It Is Time For Profit - GEI Industrial Systems

The next World War will be over water,” Ismail Serageldin, the former World Bank’s vice president once said. Therefore, any company engaged in the conservation of these precious natural resources should do well and will get adequately rewarded at the bourses. GEI Industrial Systems (GEI), a company that is doing its part for environment protection, has already seen its share prices more than double on a year-till-date basis and this has tripled in the last one year. GEI is an engineering and manufacturing company with specialisation in heat transfer technology. It manufactures air-cooled heat exchangers (ACHE), air-cooled steam condensers (ACSC), and other allied products used in critical applications in oil refineries and thermal power & gas transmission projects. GEI, established in 1970, has come a long way from being a vendor to BHEL, Bhopal to achieving market leadership in ACHEs and ACSCs.

Currently the market for GEI’s products is less as compared to that for water-cooled heat exchangers and condensers. “The product has taken its own sweet time to get accepted but now an increasing number of our potential clients are getting convinced about the efficacy of ACHEs and ACSCs,” says C E Fernandes, CMD, GEI in response to a query about the market size of the company’s product. Currently 40 power stations are working on air-cooling systems, installed by GEI and many more projects are under execution.  However, going forward we feel that the demand for ACHEs and ACSCs will increase in tune with the rising awareness. Of further impetus will be the huge capacity addition in power generation lined up by the government in the 11th and 12th five-year plans.

With the thermal segment contributing a lion’s share of more than 70 per cent of such capacity addition, the demand for GEI’s products will naturally shoot upwards. Even if we consider the sub-critical, medium and smaller-sized power plants where the product is well-tested, we find the potential for a huge market waiting in the wings. “That apart, what will help the company grow its business is the ban on the use of ground water by some state governments for cooling purposes in view of water scarcity,” Fernandes states. One of the factors that might be limiting the company’s product market is its higher capital cost compared to the water-cooled systems. However, when the cost is compared on a system-to-system basis with the inclusion of operating costs, it is found that air-cooled systems’ benefits exceed those of the water-cooled systems over a project’s lifetime.[PAGE BREAK]

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As for the company’s operations, it mainly focuses on three verticals i.e oil refining, gas processing, and power generation. For FY10, oil & gas contributed 30 per cent whereas the power segment contributed 70 per cent to its total revenue. The company’s clients in the oil & gas sector are ONGC, IOCL, etc and in the power sector these are companies with captive power plants such as Shree Cements, Jaypee Group, etc. In response to a question about how this revenue mix will change in the coming years, Fernandes says, “It will remain in the same proportion as very few new refineries are going to be set up in the next few years.” The order in this segment will essentially come from de-bottlenecking, modernisation, etc. of the existing plant.

Even the current order book reflects this position. Out of the total orders, more than 60 per cent are from the power sector and the rest from the oil & gas segment. When we dissect the order book from the company’s product angle, it is the ACSCs that dominate with 61 per cent of the total orders followed by ACHEs with 35 per cent and other products taking up the balance 4 per cent. The company is a market leader in both the products with 70 per cent market share in ACSCs and 45 per cent in ACHEs. ACSCs are primarily used in power plants whereas ACHEs are used in the oil & gas sector.

Capex
Currently the company is operating at 100 per cent capacity and to fulfill the growing demand for the company’s product it is in the mid of a three-phase expansion plan. Phase 1 has already been completed while Phase 2 and Phase 3 will be concluded by October and the end of FY11 respectively. The entire cost of capex is Rs 70 crore which will partially be raised through internal accruals (20-25 per cent) and the rest through debts. Once the capex is completed, it will help the company to serve power plants of 2,000 MW to 5,000 MW per annum.

Growth
Until now the company was essentially catering to the smaller part of the balance of plant (BOP) infrastructure of a power plant but now, through its 100 per cent subsidiary, GEI Power has entered into turnkey EPC (engineering, procurement and construction) contracts for small and medium-sized thermal power plants. The company has even booked an order in this segment. In future, this will be one of the growth engines for the company. The EPC business will grow due to its competitive edge of having the capability to manufacture a major portion of the BOP equipment.[PAGE BREAK]

Financials
The company’s topline has grown by 38 per cent CAGR in five years ending FY10 and bottomline by 39 per cent. Nevertheless, what is worth mentioning is that the total assets have grown by just 24 per cent in the same time, which means better utilisation of the employed capital. We feel that the company will maintain its growth momentum as the new capacity addition will help it to reach out and add new clients. For Q1FY11 the company posted sales of Rs 50.33 crore, higher by 29 per cent last year same time. However, there is a huge jump in net profit by 50 per cent due to an increase in ‘other’ income and lower interest cost. But the one factor for concern is the rise in commodity prices that has increased the cost of raw material as a percentage of sales from 65 per cent (Q1FY10) to 74 per cent of sales (Q1FY11).
As regards the company’s valuation, it is currently trading at 16 times its last 12-month earnings. This is not cheap but taking into account the growth of the company at more than 30 per cent in the last five years and the potential that lies ahead, we feel that it is under-valued. The current order book of almost two times the revenue of FY10 provides good earning visibility. Therefore, our suggestion to readers is to invest in the counter with more than a one-year horizon with a potential upside of 20-25 per cent from its current level of Rs 160.