Feb 02, 2012, 12.39 PM | Source: CNBC-TV18

Gloom done, blue skies ahead for Crompton Greaves: Religare

Crompton Greaves was one of the most hyped stocks in the second quarter. The company posted a 58 % drop in net profits, sale of shares by former vice-chairman S M Trehan and the company's decision to acquire a jet plane for Rs 270 crore proved to be costly.

Suhas Harinarayanan, Co-Head of Research, Religare Capital Markets
Crompton Greaves was one of the most hyped stocks in the second quarter. A massive drop of 58% in net profits, sale of shares by former vice-chairman S M Trehan and the company's decision to acquire a jet plane for Rs 270 crore proved to be costly.

However, the company surprised the streets with topline growth of 26% in the third quarter. Suhas Harinarayanan, Co-Head of Research, Religare Capital Markets mentions a couple of key takeaways from the conference call. The margins have bottomed out and the order inflow in third quarter was reasonably good. The stock can touch Rs 200 in the coming months.

The company sold aircraft in Q3 at book value but it will have no impact on Profit & Loss statement.

Below is an edited transcript of his interview. Watch the accompanying video for more.

Q1: What were the key positives you took away from the conference call of Crompton Greaves post which the stock reacted quite positively?

A: Firstly a drop in margins which we saw in Q3 was probably pertaining to one-off items and mainly in the international business. So the domestic business margin seems to have stabilized and clearly bottomed out. I dont think there is any serious downside to margins in any of the business segments. On the international business, if you take out restructuring related charges or the fact that they had a USD 50 million order which was completed at zero margins, I dont think these numbers are ever going to be repeated in FY13. The second was that the order inflows primarily in the power systems in India and also to some extent in the international business have grown very well. 

Power transmission segment has clearly held up well because Power Grid has started giving out a lot of orders to meet their 12th five year plan numbers. So clearly margins have bottomed out, orders looking good and lastly there were some other concerns related to the helicopter being taken out of the company. So net-net there are not too many negative triggers for FY13.

Q2: A large scale liquidation of inventories also happened in third quarter. Has the management confirmed? Did they also talk about whether or not the worst of that liquidation is done with this quarter?

A: I think there were three items on the international business. One was USD 50 million order at zero margins which they completed last quarter. Second was inventory liquidation, almost a similar number and lastly there were some restructuring charges primarily in Europe. So inventory liquidation is largely done and thats exactly what the management also confirmed.

Q3: It has been three rough quarters for Crompton. What would you extrapolate now for the stock in terms of expectations for FY13 on a sustainable growth and margin performance?

A: We have cut our earnings estimates on a running basis. We had revised it lower at the end of first and second quarter as well. We dont think there will be another downward revision in the earnings for FY13. Religare has cut earnings estimates to approximately about Rs 11 for FY13 and Rs 13 for FY14 which is close to 20% odd. This will capture a sequential improvement in margins. The order book looks robust and the fact that consumer and industrial cycles are largely short cycle products and they could rebound a little bit in next year given the low base of this year. The bottoming of margins should also lead to a sequential 15-20% kind of EPS growth. So the stock currently trades at about 11 times on FY14 numbers and 13 times on FY13.

I wont say these are worst case numbers but not far away from worst case scenario. So I think the stock is cheap, its a good company and with a very strong product profile. We have been recommending our clients to buy over the last two quarters. The stock has not done well in last two quarters, but the stock is also significantly under owned as we understand so that will also provide the leg-up as the earnings growth happens.

Q4: What are the chances of Crompton Greaves surprising the market in FY13? What if the company actually executes more improvement in margins and actually goes onto deliver much better numbers than the consensus estimates?

A: As you know a lot of us put our numbers based on what we can see at this point in time over the next six to nine months. The breakout scenario is clearly not priced in or factored into the consensus numbers. So as you rightly pointed out as against EPS of Rs 11 if the company does post an EPS of Rs 13, then clearly stock is going to trade much higher. Its probably going to shoot more than Rs 200 from here. So I would think there is 30-40% upside visible in the stock from current levels as well.

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