10%

12%

13%

15%

16%

0

400

800

1200

1600


EBITDA (Rs

mn

‐LHS) EBITDA

(%

‐RHS)





Compressors and auto equipment


We opine that the working capital is likely to increase marginally from current10.5% of sales to 11% in FY13E due to increase in inventory days from 42 dayscurrently to 44 days at the end of FY13.

Working capital

Rs (mn) FY11 FY12E FY13E

Net Working capital (non cash) 987 1146 1474

Net Working capital (non cash) in days 36 40 45

Current Assets 4181 4539 5160

Inventory 1148 1262 1440

inventory days 42 44 44

Sundry Debtors 11758 1233 1407

Debtors days 43 43 43

Other current assets 30 33 102

Loans and advances 1828 2011 2212

Cash 1399 1536 1702

Current liabilities 3193 3393 3686

Acceptances 244 273 296

in days 16 16 16

Sundry creditors 1258 1415 1537

in days 81 83 83

provisions 1691 1705 1852

in days 109 100 100

Source: Kotak PCG Research

We believe that going forward; with increasing share of exports company islikely to increase sensitivity between operating margins and forex fluctuations.

10.0

11.5

13.0

14.5

16.0


Compressors (%)

Auto Equip (%)





Debtor/Sales


RoE trend


We expect that the company is likely to benefit from its strong balance sheet tofuel its future growth. Stable margins and higher return on Equity at 25% areexpected to result in net operating cash flow at Rs 970 mn in FY13E vis-à-vis Rs823 mn in FY12E.

0.0%

9.0%

18.0%

27.0%

36.0%

0

400

800

1200

1600


EBIT (Rs

mn

‐LHS)) ROCE

(%

‐RHS) ROE

(%

‐RHS)

11.0

12.0

13.0

14.0

15.0

0

3000

6000

9000

12000


Revenues (Rs mn ‐ LHS) Debtors/Sales (% ‐ RHS)

Company enjoys a strong balancesheet adequate to drive its

future growth





VALUATION & RECOMMENDATION

Current valuations appear favorable vis-à-vis the potential growth in revenues drivenby pick up in the domestic infrastructure spending viz. hydrocarbons, mining,construction and water segments 2) revival in international demand for compressorsand 3) increased contribution from company’s key overseas subsidiaries.

At current price of Rs.79, stock is trading at 13.2x P/E and 7.5x EV/EBITDAmultiples on FY13E earnings.

We value the company using DCF valuation methodology that derives a pricetarget of Rs.98 per share, implying an upside of 25% over a 12- month horizon.Our DCF model employs a WACC of 13.09%, beta of 0.85 and terminal growthof 4%.

At our target price of Rs 98, stock would trade at 16.3x P/E on FY13E earnings.We highlight the P/E band below that reflects the valuation trend from the his-torical perspective.

EEL P/E Band

Source: Ace Equity, Kotak Securities-Private Client Research

We initiate coverage on the EEL stock with a BUY rating and a targetprice of Rs.98, over a 12-month horizon.

0

30

60

90

120

Oct‐08 Mar‐09 Aug‐09 Jan‐10 Jun‐10 Nov‐10 Apr‐11 Sep‐11 Feb‐12

EEL 7x 9x 11x 14x

We initiate coverage on EIL witha BUY rating and one year DCF

based target price of Rs 98





DCF valuation

Free Cash Flow to Firm

FY13E FY14E FY15E FY16E FY17E FY18E FY19E FY20E

PAT 922 1235 1551 1871 2132 2528 2838 2981

Add Depreciation 145 150 155 160 166 172 178 184Add Int (Net of Tax) (34) (32) (31) (30) (29) (30) (31) (32)

Less change in WC (328) (42) (303) (364) (393) (464) (365) (170)

Less incremental Capex (400) (150) (150) (150) (150) (150) (160) (160)

FCFF 305 1160 1222 1488 1726 2056 2460 2804

Discounting Factor 1.0 0.9 0.8 0.7 0.6 0.6 0.5 0.4

Discounted Value (FCFF) 313 1053 980 1055 1082 1140 1206 1215

Source: Kotak Securities-Private Client Research

Sensitivity Analysis

12.00% 13.00% 13.39% 14.00% 15.00%

2.50% 103.29 93.45 90.18 85.58 79.17

3.00% 105.77 95.26 91.79 86.93 80.18

3.50% 108.54 97.26 93.56 88.40 81.28

4.00% 111.66 99.47 95.51 90.01 82.49

4.50% 115.20 101.95 97.69 91.80 83.80

5.00% 119.24 104.74 100.12 93.78 85.25

5.50% 123.90 107.90 102.86 96.00 86.85

Source: Kotak Securities-Private Client Research

Assumptions

Adjusted beta 0.9Risk free rate 8.0

Risk premium 6.0

Cost of equity% 13.1

Cost of debt% 7.0

WACC% 13.1

Equity(Rs mn) 3383

Debt (Rs mn) 50

Total (Rs mn) 3433

Source: Kotak Securities - Private Client

Research

DCF Summary (Rs mn)

FCFF 8244Terminal Value 6025

Total FCFF 14268

Less net debt (1349)

Shareholder's value 15617

Value per share 98

Terminal value as % of FCFF 42.2

Source: Kotak Securities - Private Client

Research





Business review Q4FY12; revenue grew by 7% YoY driven by turnkeyprojects division, PAT grew by 23% YoY

Company's consolidated revenues for Q4FY12 grew by 7% YoY at Rs 2.7 bn &EBITDA declined by 10% YoY at Rs.262 mn. EBITDA margins stood at 9.7% in thequarter against 12.2% last year. Margins declined on account of 1) 12% YoYincrease in input prices and 2) substantial increase of 27% in employee expense.

EBIT margins for Compressor segment contracted to 8% in the quarter. Automotivesegment has observed margins and at 11% vis-à-vis 6.8 % in Q4FY11.

Management has stated that the company has been observing some signs of revivalin the domestic demand. While Europe markets were sluggish in Q4FY12, USmarket has been observing revival in demand for compressors.

Company is likely to break even in China in FY13; however meaningful contributionis expected not before FY14. Management aims as establishing itself as a long termvalue player in highly competitive Chinese markets and expects to continueinvesting Capital for next two to three years.

Company enjoys strong balance sheet and have reported a PAT of Rs 211 mn in the

quarter.

EEL Consolidated Result for Q4FY12

(Rs mn) Q4FY12 Q4FY11 YoY (%)

Income from Operations 2709 2435 11.2

Decrease/ (Increase) in stock (28) (12) 134.7

Material consumed 1648 1469 12.2

Employee expenses 319 250 27.4

Other expenses 509 436 16.7

Total Expenses 2447 2143 14.2

EBITDA 262 292 (10.3)

Other income 66 37 77.8

Depreciation 38 34 9.3

EBIT 290 295 (1.5)

Net Interest 2 2

PBT 288 293 (1.6)

Total tax 77 112 (31.3)

PAT 211 181 16.8

EPS (Rs) 1.3 0.8 58.2

EBITDA% 9.7 12.0

Tax Rate % 26.7 38.3

Source: Company

Segmental table

Q4FY12 Q4FY11 YoY (%)

Segment Revenue (Rs mn)

Compressors 2284 2023 12.9

Automotive Equipment 345 309 11.7

Segment EBIT

Compressors 182 243 (25.2)

Automotive Equipment 41 21 94.7

Segment Margins %

Compressors 8.0 12.0

Automotive Equipment 11.8 6.8

Source: Company





KEY CONCERNS

Sharp increase in raw material prices

Sharp increase in the raw material prices especially steel and aluminum wouldnegatively affect company’s profitability. In our estimates, we build a moderate

increase in key raw material costs which is likely to get absorbed by the companyachieving economies of scale going ahead.

Increasing competition

Low HP (< 20 HP) compressor segment is highly fragmented and there exists stiffcompetition between various players both from unorganized sector and organizedplayers. In large HP category, company faces competition mainly from multi-national players. We believe that the company has grown commendably in the pastamidst higher competitive intensity in the industry and is likely to maintainmeaningful growth going ahead.

Slowdown in domestic industrial activity

Compressor segment growth is highly correlated with the overall economic activitymainly mining, hydrocarbon, transport, power, oil, railways etc. Any slowdown inthe industrial capex program would imply lower off take of company’s products.





FINANCIALS

Profit and Loss Statement (Rs mn)

(Year-end March) FY11 FY12E FY13E

Revenues 9,390 9,897 11,267% change yoy 39.8 4.8 14.1

EBITDA 1,411 1,083 1,484

% change yoy 34.3 (23.3) 37.1

Depreciation 115 132 145

EBIT 1,297 951 1,340

% change yoy 35.9 (26.6) 40.8

Net Interest 4 7 (50)

Earnings Before Tax 1,410 1,106 1,417

% change yoy 38.1 (21.6) 28.0

Tax 472 350 467

as % of EBT 34.6 31.7 33.0

XO Items 49 0 0

Recurring PAT 890 756 949

% change yoy 34.8 (15.1) 25.5

Shares outstanding (m) 158.5 158.5 158.5

EPS (Rs) 5.6 4.8 6.0

DPS (Rs) 1.0 1.0 1.1

CEPS 6.3 5.6 6.9


Cash Flow Statement (Rs mn)


Profit Before Tax 1,410 1,106 1,417

Add:

Depreciation 115 132 145

Current liabilities incl provisions 697 200 292

inc in inventory 361 115 178

inc in sundry Debtors 269 58 174

inc in advances 488 183 201

Tax Paid 472 350 467

Other Adjustments 8 3 69

Net cash from operations 625 729 765

less:

Purchase of fixed Assets (235) (400) (400)

Net investments - - -

Net cash from investing (248) (401) (400)

secured 23 0 -

unsecured (1) - -

Dividend Paid (184) (191) (200)

Net Cash from financing activities (162) (191) (200)

Net Cash Flow 215 137 166

Cash at the end of year 1,406 1,536 1,702


Balance sheet (Rs mn)


Balance sheet (Rs m) FY11 FY12(E) FY13(E)Cash and cash equivalents 1,399 1,536 1,702

Accounts receivable 1,175 1,233 1,407

Loans & advances 1,828 2,011 2,212

Inventories 1,148 1,262 1,440

Misc expenditure - - -

Current Assets 4,181 4,539 5,160

WIP 987 1,146 1,474

LT investments 173 173 173

Net fixed assets 844 1,112 1,367

Total Assets 3,455 4,020 4,769

Provisions 1,691 1,705 1,852

Current Liabilities 3,193 3,393 3,686

Minority Interest - - -

LT debt 50 50 50

Other liabilities(deferred tax) 31 31 31

Equity & reserves 3,383 3,948 4,697

Total Liabilities 3,464 4,028 4,778

BVPS (Rs) 21 25 30


Ratio Analysis


EBITDA margin (%) 15.0 10.9 13.2

EBIT margin (%) 13.8 9.6 11.9

Net profit margin (%) 9.5 7.6 8.4

Adjusted EPS growth (%) 34.8 (15.1) 25.5

Receivables (days) 43.0 43.0 43.0

Inventory (days) 41.9 44.0 44.0

Sales / Net Fixed Assets (x) 4.9 4.4 4.3

Interest coverage (x) N.M N.M N.M

Debt/ equity ratio 0.0 0.0 0.0

ROE (%) 29.6 20.6 22.0

ROCE (%) 32.7 23.7 24.8

EV/ Sales 1.2 1.1 1.0

EV/EBITDA 7.9 10.3 7.5

Price to earnings (P/E) 14.1 16.6 13.2

Price to book value (P/B) 3.7 3.2 2.7

Price to cash earnings 12.5 14.1 11.4





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