Crompton Greaves: negatives priced in, no near-term upsides

Given its dismal earnings trajectory in the last few quarters, the Street did not expect any major surprises in the March quarter from capital goods company Crompton Greaves Ltd.

The poor performance through fiscal 2012 is mirrored in the 58% fall in its stock price in the past one year to Rs 108. March quarter revenue and net profit was significantly below Bloomberg’s consensus estimates at Rs 3,077.4 crore and Rs 100.3 crore, respectively.

Net profit contracted 65.4% from a year ago, partly due to low operating leverage in its overseas operations, where revenue accretion was low. Hence, high costs took a toll on profitability.

Crompton’s overseas units bled to post a Rs 36.6 crore loss for the quarter, compared with a Rs 33.6 crore profit in the year-ago period. Domestic operations were better off, registering a Rs 136.9 crore net profit, although it was around 37% lower than a year before.

On a consolidated basis, the biggest disappointment came from the power segment, which accounts for a little over two-thirds the total revenue. It clocked a mere 2.3% year-on-year (y-o-y) growth in revenue during the quarter. Moreover, profit margin before interest and taxes tumbled by a huge 1,060 basis points (bps) to 2.7%. One basis point is one-hundredth of a percentage point.

“The drag in profitability is mainly from the overseas subsidiaries partly on account of legacy orders from its acquisitions, which might have seen cost overruns,” said John Perinchery, analyst, Asian Markets Securities Pvt. Ltd. The power sector profitability was higher in domestic operations, during the quarter and for the full year.

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However, the industrial and consumer segments’ performance was relatively better in spite of a margin decline, as they posted a year-on-year (y-o-y) growth in revenue generated for the quarter.

That said, the question is whether the worst is behind the company. In an analysts’ meet, Crompton’s management reportedly detailed stringent measures that would improve profitability.

It forecast a 450 bps rise in operating margin over the next three years, stemming from lost-cost zone manufacturing, rationalizing production across various manufacturing units to improve capacity utilization and forays into new regions. Reports say the company’s share in big public sector orders has also increased in spite of competition from Chinese and Korean firms.

But the wait seems long and optimistic, given that the state of overseas economies, which account for about 45% of Crompton’s revenue. Consolidated operating margin for the March quarter at 6.9% was way below 12.8% clocked in the year-ago period.

The only silver lining in a rather hazy outlook is its improved order inflows for the quarter—11% higher than the year-ago period. Full year order inflows for fiscal 2012, too, grew by a robust 15% in difficult times to Rs 10,264.4 crore, with strong inflows in the power segment.

Although the stock trades at reasonable valuation of 10 times estimated price-earnings multiple, a steady improvement in profitability to validate management optimism would be the only shot in the arm for the stock.

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