Greaves Cotton stays a step ahead with focus on 4-wheeler engines

Greaves Cotton Ltd, one of the leading engineering companies manufacturing diesel engines, agro equipment and construction equipment, is expected to maintain its strong growth momentum on the back of stable commercial activities and huge infrastructure spend planned in the coming years.

Business: Greaves Cotton engages in manufacturing and marketing of various industrial products in India. The company’s business can be divided into two broad segments — engines and infrastructure equipment.

The engines segment is the main earnings contributor with almost 85% of revenues and 92% of profits. It has four business divisions — agro equipment, automotive, auxiliary power and industrial engines.

Automotive engines is the largest business division manufacturing light weight fuel efficient (single and twin cylinders) diesel engines for three-wheelers and light commercial vehicles (LCVs).

The infrastructure segment contributes almost 12% to the revenues. This includes construction equipment division that manufactures and markets batching plants, concrete pumps and concrete mixers for the construction industry and vibratory rollers for asphalt & soil compaction.

Greaves Cotton has nine manufacturing units across India, two offices in UK and China and one subsidiary in Germany.

Investment rationale: Three-wheeler market has been growing at a compounded annual growth rate of over 10% over the last five years. Greaves Cotton supplies mono engines for three-wheelers with over 80% market share. 

Also, a large number of original equipment manufacturers (OEMs) are coming out with smaller LCVs for transporting goods to shorter distances.

Greaves Cotton has started to increase its focus on developing engines for four-wheelers and has recently got orders from Tata’s new half-tonne mini truck ‘Ace Zip’.

The company has signed long-term contracts with manufacturers like Piaggio, Tata Motors and M&M for supplying mono engines apart from supplying to 40 other companies on spot basis.

The company, being a sole supplier to Piaggio for its three-wheeler division apart from supplying diesel engines for its four-wheeler models, gets almost 25-30% revenues from Piaggio alone.

These long-term contracts ensure steady revenue stream over the next several years as the company derives almost 70% revenues from the automotive segment.

The company which produces more than 3 lakh automotive engines annually is also setting up capacity to manufacture 80,000 engines at Aurangabad.

Greaves Cotton would benefit from the increased focus on irrigation projects and agriculture apart from seeing demand for its gensets.

The construction equipment division, which was making losses over the last several quarters, has also started to see turnaround and is expected to start contributing from the next quarter.

The company has a good track record with high return ratios and consistent financial growth performance. Greaves Cotton, which has a strong balance-sheet with almost zero debt, is well equipped to undertake future growth opportunities as well.

Concerns: The company faces risk of high input commodity prices even though it has been able to pass on price hikes to OEMs. Also, rising interest rates and tight liquidity conditions may affect the demand for engines and construction equipment.

Valuations: The company revenues are expected to grow at a compound annual growth rate of 19% from fiscals 2010 to 2012 on strong demand for diesel engines for three-wheelers and LCVs and higher infrastructure spend leading to increased sales of construction equipment.

Net profits are expected to grow over 29% during the period, led by stable operating margins as the infrastructure segment starts contributing to bottomline once again.

At current market price of Rs87.30, the company’s stock trades at 13.6 times its expected fiscal 2011 earnings per share and 10.8 times its expected fiscal 2012 earnings.

Considering its consistent operational performance, high return ratios and strong balance-sheet, investors can consider the stock at current levels from medium- to long-term perspective.

Disclaimer: The writer does not hold any shares in the company.