Hindustan Powerplus: Hold

Recommendation: Hold

A.Srikanth

MOST companies in cyclical industries invariably come up with expansion and fund-raising programmes at the peak of their business cycles.

But, invariably, these end up as bad decisions. The subsequent downturn in the business cycle makes it almost impossible for the company to recover the investment cost. This is what happened to Hindustan Powerplus also. The company made a 1:5 rights offer at Rs 85 per share in mid-1997, on the back of an impressive 1996-97 performance.

In 1996-97, which marked the high point in Hindustan Powerplus' financial performance, sales rose by 51 per cent and post-tax earnings 27 per cent. However, since then, the company has never managed that kind of a performance. The subsequent decline in the overall economy and the industry prospects never really gave the company a chance to revive.

While the turnover declined 3 per cent per annum from Rs 195.22 crore in 1996-97 to Rs 181.92 crore in 1999-2000, post-tax earnings fell 21 per cent per annum from Rs 12.49 crore to Rs 6.23 crore over the same period. The share price returns too declined in line with the fundamentals. From Rs 81 in early January 1996, the share price fell to Rs 20 now. The stock posted negative returns in all the years since 1996-97.

Click here for Table

Is it yet another case of bad timing taking its toll? Not really. Bad timing, which is a generic phenomenon with almost all cyclical companies, is only partly to blame. Otherwise, how does one explain the superior performance of Cummins India, the main competitor, over the last three years, when the industry prospects were sluggish.

The decline in the overall performance has more to do with company-specific factors. For a company which operates in the higher-end engines market (in the 164-1944 kVA range), the (post-1995-96 boom) the entry of foreign companies resulted in loss of market share. Though Cummins India managed to regain most of the market it had lost, Hindustan Powerplus could not.

Over the last three years, in a sluggish industry situation, the pace of indigenisation, exports and sale of spares have been the key determinants of profit maximisation model and for managing earnings risk. But Hindustan Powerplus fell short on these parameters; especially slow has been its indigenisation effort.

For Hindustan Powerplus, imports as a percentage of total raw material cost work out to 42 (as per latest available figures). This is among the highest in the industry. For Cummins India, the import content is just 28 per cent. Higher import content not only exposes the company to exchange rate fluctuations but also affects its ability to service domestic clients. Consequently, the operating profit margins of the company fell from 12.63 per cent in 1995-96 to 10.40 per cent in 1999-2000.

Export as a percentage of sales is just 1 per cent (as per the latest available figures) for Hindustan Powerplus. It is 40 per cent for Cummins and 8.50 per cent for Greaves and 3.50 per cent for Kirloskar Oil Engines. Similarly, after-sales service and sale of spares contribute little to the revenues. The company has a tie-up with GMMCO for supply of spares.

The combined result of all these negative aspects is the decline in net profit margins and the rate of assets turnover. The return on net worth fell from 45.65 per cent in 1996-97 to 6.70 per cent in 1999-2000.

The large engines segment, for power generation and large industrial applications, grew 10 per cent in volumes in 1999-2000. Industry sources expect the same growth rate this fiscal also. But the extent to which Hindustan Powerplus would benefit from this largely depends on its strategies.

Going by the recent indications of Caterpillar, US (which holds 37.74 per cent stake in the company) offering to buyout the share of the other promoters (the C. K. Birla group and others), a major reshuffle in on the cards. This could change significantly the company's fortunes for the better. The stock valuation could improve. Meanwhile, the company is also taking steps to enhance the indigenisation levels.

Though there was some improvement in the first quarter performance, it is not of any significance. While investors can stay invested at the current levels (Rs 20), fresh investments can wait for positive events to unfold.