Greaves cotton manufactures diesel engines, generator sets and construction equipment. Over the past three years, the company has recorded more than 50% compounded annual growth rate (CAGR) in its profits. Various business restructuring processes over the past few years have also aided the company’s profitability. The stock is currently trading at a P/E of around 15, which is at a significant discount to its peers, such as Kirloskar Oil Engines (KOEL) and Cummins. Despite the expected stagnation in sales from Piaggio, a major customer of the company, the stock looks undervalued and can be expected to get re-rated soon.

Business
The company’s business is divided into two main segments — engines and infrastructure equipment. The former has been the growth driver, contributing around 78% of revenues for the year till March ’07, though its share has fallen over the past year. Currently, the company manufactures about 300,000 units, and boasts of a capacity utilisation of more than 90%. In the past few years, the company has sold its gears/coupling business and oilfield & drilling business, which has helped it to focus on core areas.

Though the company has not been an active player in the exports market so far, it recently acquired a diesel engine manufacturing company in Germany for Rs 25 crore. The acquired company had an annual turnover of around Rs 50 crore, but had low capacity utilisation. The acquisition offers an existing network, which can help Greaves Cotton expand fast in the European market.

The company suffered a setback with Piaggio’s decision to set up a diesel engine manufacturing plant in India, which is expected to be operational in ’10. Piaggio is a major customer for the company, accounting for about 25-30% of its sales. But Piaggio plans to source about 40% of its requirement from Greaves Cotton after the plant becomes operational, which is equivalent to current supply.

Financials
For the nine months ended March ’07 (Greaves Cotton’s financial year ends in June), sales rose 36% to Rs 933 crore. While raw material costs increased 41%, total expenditure grew less sharply as other expenses, including employee costs, did not rise as fast. This, coupled with lower taxes and depreciation, boosted the net profit by 54%. The company’s net margin (excluding extraordinary items) over the past few years has gone up to over 9% from 6% due to improving operating performance.

Within segments, the engines unit grew by 30%, while infrastructure division rose 84%. Profit growth for the two segments is even more diverse at 30% and 136%, respectively. The infrastructure unit has increased its contribution in profits from about 8% to 14% over last year. However, the engines segment is still more profitable with a margin of 16.5%, against 13.4 % for the infrastructure segment. Infrastructure equipment has been a thrust area for the company. Greaves Cotton recently commissioned another plant in Chennai.

Outlook
Both segments of the company look quite attractive. The increased thrust on infrastructure is expected to help the company reduce the impact of loss of business from Piaggio. The thrust should pay off handsomely as construction equipment is in demand with all-round infrastructure development. The stock looks attractively priced and is still undervalued. Investors may expect significant gains in the next 12-15 months.