BackDownsizing to aid Crompton’s profitability
Downsizing to aid Crompton’s profitability
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Last Friday, capital goods company Crompton Greaves Ltd (CGL) announced cost-reduction and right-sizing measures at its Belgium operations. Nearly one-third of its workforce, comprising 730 employees, will be laid off. The unit accounts for most of the overseas power systems segment’s sales. The segment comprises two-thirds of the total revenue clocked in the March quarter.
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The strain on the power systems division is reflected in falling revenue growth in recent quarters. March quarter revenue from the segment at a consolidated level grew by a paltry 2.3%, while the profit (before interest and tax) margin was 2.7% compared with 13.5% a year before. Naturally, CGL’s stock, along with the capital goods index, has tumbled, with its price coming down by 50%. Although the consumer products and industrial systems segments also fared badly on the profitability front, the power systems segment was the worst hit, which justifies the cost cutting.
Domestic operations performed a tad better though competition across segments continues to erode profitability. The management is also cautious on the industrial segment in India for the near term because of the sluggishness in the economy. Analysts believe that steps to cut back workforce and reallocate production across geographies to trim costs are a part of the management’s stated strategic objective to improve operating margin over a three-year horizon.
That said, the silver lining is that CGL’s order inflows have been robust compared with most peers, driven by new orders in power equipment. By end-March, the company had an order book worth 0.7 times its fiscal 2012 revenue. This should help meet the guidance of a 12-14% increase in fiscal 2013 revenue and 8-9% operating margin. Note that the operating margin in fiscal 2012 plunged by about 620 basis points to 7% from the year-ago period. One basis point is one-hundredth of a percentage point.
No doubt, news related to production cuts or downsizing is perceived negatively by the Street in the near term. At ₹ 121 a share, CGL’s stock trades at about 12 times its estimated earnings for fiscal 2013, which implies reasonable valuations given its poor profitability. However, an improvement in operational parameters in the near term could lead to a smart increase in valuations.
Graphics by Ahmed Raza Khan/Mint
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