Areva T&D India Ltd’s shares are down 57% compared with their peak around two years ago, while the broad markets are around 23% lower. One would get the impression that Areva’s shares must be reasonably valued. But based on the company’s latest annual net profit, its shares are valued at as high as 34 times its earnings.
What’s more, this is at a time when earnings growth has been negative because of pressure on margins. The company follows January-December as its accounting year, and in the year till December, operating margin fell by 3.8 percentage points. Even though net sales grew by 35%, operating profit was flat because of the drop in margin. And with interest costs and depreciation charges rising sharply owing to capacity addition and increased working capital, net profit fell by 15%.
This comes on the back of a 2.3 percentage points drop in margin in the year till December 2008. In 2008, sales grew by a healthy 32%, but net profit by just 4.6% because of the drop in margins and higher interest costs and depreciation charges.
Areva’s margins have been under pressure because of a combination of factors. First, the proportion of product orders in its portfolio has come down substantially, as growth has been driven by systems orders, which have lower margins. Product orders used to account for over 75% of the company’s order backlog till recently. In 2008, this fell to 65% and has now dropped further to around 50%. Besides, realizations have dropped owing to competitive pressure, especially in the transformer segment where South Korean manufacturers are bidding aggressively. And even though commodity prices fell last year on an annual basis, the company didn’t benefit much because most of its customers have price variation clauses in their contracts.
Meanwhile, Areva’s order inflows continue to be robust, and this is reflected in the strong growth in revenue in the past two years. With operating profit margin having fallen to 11.5% last year, from almost 18% in 2007, the downside to margins may be limited in the near future. And earnings growth should more or less track revenue growth. Having said that, the high price-earnings multiple of 34 times leaves little room for error in terms of execution. In fact, as the chart shows, Areva’s shares were getting along well until the company started disappointing with its results in 2009.
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