Atlas Copco: An attractive long term option

Recommendation: Hold

A. Srikanth

Shift in focus towards volumes; product rationalisation; increase in import substitution; cost reduction measures and the benefits that could accrue through the merger of Chicago Pneumatic could have a positive impact on the financial performance of Atlas Copco and it is a question of time before the valuation catches up with the improvement in fundamentals.

The Atlas Copco stock, ruling at Rs. 120, appears to be an attractive investment option for the medium-to-long term. For one of the leading companies in compressors (69 per cent of sales) and mining equipment (11 per cent), 1999 was lacklustre. Though the turnover improved 24.80 per cent to Rs. 126.87 crores, post-tax earnings fell 28.50 per cent to Rs. 6.83 crores. Sluggish industry prospects resulted in the postponement and cancellation of orders and, consequently, lower capacity utilisation.

However, margins were significantly better compared to the previous year because of the restructuring of operations and the cost-reduction measures. Apart from shifting from manufacture to assembly of compressors, the changes in design of products, sourcing of supplies, discontinuing products with negative margins and import substitution resulted in significant savings.

Similarly, the margins in mining equipment also improved with the re-layout of operations and changes in resource allocation focussed on product-driven manufacturing. Strict adherence to project completion time schedules also helped in reducing costs. With the company the global sourcing base for rock drills and pushers, export revenues grew 71.40 per cent to Rs. 12.74 crores.

With the revival in the overall economy, the future holds much for the company. While it may take some more time for large value orders to come, the company has been concentrating on volume growth to improve capacity utilisation. With a volume growth of 7-10 per cent in the first quarter of this year, the company expects to post overall volume growth of 10-15 per cent for 2000. Realisations are also expected to go up by around 10 per cent.

With an order-book position of around Rs. 25 crores for the compressors division and another Rs. 25-30 crores for the mining equipment division, the financial performance in 2000 could be better compared to the previous year. The revival in the economy could further increase the flow of fresh orders.

The merger of Chicago Pneumatic with the company could bring in both operational and administrative synergies. While the rationalisation in product profile (there is significant overlap in product profile) and an enlarged customer base could give a boost to topline growth and market-share, the benefits of synergies in administration and operational functions could lead to a significant improvement in margins and bottomline. The overall export revenue could also jump up, especially in the background of the encouraging response for new product launches.

For the first quarter of this year, though the turnover went up by 0.44 per cent to Rs. 27.37 crores, the post-tax earnings jumped around 4.75 times (375 per cent) to Rs. 1.76 crores. At the current discounting of 12.30 times (going by a conservative EPS estimate of Rs. 9.70), the stock holds potential for capital appreciation in the medium-to-long term.