Kirloskar Brothers Ltd – Shifting its focus to its core products business
KBL is a world-class pumps manufacturing company with expertise in engineering and manufacture of systems for fluid management. Company has expertise in engineering and manufacture of systems for fluid management. Established in 1888 and incorporated in 1920, KBL is the flagship company of the USD2.1bn Kirloskar Group. KBL provides complete fluid management solutions for large infrastructure projects in water supply, power plants, irrigation, oil & gas and marine and defence. The company engineers and manufactures pumps (industrial, agriculture and domestic), valves and hydro turbines. It also undertakes turnkey projects in large irrigation and infra projects involving design/system engineering, product supply and site erection, besides various other services involved in a large project.
KBL’s business can be broadly categorized as domestic business and International business. In domestic business company has two divisions which are products division and projects division. In international business company has exposure offshore oil business where it has grown inorganically in diverse geographies as a products player, specializing in engineered pumps and services.
Domestic Business: Shifting focus to high margin products business
During FY05-09, veering away from its core products business, KBL had aggressively bagged irrigation and water supply projects as an EPC contractor. Unfortunately, the economic slowdown post 2008 and political instability in Andhra Pradesh put the company’s entire irrigation project portfolio at risk. However, post FY09, the company prudently sharpened focus on scaling up the high-margin products business, with its market share expanding from 7-8% in FY09 to ~14% in FY16. Also, its share in standalone revenue jumped to 76% in FY16 from 43% in FY09 underpinned by sustained investments in capacities, strong R&D capabilities, large distribution network and brand building.
International Business: Diversifying revenue streams with keen focus on bottom line
Kirloskar Brothers International BV, holding company for KBL’s international businesses, clocked CAGR of 16.3% to INR975cr during FY10-15 propelled by entry in new markets, growth in core business and inorganic spurt via acquisitions. But, the sharp fall in crude prices dented the company’s international business as the beleaguered oil & gas sector contributes 30% to revenue. KBL’s international business is a reasonably profitable business, with ~10% operating margin. However, due to acquisition of sick companies, losses from these acquired companies are pulling down overall margin.
KBL is diversifying its international business into different industries—onshore exploration, desalination and downstream petrochemicals—and varied geographies—US, South Africa, South-East Asia. The company is also looking to expand its spares & services business in the international market to derive higher profitability and annuity income. In FY14, this business accounted for INR150cr, which fell to INR90-95cr in FY15 and FY16 in the absence of demand from the oil industry. However, as oil prices are settling at USD55/barrel, KBL anticipates to regain the INR150cr level over the next 2 years.
Fundamental to improve significantly:
During the previous capex cycle (FY02-08), KBL was predominantly a products company, clocking EBITDA margin of 8-13%, with peak margin of 13.3% in FY06. During FY11-16, the company wrote off debt of INR205cr, appointed consulting companies for restructuring (INR18cr) and invested INR40cr in integrating all the facilities with planning, procurement and sales functions through robust IT systems.
As the company made sustained efforts to increase the contribution of the products business, raw material cost has gradually reduced from 70.9% in FY10 (products business at 51% of sales) to 59.4% in FY16 (products business accounting for 76% of revenue). Taking into consideration the higher contribution of the products business, lower provisioning and zero one-time restructuring expenses, EBITDA margin is estimated to trend closer to 10% in the near future.
Despite the projects business dragging down profitability and stretching the execution cycle, KBL has commendably managed to limit stress on net working capital and reduced debt-to-equity (D/E) below 0.3x. Existing INR255cr debt on standalone basis is entirely related to the projects business and expected to gradually reduce to zero as the projects business’ contribution to overall revenue falls.
On consolidated basis, we estimate KBL to post sales and EBIDTA CAGR of 8% and 65%, respectively. Net profits are expected to reach INR1.5bn in FY19E from a loss of INR33cr in FY16, with RoCE improving from negative 0.9% to 10.3% over FY16-19E. KBL is trading at a significant discount to the peers in the engineering industry eg. peers from pumps and oil engines segment.