Equity Research: Kirloskar Oil Engines

Summary

Kirloskar Oil Engines Ltd. (KOEL), a leading diesel genset player with dominant market share of 24%. KOEL has developed strong manufacturing base with eight manufacturing facilities and presence across thirty countries.

 ABOUT: -

• Kirloskar Oil Engines Ltd. (KOEL), a leading diesel genset player with dominant market share of 24%. KOEL has developed a strong manufacturing base with eight manufacturing facilities and presence across thirty countries. KOEL develops and offers indigenous engines for agriculture, genset, and industrial off highway equipment segments, also in the coming years KOEL focus on diversified businesses such as water management, bio waste management, induction motors, and firefighting pumps with an aim of decreasing its reliance on diesel engines from 80% to 60% over the next five years.

• Manufacturing facilities: KOEL has eight facilities with a workforce of more than 2,100 employees. The company has set-up manufacturing units in India at Pune, Nashik, Kolhapur, Rajkot, and Bhare.

• Market Position

• India’s largest Industrial Engine manufacturer with over 40,000 engines manufactured annually.

• India’s largest diesel Agri engines and pump sets manufacturer with over 1,45,000 units manufactured annually.

SEGMENT:-

• Prime power solutions

The segment consists of power generation, industrial engine segments and associated customer support services. KOEL manufactures both air-cooled and liquid-cooled engines (Diesel, Petrol and Natural Gas) and gensets. The segment caters to 35+ sectors with quality diesel engines powering more than 85 applications.

• Water management solutions 

KOEL’s water management solution unit offers a wide array of products for domestic, commercial and agricultural use. Over the years, they have established a strong brand name in the agricultural pump segment with a significant market share.The company manufactures and supplies quality diesel engines used for powering various agricultural applications.They also manufacture and sell an electric variant of the pump sets. 

• Farm mechanisation solutions

KOEL farm mechanisation range is created to realise the Company’s vision of empowering the world’s small and marginal farmers, with innovative farm machines. They design products based on consumer insight, thus making them more ergonomic and efficient, which help farmers to improve their productivity. Their products are designed to meet farmers' unmet demands for safety, comfort, and affordable productivity.

• Institutional and project solutions (IPS) 

Through IPS, formerly known as the large engine business, KOEL supply a range of products to the defence (Army, Airforce and Navy) and commercial marine sector including energy systems, gensets, vehicle repowering and propulsion engines.The company operate as the system integrator and provide end-to-end solutions to our key customers.

• International business 

KOEL offers products and services to more than 30 countries across the globe. They have seen significant organic growth in the business in the last five years and expect thier new products to further drive business growth.

• Financial services business 

Through the financial service business, we focus on providing structured-term financing solutions to corporates and financial loans to Micro, Small and Medium Enterprise (MSME) borrowers in India. This business comes under Arka Financial Holdings Private Limited. Arka Fincap Limited (Formerly known as Kirloskar Capital) is licensed by the RBI as a Systemically Important Lending NBFC (Non-Banking Finance Company). The growth of the business is built on robust digital credit assessment and concrete digital onboarding for a faster TAT (Turn Around Time) and a fast tracked disbursement process.

SHAREHOLDING PATTERN:

KEY BUSINESS & GROWTH DRIVERS

• Key end market recovery provides a fillip to domestic sales: - Post lockdown, as economic activity resumed, end markets have registered a strong comeback which has helped KOEL register 21% YoY growth in FY22.

• Powergen: Over FY14-20, KOEL registered 64% YoY growth in 1QFY22 in the power generation segment supported by demand recovery in areas of real estate, hospitality, and construction. KOEL has forayed into the HHP segment and is enhancing its range to 1500 KVA in order to tap data center opportunity

• Real estate on recovery mode post sharp decline in CY21. IT/ ITES accounts for 27%, followed by the co-working segment with 17% transactions, and BFSI at 15%. Vacancy, which peaked at 20% in CY12, bottomed out at 11% in CY17 and has reached 17% levels in 1HCY22

• Outlook: Commercial market has been on a growth trajectory for the last four years and reached a peak in CY19, which saw net absorption at a new high of 46.5 mn sq. ft. and new completion reaching the 50 mn sq. ft. mark.

• Residential real estate Even residential real estate has witnessed massive improvement post the sharp decline witnessed in CY20. Both new launches as well as sales have recovered smartly and have reached pre-Covid-19 levels

• Industrial: KOEL's domestic sales growth over FY14-22 KOEL is a preferred vendor for many leading construction equipment players, both in the local as well as global markets, and thus pick-up in infrastructure spending augurs well for KOEL.

• Powergen gains market share in the UHP segment; plans to increase range: - Business inquiries in this segment continue to remain healthy due to strong demand in the MHP segment, where KOEL is the market leader. In order to plug the product gap, KOEL plans to develop a 1500KVA+ portfolio (current portfolio at 1000KVA), which will help it tap the data center segment.

• Industrial engines to witness a surge in demand driven by infra. spend from a pre-buying surge of industrial engines in 2HFY21 due to the transition from BS-IV to VI emission norms, there has been a moderation in demand thereafter.

• Various factors converge to provide impetus to KOEL's Agri portfolio better availability of power has subsequently increased demand for electric pumps, which it sells through the acquired brand LGM and under its own brand name.

• New firefighting engines, CPCB IV norms to aid export growth KOE export contributes 9% to its revenue. The transition to CPCB IV norms will not only help KOEL further improve its export contribution in the medium to long term but also bring India's power generation portfolio to par with global emission control standards.

FINANCIALS

KOEL's FY21 domestic sales declined sharply by 20% YoY impacted by Covid-19 led business challenges and weak demand from end user markets. However, post lock down, as economic activity resumed, end markets have registered a strong comeback which has helped KOEL register 21% YoY growth in FY22. Sectors like commercial reality (IT/ ITES, e-commerce, manufacturing), infrastructure, and hospitality have started to see growth, which should help the company deliver 14% domestic growth over FY22-24E.

Financial Analysis

• Demand momentum to push revenue to 14% CAGR over FY22-23 An under-performance was witnessed in FY21, which was impacted by Covid-19 impacted sluggish CAPEX activity. For KOEL, revenue growth over FY14-22 stood muted at 5% CAGR.

• Margin improvement leads to 31% op. profit CAGR over FY22- The company witnessed EBIDTA decline by 5% in FY22 despite 22% YoY growth in revenue impacted by a sharp increase in input cost.

• Net profit to register 43% CAGR over FY22 KOEL profitability has been under pressure on account of weak demand from end markets, intense competition, and input cost pressure over the last two years, which has led to its net profit registering -3% CAGR over FY14-22E.

• Robust cash generation model strengthens cash position KOEL has developed a very robust cash flow generating business model, generating FCF of INR 3.3 bn annually over FY17-22 supported by low working capital requirement (15 days in FY22) high cash flow conversion ratio (OCF/ EBIDTA) of 86%. A combination of all these factors has helped KOEL generate a strong FCF and cash balance.

• Return ratios mediocre, expected to brighten as business env. gains momentum- KOEL RoE/ RoCE profile at 7%/ 10% for FY22 looks sub-par given, the subdued business environment and operational performance over the last 10 years and large quantum of cash and cash equivalents sitting on the balance sheet.

ANALYST COMMENT:

Given the muted sales and earnings growth trajectory that KOEL has exhibited historically, coupled with a rejig of its senior management and capital allocation to NBFC arm (ARKA Fincap) worth INR 10 bn, the company has seen multiple valuation derating, leading to it trading at a sharp discount to its competitor, Cummins (trades at 30x its FY24EPS). We believe that a sharp correction pertaining to these issues provide good entry point, as KOEL plans to reduce dependence on diesel engines from current 80% to 60%. This it plans to achieve by venturing into new business areas, which will help expand its addressable market and support future growth. Wr assign "BUY" recommendation.

Sources: 

https://www.sharescart.com/company/kirloskar-oil-eng/

https://www.bseindia.com/bseplus/AnnualReport/533293/73712533293.pdf

https://www.crisil.com/mnt/winshare/Ratings/RatingList/RatingDocs/KirloskarOilEnginesLimited_February%2018,%202022_RR_288135.html