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S. Vaidya Nathan

SHAREHOLDERS of Alfa Laval can retain their exposure in the stock though the company may be hard-pressed to repeat the robust earnings growth of the past couple of years.

Higher prices of steel and other commodities could have an adverse bearing on profitability and earnings growth, if the company is not to pass them on entirely to customers. A higher base effect is also likely to temper the earnings growth.

The business environment appears conducive for revenue growth with buoyancy across several industries. The improved investment climate, the enhanced sourcing of products by the parent company and the strength of the euro are positive factors. So are Alfa Laval's hefty cash holdings, healthy balance-sheet and dividend payouts (it paid Rs 25 per share as dividend for 2003 and 2004), which could cushion downside risks from the present levels.

The Alfa Laval stock trades at a price-earnings multiple of about 14 times its likely per share earnings for 2006. This is closer to the upper end of the valuation that the stock enjoyed and the gains may be more moderate.

The stock had moved past the Rs 850 mark in the two weeks after the Budget and subsequently shed those gains to now trade at about Rs 700.

Business Line has multiple `buy' recommendations outstanding on the stock and we remain bullish on the long-term prospects, though our near-term view is tempered by concerns of a slippage in margins.

Alfa Laval offers a range of process equipment and services that find application in a variety of industries. In the domestic market, the company's revenues flow mainly from supplies to vegetable oil processing, breweries, sugar and ethanol industries. A steady stream of revenues is likely from these sectors over the next few years.

Over the past year-and-half, Alfa Laval has also made considerable progress in catering to the pharmaceutical and biotech sectors.

With companies in these two segments on investment mode as they modernise and scale-up operations to cater to global opportunities, Alfa Laval should benefit with more orders. It has already executed orders for biotech players such as Biocon. The Government's thrust on improving the food-processing and refrigerated storage systems across the country also augurs well.

Exports are likely to drive top-line growth. For a few product categories, Alfa Laval India is a designated supply centre for the global operations of the parent; these products account for about one-third of the revenues of the latter. This gives an idea of the scope that exists for growth in export revenues.

Alfa Laval has managed to scale up exports to about 40 per cent of its revenues and this has corresponded to the recovery in the domestic market. It has also expanded its offerings within these product categories and has the flexibility to market its services independently in several Asian markets. These aspects are likely to sustain the buoyancy of export revenues.

The firm trends that are likely in the euro may bolster earnings as most of Alfa Laval's exports are denominated in this currency. A gradual increase in the outsourcing of services by the parent would open up a new revenue stream. With exports and services accounting for about 50 per cent of revenues, Alfa Laval is less vulnerable than in the past to a slowdown in domestic demand, which is, however, unlikely to be a threat in 2006.

But the change in the revenue profile is significant as it ensures that Alfa Laval avoids the difficult situation it faced in the late 1990s when there was a slowdown in India and exports were a marginal part of its operations. The looming risk for Alfa Laval is the firm undertone in steel prices. Most of its equipment is manufactured using stainless steel. If oil prices remain high for long, it could stifle industrial growth and cause for concern.

Operating profit margins have remained stable at around 20 per cent the past four years. On a quarterly basis, however, they have tended to fluctuate, which is only to be expected in an engineering company due to lead-lag effect between implementation and recognition of revenues and costs. But what is cause for concern is the sharp decline in operating margins that was evident in the October-December 2004 quarter after seven such periods when the number was in the vicinity of 20 per cent.

A development that needs to be closely tracked is the parent's plan to set up a wholly-owned subsidiary to support the global operations.

The board of Alfa Laval (India) had given a no-objection clearance to this plan last December. The business activities outlined for the proposed new entity in India do not overlap those of the listed company.

But if the nature of the arrangement is altered, it could affect the growth prospects of Alfa Laval and valuation of its stock.

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