Higher order inflow visibility makes Engineers India Ltd an attractive bet
Engineers India (EIL) is well placed to benefit from a pickup in the refining capex in India. Refining capacity expansion of 70 MTPA across key PSUs is planned over the next 4-5 years. Consequently, EIL is all set for a sustained growth in order inflows post four years of a lull. With rising profitability at OMCs, confidence on capex is high. Apart from reviving prospects in the domestic market, EIL will also benefit from improved pre-qualification of international orders once it completes execution of the Dangote refinery in Nigeria (20 MTPA, order size of Rs 8.5bn). Further expansion is also planned in this project, which enhances medium-term order flow visibility for EIL.
Strong growth in FY17 Order flow:
Post decline in FY16, EIL witnessed a strong growth in order inflows in 1HFY17. As against ~Rs 16.0bn of orders in FY16, the company has secured orders amounting to Rs 22.5bn in 1HFY17, primarily led by orders related to BS-VI emission norms. Historically, EIL’s order flows have been highly cyclical in nature. As can be seen in the chart below, EIL’s annual order inflows have been highly volatile and skewed towards the years which have seen major refinery expansion. This cyclicality has been primarily on account of bunching up of capex across the top 3 PSU downstream oil and gas companies (BPCL, HPCL and IOC). With 90% of its revenues coming from the hydrocarbon space, there is limited scope for EIL to insulate itself from the cyclicality of refinery capex.
Domestic Hydrocarbon orders set to flow in the coming years
All PSU refineries have announced substantial capex plans (70 MTPA) over the next 4-5 years. Refining capacity expansion is driven by several factors like consistent growth in demand for petroleum products, the government’s drive for “Make in India” and improved finances of downstream oil and gas companies.
Demand for petroleum products has grown at a CAGR of 5.5% over the last 5 years. When compared to GDP growth, the average energy multiplier for India has been at ~0.75x of GDP growth. To meet the increase in demand for petroleum products, most of the downstream oil and gas companies are looking at expanding their capacities. Currently the total capacity of refineries in India is ~235 MTPA, in which the public sector accounts for 150 MTPA (~64%). These public sector companies have announced a capacity addition of ~70 MTPA (capex of Rs 1.6tn) over the next 4-5 years. The opportunity size for EIL could be 4-5% of the planned capex i.e ~Rs 80bn.
Over the years, the government has focused on reducing the dependence on imports of petroleum products. With this clear intent of the government, the refining capacity has grown at 4.7% CAGR over FY02-FY17. Further, with the Modi government coming into power, “Make in India” has taken center stage and the refining capacity is likely to now grow at 5.7% CAGR until FY22.
This growth in refining capacity is largely to be contributed by PSU’s (IOC contributing the highest, followed by BPCL and HPCL). Post expansion, the share of PSU’s in the refining capacity in India is likely to increase to 71% from the current level of 64%. This assumes significance as EIL’s enjoys preference amongst PSUs. Looking at meeting the long term growth in demand, talks have already been initiated by GOI for setting up a mega refinery with a capacity of 60 MTPA (in 2- phases). On a conservative basis, we have considered a contribution from the mega refinery to the refining capacity at only 30 MTPA over the next decade.
New opportunities are on the rise to add to the growth:
Dangote project (Rs 8.5bn), Nigeria is the largest international project in EIL’s kitty, slated to be commissioned by FY19E. This project currently is being built for a ~20 MTPA refining capacity. There are plans to expand the capacity further to 32 MTPA. There also exist orders for some subsea pipelines thereby improving the order flow prospects for EIL. Importantly implementation of such large projects should substantially increase EIL’s credentials and prequalification levels, placing it favorably for further order wins in the international markets. To cater to the MENA market, EIL has also set up a marketing office in Abu Dhabi.
EIL has recently bagged a Rs 0.8bn project under the Namami Gange programme of the Govt. of India. The programme has an estimated cost of Rs 200bn to be spent over 5 years. Until FY16, Rs 50bn (vs. budget of Rs 74bn) has been spent in the first phase. The government has lined up 1,000 projects for the second phase, which include setting up of sewage management plants and effluent treatment plants, amongst others. Opportunities for EIL relate to providing PMC for these projects. However, a lower degree of specialization in these projects would mean lower hydrocarbon margins for these projects.
EIL also has capabilities in sectors like infrastructure and metallurgy amongst others. It has so far prepared smart city proposals for Moradabad and Rampur. It has also rendered services for airports and large building construction projects. However the opportunity size under these projects is not substantially large (as compared to hydrocarbons). The margin/RoE profile is also low, given lesser levels of engineering skills required for such projects.
With the operating leverage, the profitability is expected to improve:
The margin profiles for both the segments of EIL viz. PMC and LSTK vary drastically. LSTK, being low on technology and commodity intensive, has relatively lower margins as compared to PMC. Over the last 2-3 years, EIL has witnessed pressure on margins both in the PMC and LSTK segments. This was mainly on account of subdued order flows and thereby negative operating leverage. With the projects being executed over the next couple of years, the earnings’ quality is set to improve for EIL. Going ahead, margins are expected to stabilize at 30% / 6-7% levels for the PMC/LSTK segments respectively
EIL is one of the unique companies in the listed engineering space, wherein the core business is services, based on strong technical knowhow. The same enables it to operate on negligible capital employed leading to strong cash flows. The stock is up 50% over the last 6 months on the back of improved order flow visibility. Consequently, the valuations have turned expensive. With rising earnings visibility over the next 3 to 4 years, we think it is still an attractive opportunity.