Areva T&D India: Buy


The company's technology-focussed approach is likely to earn higher margins.




Hiving off non-core businesses and focus on T&D has improved profitability. Vidya Bala

Areva T&D is well-equipped to demonstrate its competitiveness in the transmission and distribution market in the country. Steady market leadership in key high-end products, ability to introduce new products/technology, focus on T&D business by hiving off non-core businesses and merger of group companies with T&D related businesses have provided a strong base to capitalise on the T&D investments in the country. Capacity expansion plans, outsourced projects from the foreign parent and strong order-book position lend visibility to the company's earnings.

At the current market price, the stock trades at 19 times its expected earnings for CY-09. Investment with a three-year perspective will allow capacity expansions to fully translate into revenues. A longer time-frame may also help weather the turbulence in stock markets. Invest in small lots and accumulate on weakness linked to broad markets.

First-mover in technology

Areva has many 'firsts' to its credit, thus gaining market leadership in a number of products; The company commissioned India's first Extra High Voltage substation of 765 kV for NTPC in 2007. It built the largest power generating transformer for Reliance Energy in the same year. It is also a market leader in GIS (Gas Insulated Switchgear) substation. GIS are much more compact as they occupy significantly lesser space compared to AIS (Air Insulted Switchgear). Given the demand for space in the country, the company quickly capitalised on this need especially in urban substations. Areva is also expanding capacities for the high voltage transformers and GIS switchgears to cater to the growing market and retain leadership position.

Such strategic moves have led to operating profit margins climbing from less than 5 per cent in 2005 to about 11 per cent in 2007.

This first-mover advantage has not only fetched higher margins for the company but also enabled it to retain clients.

In the power transformer space, the company has a mix of Government and private sector clients. The company has been approved for supply of equipment for three of the ultra mega power projects and has other private sector clients such as Lanco and Adani Group. Similarly, the company's distribution transformers and industrial transformers have takers such as the Tatas (for the Nano plant) and Jaypee Associates.

Focus on profitability

Areva's endeavour to focus on profitable businesses was evident from its move to hive off non-core less profitable businesses a couple of years ago, and instead consolidate group companies in the T&D space.

As an extension of this strategy and in line with the parent's global strategy, the company has become choosy on the nature of projects it undertakes even within the T&D space.

It has decided to stay out of rural electrification projects, which requires relatively lower technology and involves dealing with local contractors. It has instead remained focussed on products that operate on higher technology such as the one supplied to NTPC or Reliance Power.

While the company may be losing out on some opportunities in the local market, we believe the technology-focussed approach would benefit the company over the long term, as the larger power generation facilities to be set up in the country would require high-end products.

The profit margins would also be less dependent on volumes and more reliant on the product and its competitive edge. Profitability may, therefore, show more resilience in times of slowdown in order flows.

Expansion

Areva plans to double its capacity over the next two years with Rs 700 crore investments in Greenfield projects. The expansion move appears timely as the company, apart from catering to local demand, has also started receiving outsourced orders from its parent.

The company has recently won an outsourcing order worth Rs 560 crore (17 per cent of the value of order bagged by the parent in Qatar) for GIS. This would be exported from the new plant coming up in Padappai, Chennai. Support from the parent is likely to ensure better geographic diversification.

Areva's net profits grew by 115 per cent over the three years ended CY-07 aided by restructuring. While the current order-book of over Rs 3,000 crore is likely to translate into healthy earnings growth, the sharp growth witnessed in earlier years is unlikely to repeat itself.