AIA Engineering: Buy

>> Sunday, April 12, 2009

Investors can consider buying the stock of AIA Engineering, the world’s second largest manufacturer of high-chrome mill internals. Our recommendation stems from the steady demand for AIA’s products from cement companies, both domestic and global, as also the revival of enquiries from the mining sector. Production cuts taken by some of its potential clients in the mining sector had earlier limited AIA’s revenue opportunities.

AIA, with a dominant presence in the domestic and overseas markets, appears well-placed to leverage from the revival in demand from the mining sector. At the current market price of Rs 163, the stock trades at about 9 times its likely FY-10 per share earnings.

While valuations are at a premium to capital goods stocks, that AIA is the only listed player in this space justifies its premium. However, given the recent surge in the markets, investors may be better off phasing out their exposure to this stock over a period of time.

Demand boosters

AIA specialises in design, manufacture, installation and servicing of high-chrome mill internals (which find application in cement, mining and thermal power industries). The demand for AIA’s products stems primarily from the switch in the user industries’ preference to high-chrome mill internals against the conventional forged ones.

This leaves plenty of room for growth as the current share of high-chrome mill internals stands at only about 15 per cent of the total demand. High-chrome mill internals, which are used to grind clinker in cement mills; coal in thermal power plants and mineral ore in mines are likely to attract higher demand in the coming years as they offer higher productivity, greater control over grinding process, lower power consumption and lower wear rates.

Demand for AIA’s products may also derive strength from the fact that there has not been any major scaling down in capex plans by the cement majors.

While sustained capex may help keep the demand from the cement sector strong (the sector is the primary revenue contributor for AIA), a good part of the company’s overall business (nearly 70 per cent) comes from replacement demand. That, to an extent, insulates AIA’s revenues from any sharp slowdown in its user industry’s capital spending cycle.

Besides, AIA is also looking to increase the share of its revenues from the mining sector. This appears to hold promise, as the market potential in this sector is immense, while competition is limited. Besides, it also plans to tap global market in this space. Trends in order inflows from the mining sector, therefore, may bear a close watch in the coming quarters.

Going slow on expansion

While the company had earlier gone in for a large capacity expansion programme, it has in conformity with the current market scenario toned its capex plans considerably. The second phase of its capacity expansion plan (100,000 tonnes) is now under review. AIA now plans to incur limited capex that will entail only the de-bottlenecking its current capacity. This appears prudent, as it will help the company conserve its cash.

Earnings scorecard

For the quarter ended December 08, AIA managed to report a 45 per cent growth in consolidated revenues, helped primarily by the new capacities it had added last May as also an improvement in its realisations. In terms of sales break up, exports made up for 57 per cent of its revenues and domestic sales the rest.

The cement sector continued to be the lead contributor, making up a good 65 per cent of its total sales. Utilities and mining segment made up for 25 per cent and 10 per cent respectively. But revenues in the coming year may be more or less flat as the management expects realisations to drop, led by the correction in raw material prices, even as it expects an increase in sales volumes.

Operating margins for the quarter, however, dropped by about 2.2 percentage points to 25.5 per cent, driven by a high base effect (as the company had initiated price hikes last year) and then prevalent high raw material prices. Net profit growth was pegged at about 17 per cent. HBL