Good Business Good Returns - Hindustan Dorr Oliver

Environmental engineering solutions company Hindustan Dorr Oliver (HDO) operates in a niche segment which provides abundant growth opportunities. After coming within the fold of IVRCL Group, HDO has been making rapid strides in the environmental engineering space and also other areas of its engagements. It has made sustained investments in metal and process industries and is set to capitalize on strong order placements. At FY08 end, it had pending orders running into Rs 740 crore, which gives it a good revenue visibility. It also gives it a 2x jump over FY08 revenues.

HDO leveraging its technological base has entered the knowledge process outsourcing (KPO) business. It has also set its sight on EPC, manufacturing and special engineering services. In these areas as well given its background, the company has high growth opportunities.

In terms of current valuation, the scrip is well placed. At a current market price of Rs 79.70, it discounts its FY09E earnings by 8.40x, which provides scope for further upward movement. Its market cap-to-sales ratio of 0.57 is less than its peer, making it an undervalued counter. Even the EV/EBITDA of 4.23x – compared to industry average of more than 7x – makes it more lucrative. But what it most clinching is its debt-free status in the current scenario of rising interest rate cost. We recommend investors to buy the scrip at current levels with a target price of Rs 110 in the next one year.

Venture Spheres
The company’s engineering ventures can be broadly divided into segments of mineral beneficiation, environment management, fertilizers and pulp and paper.  In FY08, mineral beneficiation contributed 29 percent to the total revenues, Environment management 24 per cent, special projects24 per cent and equipment manufacturing17 per cent. The balance revenue comes from its other business streams.

Under the IVRCL umbrella, HDO has initiated streamlining of its businesses. The focus is on operational excellence, cost, and quality and on-time performance. The reprocessing is helping HDO make faster decisions, increase through-put, dispatch and commissioning schedules. It has also allowed it to upgrade business processes to match the changing business dynamics and, most importantly, increase its margins.[PAGE BREAK]

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Commenting on current margins, Sekaran (Exicutive Director, HDO) says, “In the mineral business, margins have been around 18-20 per cent, in environment it is around 10- 12 per cent and in fertilizers it is around 20-22 per cent. In manufacturing, which we are concentrating on, it is between 15 and 20 per cent.”

It is certainly remarkable that even amid rising raw material prices, HDO has managed to improve its margins. According to the management,  “Margins have expanded mainly in mineral benefication because of Nalco project and in fertilizer because of RCF project.” The management is quite confident of maintaining its margins going forward. “This year, we had seen EBITDA margin of around 11 per cent. Next year, we should see around 1-1.5 per cent increase in EBITDA margin.”

Mineral Goldmine
HDO has bagged large mineral beneficiation orders in the past. Execution of such large orders, which need to be executed in a short period, has led to improvements in the company’s competence and capability as also its technology deployments. Timely execution of projects has ensured many repeat orders. With a robust growth in the Indian economy, the demand for metal commodities has been on the rise. We foresee heightened activity in the domestic mining and metal sector.

HDO has also been a long-term player in water and waste water treatment plant market in India and has executed projects for core sector industries like refineries, process chemical, steel, fertilizer and pulp and paper. The water infrastructure market in India has been consistently growing in the last few years. The Indian government has identified these needs and is taking steps to address them by way of increased funding through central government grants. Many municipal corporations and state governments are planning projects with funding from international agencies like World Bank, Asian Development Bank and JBIC, providing huge opportunities for the company.

In the area of phosphate-based fertilizers, HDO has executed most mineral beneficiation plants for this fertilizer in the country.

Order-Book Visibility
At current levels, the company’s order book stands at Rs 740 crore. According to the management,  “Our environmental and mineral beneficiation account for Rs 300 crore and Rs 370 crore respectively, while paper, fertilizers and water business account for another Rs 75 crore.” As regards the order-book, HDO has also made a bid for projects of than Rs 1,000 crore. The advantage here is that most of the orders are from existing clients or clients whom HDO has served earlier. It gives it an edge over the others.[PAGE BREAK]

HDO has been a pioneer in the field of solid-liquid separation, and is recognized globally. To leverage the advantage, HDO plans to exploit this to reach out to MNCs for their design, engineering, procurement and manufacturing requirements. The company has assessed an outsourcing potential of Rs 50 crore on an annual basis from equipment manufacturing.

Capex Rollouts
HDO spent Rs 9 crore in FY08 to expand its capacity at Vatva (Ahmedabad) plant. It next plans to spend Rs 50 crore in FY09 through internal approvals. HDO’s financial performance has been good. It has posted a consistent topline and bottomline growth in the last four years. In FY08, it posted a topline of Rs 305.07 crore and a bottomline of Rs 22.69 crore as against Rs214.59 crore and Rs 15.36 crore respectively in FY07. Considering the order backlog, in FY09 it is expected to post a topline of Rs 495 crore and a bottomline of Rs 34.20 crore, resulting into an EPS of Rs 9.50. Based on this, CMP discounts FY09E earnings by 8.40x, giving scope for further upward movement. We recommend investors to buy the scrip at current levels, with a one-year target price of Rs 110.