The Hindu Business Line : Honeywell Automation India: Buy

Automation and control solutions provider Honeywell Automation India Ltd’s (HAIL) financial performance in 2008 and over the first three quarters of 2009 has been superior to most other automation players in the country.

A well-entrenched presence in the automation and process solutions space, especially in hydrocarbons and other process industries, combined with steady business from the parent company hold out good prospects for HAIL’s earnings growth. The company’s almost zero-debt status and utilisation of accruals for expansion also lend strength to its financial credibility.

At Rs 2000, the HAIL stock offers a good buying opportunity; it currently trades at 14 times its likely per share earnings for the year ending December 2009. Investors with a two-year perspective can add the stock on declines linked to broad markets.

Business drivers

HAIL is an 81 per cent subsidiary of Honeywell US. The company derives its business from five major divisions — process solutions, building solutions, environment and combustion control, sensing and control and the export business group. The first division, with a contribution of over 65 per cent to revenues, has been the key growth driver. HAIL has traditionally been a domestic market leader in the hydrocarbon space, and tops the ranking in the list of process control equipment players in the country (CMIE Market Size & Shares 2007-08), with market share of 22 per cent.

ABB stands second in this list. However, it is important to note that larger players such as ABB and Siemens are leaders in the power automation space, specialising in power transmission and distribution equipment, while HAIL’s market share in this space is miniscule.

This limited contribution could have stemmed from the company’s lack of participation in state utility orders as they limit the profitability from after-market revenue streams (such as annual maintenance contracts) given that they are typically pegged to tariffs.

HAIL has, therefore, been selective in this space and has been targeting captive power projects.

However, with increased private participation in the power generation space, HAIL may be expected to actively participate in this segment as well. The company has bagged orders from private power players such as Tata Power. HAIL’s strength in the hydrocarbon space has enabled it to partner with clients such as ONGC, HPCL, IOC, BPCL. A high level of automation and after-sales services sought by the hydrocarbon industry tie in with HAIL’s sales-cum-service business model. Maintenance contracts often account for as much as 15 per cent of the project cost in the process solution segment. This could translate into an extended alternative revenue stream for HAIL, in times of slowdown in capex spending in the above industries.

Currently, HAIL offers services across the hydrocarbon value chain — exploration, transportation (pipelines) and retail (distribution). While volatility in oil prices during most of 2008 did see some delay in capex spending decisions in the segment, the more stable pricing regime prevailing now is likely to benefit HAIL. The company also serves firms in the metals, chemicals and sugar industries.

We also expect an uptick in HAIL’s building solutions space, with the revival in real estate activity in the country. HAIL’s products and offerings in this space, such as fire automation, security solutions, energy conservation and building management systems fit together well with the requirements of the massive housing projects and large commercial complexes currently in vogue, especially in Tier-I cities.

Some of the above requirements have become mandatory for certain large facilities under the law. This division is also likely to benefit from infrastructure development work in areas such as railways and airports. The company has already won several projects from the Airports Authority of India, including a terminal at the Delhi airport as well as projects from the Delhi Metro Rail.

Exports accounted for a fourth of HAIL’s revenues in CY-08, partly aided by a depreciating rupee. The company has an export manufacturing unit in Pune which addresses the manufacturing and engineering service needs of the parent as well as other global customers. The cost advantage and skill available locally is likely to ensure that the Indian unit remains the preferred outsourcing destination for Honeywell US.

The financials

HAIL’s revenue expanded at a compounded annual rate of 25 per cent over the three years ending CY-08 to Rs 962 crore, while net profits grew 34 per cent annually to Rs 82 crore. For the nine months ending September 2009, net profits jumped 70 per cent over a similar period in 2008.

While operating profit margins shifted to 17 per cent levels in the current year , perhaps as a result of superior product mix, OPMs at 12 per cent levels appear more sustainable. Further, competition from international players as well as larger peers such as ABB and Siemens could thin margins, especially if the company expands in the power industry.

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