Edel Invest Research BUY Coverage Stock: Kirloskar Brothers Ltd

Pumping back to profitability CMP: INR 246 Target: INR 300

Salil Utagi Kirloskar Brothers (KBL) is the largest pump manufacturer in India with 14% market share in the domestic Research Analyst organised pump industry. We envisage the company to benefit significantly from government’s policy +91 (22) 4272 2319 push on affordable housing and irrigation. Moreover, in the domestic business, it has prudently realigned [email protected] focus on the high-margin products business from the loss-making projects business. Sustained investments in capacities, strong R&D capabilities, large distribution network and brand building are Debashish Mazumdar bound to propel the products business. Additionally, sharpening focus on the products business and Research Analyst waning exposure to the projects business will boost profitability, deleverage the balance sheet and +91 (22) 4088 5819 improve cash flows in the domestic operation. In the international business, the company has pruned [email protected] exposure to the beleaguered offshore oil business to below 25% of turnover and is diversifying into

various industries and geographies, insulating itself from single segment/ geography risk. We believe,

these initiatives will boost the international business’ profitability in FY18. We initiate coverage on KBL with a BUY rating and target price of INR 300, valuing it at FY19E P/E of 15x.

Changing tack: Realigning focus on high-margin products business During FY05-09, veering away from its core products business, KBL had aggressively bagged irrigation and water supply projects as an EPC contractor. Unfortunately, the economic slowdown post 2008 and political Bloomberg: KKB:IN instability in Andhra Pradesh put the company’s entire irrigation project portfolio at risk. However, post FY09, the company prudently sharpened focus on scaling up the high-margin products business, with its 52-week range (INR): 249 / 113 market share expanding from 7-8% in FY09 to ~14% in FY16. Also, its share in standalone revenue jumped to 76% in FY16 from 43% in FY09 underpinned by sustained investments in capacities, strong R&D Share in issue (Crs): 7.95 capabilities, large distribution network and brand building. Ergo, we estimate this business to clock 9.8% M cap (INR crs): 1,953 CAGR during FY16-19E and constitute 78% of standalone revenue by FY19E. Higher growth in products business, improving gross margin, non-recurrence of one- time expenses, and operating leverage are Avg. Daily Vol. BSE/NSE anticipated to propel KBL’s standalone EBITDA margin to 10.8% in FY19E from 3.5% in FY16. 143.6 :(‘000): International business: Diversifying exposure and sharpening focus on enhancing profitability Plummeting crude oil price took a toll on KBL’s international business, as the oil & gas sector accounts for 30% revenue. Hence, in order to insulate itself from single segment focus risk, the company diversified its SHARE HOLDING PATTERN (%) international business into different industries—onshore exploration, desalination and downstream petrochemicals—and varied geographies—US, South Africa and South-East Asia. It is also looking to expand its spares & services business in the international market to derive higher profitability and annuity income. In FY14, this business accounted for INR150cr, which fell to INR90-95cr in FY15 and FY16 in the absence of demand from the oil industry. However, as oil prices are settling at USD55/barrel, KBL hopes to regain the INR150cr level over the next 2 years. In our view, the international business is set to recoup 8% operating Public, 34.6 margin by FY19E with stable growth in UK and US.

Promoter, Outlook and valuations: 65.4 On consolidated basis, we estimate KBL to post sales and EBIDTA CAGR of 7.7% and 68%, respectively. Net profits are expected to reach INR1.6bn in FY19E from a loss of INR33cr in FY16, with RoCE improving from negative 0.9% to 10.3% (ex-cash at 12.1%) over FY16-19E. KBL is trading at a significant discount to the peers in the engineering industry eg peers from pumps and oil engines segment. During the capex cycle of 2003-08, as a focused products player, KBL had posted peak EBITDA margin and RoCE of 16% and 48%, 140 respectively, in FY06 while trading at an average 1-year forward PE multiple of 18x for the period. We 130 initiate coverage on KBL with a target price of INR300, valuing the company at a target multiple of 15x on 120 FY19E. 110

100 90 Year to March (Consolidated) FY15 FY16 FY17E FY18E FY19E 80 Revenues (INR cr) 2,728 2,594 2,707 2,960 3,244 70 Rev growth (%) 1.4 (4.9) 4.3 9.3 9.6 60 50 EBITDA (INR cr) 190 65 102 204 308

40 PAT (INR cr) 41.2 -32.6 -2 80 160

16 17

- -

- EPS (INR) 5.2 -4.1 0 10 20

Jul

Jan Jan

Sep

Nov Mar May EPS growth (%) (37.1) NA (94.5) NA 98.8 Kirloskar Brothers Sensex P/E (x) 47.5 NA NA 24.3 12.2

P/B (x) 1.9 2.0 2.0 1.9 1.7 Date: 28th February, 2017 RoACE (%) 6.3 -0.6 0.9 5.4 10.3 RoAE (%) 4.1 -3.3 -0.2 8.1 14.9

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Focus Charts

Organised sector – Leading market share Domestic order inflow – Standard pumps witnessing strong traction Kirloskar Bros 600 (Stnd) 13.6%** CRI 550 10.9%

Other organised Crompton 500 players Consumer 450 (45% 6.5%

400 KSB Pumps

7.7% 350 (INR cr) (INR Sulzer 300 Texmo 5.3% 4.5% 250 WPIL Grundfos

(Stnd) Shakti 200

3.7%

2.0% 2.5%

Q2FY13 Q3FY13 Q4FY13 Q1FY14 Q2FY14 Q3FY14 Q4FY14 Q1FY15 Q2FY15 Q3FY15 Q4FY15 Q1FY16 Q2FY16 Q3FY16 Q4FY16 Q1FY17 Q2FY17 Q3FY17 Q1FY13

Products business to be the driver of the domestic business High retention with Govt – Hoping to recover in 3-4 years 100% 3000 75% 42% 30% 25% 25% 23% 22% 2500 65% 80% 2000 55% 60% 1500 (INR cr) (INR 45% 1000 40% 75% 75% 77% 78% 70% 500 35% 58%

20% 0 25%

FY10 FY11 FY12 FY13 FY14 FY15 FY16

FY14 FY15 FY16 FY17E FY18E FY19E Projects Revenues H1FY17 Projects order backlog Products Segment Projects Segment Retention money as % of debtors & other CA(RHS)

International business – OPM is expected to get back to 8% in FY19E D/E and NWC remain in control

1,400 10.0% 50%

1,200 8.0% 40%

1,000 6.0% 30%

800 4.0% 20%

600 2.0% 10% (INR cr) (INR 0% 400 0.0% -10% 200 -2.0%

-20%

- -4.0%

FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16

FY10 FY11 FY12 FY13 FY14 FY15 FY16

FY17E FY18E FY19E

FY17E FY18E FY19E Net Debt/Equity Net Working Capital as % of sales Net Revenues EBIDTA Margin(RHS)

Source: Edel Invest Research

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I. Oil & gas capex slump taking toll on global pumps market; domestic market on strong turf The global pumps market posted 4% CAGR over FY06-15 from USD33bn to USD47bn, with China, India and CIS countries contributing majorly. However, plummeting crude oil prices have taken a toll on growth as the oil & gas sector contributes ~10% to the global pumps market.

The European Industrial Foundation (EIF) estimates the pumps market to grow by 3.5% during FY15-20. Growth is envisaged to be driven by investments in irrigation, water & water resource projects, sewage and power capacity additions in developing countries. On the other hand, developed countries are anticipated to spend on municipal water, nuclear power, fire & HVAC packages and commercial establishments.

World Pump Market 2006 - $33bn World pump market 2015-$47bn

Western Europe Others Western Others 27% 25% 18% Europe 19%

Americas 23% Asia Americas 40% Asia 21% 27%

Source: EIF, Edel Invest Research.

Domestic pumps market: Growing at a faster clip; organised players consolidating position EIF as well as the Indian Pump Manufacturers Assocation (IPMA) peg the organised pump market in India in 2016 at around INR11,178cr and estimate it to catapult to ~INR14,255cr in 2020 at a CAGR of 6.3%. The organised pumps market is represented by over 300 players, with the top 10 accounting for 45% of the overall pie. Over and above the organised market, value of the unorganised market (more than 600 players) and imports is ~INR9,000cr. The share of organised market has jumped from 35% to 55% over FY09-16.

Sector composition - By user industry Organised sector - Market share

Kirloskar Bros Others CRI Metal & (Stnd) 13.0% Agri- 10.9% Mining culture 13.6%** 4.0% 27.0% Crompton Other Oil & Gas Consumer organised 6.5% 8.0% players (45% KSB Power Pumps Gener- 7.7% ation Building Sulzer 12.0% Water & Services 5.3% 19.0% Waste WPIL Texmo Water (Stnd) Shakti Grundfos 3.7% 4.5% 17.0% 2.0% 2.5% Source: Edel Invest Research. ** includes product content in projects

KBL, the largest pumps manufacturer in India, has expanded its products market share from 9% in FY10 to 14% in FY16 in the domestic organised segment on the back of healthy growth in standard pumps.

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Domestic pumps industry on cusp of recovery; KBL to be major benefeciary a) Agriculture: EESL driven demand could be a game changer Agriculture accounts for 18% of India’s total electricity consumption, as majority pumps installed on farms are highly inefficient (20% efficiency). With the government’s thrust on higher efficiencies and cost savings, Energy Efficiency Services Ltd (EESL) has outlined plans to replace 2cr pumps installed on farms in India at an investment of INR70,952cr.

EESL targeting to double energy efficiency of pumps Investments envisaged INR 71,000 cr Particulars Unit Value Particulars Unit Value Total No. of pump sets installed in Agri. Total No. of pump sets installed in Agri. Million Nos. 20.27 Million Nos. 20.27 Sector Sector Average saving potential per pump (%) 25 Average cost of pump sets (incl panels INR./pump 35,000 Average annual consumption per & warranty) kWh/pump/year 9000 pump Total Investment envisaged INR (crore) 70,952 Average annual saving potential per kWh/pump/year 2250 pump Total annual project benefit (DISCOM INR (crore) 20,526 Total Energy Saving (PAN) India BU/year 46 and Govt.) @ Rs. 4.50 / unit SouSourcSsssSe: SSrce: Edel Invest Research. Source: EESL document, Edel Invest Research

Despite being an ambitious scheme, participants are sceptical about the scheme’s terms & conditions related to assigning bank guarantee for entire life of the pump and debtors recovery in bullet payments rather than immediateLY. Due to lack of interest from most large players, the EESL scheme has not taken off in a big way as expected. We believe, unless EESL alters the terms & conditions to suit manufacturers, it is unlikely to take off.

Building services & drinking water resources/treatment, urbanisation, pollution control to drive demand The government has envisaged a capital expenditure of INR80,000cr during FY16-20E to bring 16.7mn hectares under irrigation, including canal and drip irrigation. This alone creates an INR10,000cr opportunity for the pumps industtry. Our estimates peg untapped long-term irrigation potential in top 8 states at 90.4mn hectares, requiring an investment of INR54lakh cr, leading to INR54,000cr opportunity for the pumps industry.

The status of water treatment in India also remains critical, as 80% of the country’s surface water is polluted. Domestic sewage, which is discharged untreated into local water bodies, is the cause for 75% of water pollution.

Irrigation sector opportunity for small & large engineered pumps Waste water an opportunity for medium and large engineered pumps Expected capex Opportunity during FY16-20E Expected capex Opportunity during FY16-20E

Bringing 16.7mn hectares under Capex on waste water treatment – INR 50,000 cr INR 10,000cr INR 2,000 cr irrigation with a capex of INR 80,000 cr over FY16-20

Long-term potential for irrigation in INR 54,000cr top 8 states

Source: industry, Edel Invest Research

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The government’s flagship projects of building 100 Smart Cities and the AMRUT scheme are likely to open up opportunities for the pumps sector. Also, projects to clean up the Ganga river and create in-land waterways by inter-connecting rivers are likely to result in several opportunities for the pumps sector.

Opportunity for small pumps under flagship housing schemes Opportunity for engineered pumps under Namani Gange & In-land waterways Expected capex Opportunity during FY16-20E Expected capex Opportunity during FY16-20E INR48,000 cr to be spent on building INR 2400 cr Namami Gange Project – INR 50,000 cr INR 1,000 cr 100 Smart Cities INR 50,000 cr to build 500 cities under Long-term investments planned in Inland Waterways INR 2500 cr INR 2,500 cr AMRUT Project – INR 250,000 cr

Source: industry, Edel Invest Research

c) Industrial sector: Initial signs of recovery apparent in a few sectors

Currently, the industrial sector, including power and oil & gas, is not in expansion mode. However, a few industries are spending on greenfield capacities, viz., sugar, chemicals, paper and pharma, opening up incremental opportunities for the pumps sector.

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II. Consolidating leadership in domestic pumps market Kirloskar Brothers Ltd (KBL) is the largest pump manufacturing company in India with 8 factories across India. In the domestic market, KBL operates primarily into products (standard as well as assembled) and projects (containing large engineered pumps). KBL’s domestic subsidiaries act as backend to company acting as suppliers of motors and castings. Since 2002-03, in the international market, KBL has grown inorganically in diverse geographies as a products player, specialising in engineered pumps and services.

Kirloskar Brothers Ltd – Organization Structure

KBL- Standalone Kirloskar Brothers Ltd Joint Ventures (INR 1680cr) (INR 2994cr) Subsidiaries

Kirloskar Kirloskar Kirloskar Brothers Karad Project Kolhapur Steel Kirloskar Systech Corrocoat Ebara(45 %) International BV (100%) (Rs263cr) (96% )(INR 39cr) (100%)(INR 22cr) (100%) (INR 873cr) (65%)(INR 46cr) (INR 71cr)

Kirloskar Kirloskar SPP Kirloskar SPP MENA Brothers Brothers (UK) Pompen (Egypt) Thailand Ltd Africa (PT)

SPP SPP Breybar Rodelta (South (US) (Mining) Africa)

Syncroflow

*- Revenue numbers are on gross levels (before inter-segmental) Source: Compnay data, Edel Invest Research

During FY10-16, KBL’s consolidated revenue remained flat, with a mere 0.7% CAGR as growth was impacted by overall economic slump and delay in large projects. However, the revenue composition has altered over FY10-16, wherein the international business has jumped from INR459cr in FY10 (16% of revenue) to INR873cr in FY16 (31% of revenue). KBL’s net profit plummeted from a high of INR146cr in FY10 to a loss of INR7cr in FY16, as projects faced execution issues with huge cost over runs and lower oil prices post FY15 led to curtailment of global oil & gas capex.

Revenue composition - International operations Profitability deteriorates due to project cost over-runs and growing in size (INR cr) slowdown in Oil & Gas capex (INR cr)

2,86 2,868 2,849 2,893 2,950 3,057 2,994 146 100 61 68 66 57 -7 100% 100% 303 18 23 13 339 502 430 356 445 441 80% 10 31 31 80% 459 16 37 411 658 60% 591 882 873 975 40% 118 36 60% 61 20% 31 43 48

40% 0% (1)

2,066 -20% (6)

1,955

1,879

1,828 (15)

1,765 (19)

1,680

1,637

20% -40% -60% 0% (4) -80% FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY10 FY11 FY12 FY13 FY14 FY15 FY16 kirloskar Bros - Standalone Kirloskar Brs International BV kirloskar Bros - Standalone Kirloskar Brs International BV Indian Subsidiaries+JV Indian Subsidiaries+JV

*-revenue nos are before intersegmental , *-profits are before intra group transactions and share of assoc/minority interest Source: Compnay data, Edel Invest Research.

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Changing tack: From projects to high-margin products business in domestic market Rebuilding products business During FY05-09, KBL had aggressively bagged irrigation and water supply projects—peak order book of ~INR3,000cr in FY09—as an EPC contractor, veering away from its core products business. Unfortunately, the economic slowdown post 2008 and political instability in Andhra Pradesh after the demise of Chief Minister YSR Reddy put the company’s entire irrigation project portfolio at risk. While some of these projects never took off, most faced inordinate delays due to lack of financial closure and leadership, exacerbated by formation of the new state of Telangana.

Post FY09, KBL prudently sharpened its focus on scaling up the products business (inherently high-margin business), with its market share expanding from 7-8% in FY09 to ~14% in FY16. The products business’ share in standalone revenue too jumped to 76% in FY16 from 43% in FY09 underpinned by sustained investments in capacities, strong R&D capabilities, large distribution network and brand building.

Products business contributed 76% to domestic revenue in FY16 vs 43% in FY09 (INR cr) 1830 1947 1878 1742 1855 1723 1602 1632 100% 1043 954 748 871 776 721 478 403 80%

60%

40% 1124 1229 1129 1079 1002 20% 787 993 871

0% FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16

Products Segment Projects Segment

Source: Company data, Edel Invest Research.

Products business – Doubled to INR12.3bn in last 5 years

Domestic Assembled - B2B 21% 24%

Made to Assembled stock to order Industry Assembled - 20% Dealers 16%

Farm 19% Source: Company data, Edel Invest Research.

Product business can be divided into 2 major sub segments: a) Made to stock pumps: Standard pumps which are sold through the distribution channel to industry, domestic (housing, infra) and agriculture are categorised as ‘Made to Stock’ pumps by KBL. The company has been historically strong, especially in industry and domestic pumps, with market share upwards of 15% in the organised sector. As the agriculture segment is at the lower end of pumps in terms of engineering and value, the segment is dominated by unorganised players.

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Competitors in the organised segment Industry Domestic Agriculture Kirloskar Bros Kirloskar Bros Kirloskar Bro KSB Pumps CRI CRI Johnson- SPX Crompton Consumer Ruby WPIL Grundfos Texmo Grundfos Shakti Sulzer Texmo

During FY09-16, KBL the products business registered volume CAGR of 14-15% (value CAGR of 6.6%). Importantly, it has transitioned from high exposure to assembled to order pumps to standard made to stock pumps, and value growth has also been impacted by decline in commodity prices.

KBL’s small products business has surged as it set up 2 new facilities in Sandand and Coimbatore and is also expanding retail touch points to increase penetration in South and Central India, while entering new markets of North India. The company’s current retail touch points of 15,000 and distributor network of 500 is more than 2x the next competitor (CRI Pumps).

b) Assembled to order pumps: Under this segment, KBL supplies pumps to large buildings, infrastructure projects like metros/airports, complex industrial applications, municipal water supply, and water & chemicals treatment. The company clocks almost INR200cr sales through the traditional distribution channel wherein distributors get orders from local government bodies as well as private sector companies. Moreover, assembled pumps of almost INR300cr are sold directly to EPC companies in infrastructure and selected government bodies.

Current order book and order inflow: Reflect gains of prudent strategy shift

Domestic order inflow – Standard pumps witnessing strong traction 600

550

500

450

400

350 (INR cr) (INR 300

250

200

Q2FY13 Q3FY13 Q4FY13 Q1FY14 Q2FY14 Q3FY14 Q4FY14 Q1FY15 Q2FY15 Q3FY15 Q4FY15 Q1FY16 Q2FY16 Q3FY16 Q4FY16 Q1FY17 Q2FY17 Q3FY17 Q1FY13

Source:Company data, Edel Invest Research.

KBL’s domestic order book has gained palpable momentum—from INR1,485cr in FY13 to INR1,925cr in FY16, followed by INR1,520cr order booking in 9mFY17. QoQ as well, the company’s order booking has been gaining strength with order inflows accounting for more than INR550cr each in 3 of the past 4 quarters. Orders have been booked in standard domestic/industrial pumps, infrastructure projects like metro railway, food processing, chemicals, tyres, among others.

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On the other hand, order book of projects business in FY16 stood at INR1,140cr, significantly down from INR2,773cr in FY11. Around 70% of current projects’ order book is from pre-2009, when KBL had completed a good part of civil work. In the project segment—irrigation, power, and oil & gas—the company continues to book orders entailing favourable financial terms like advance and Letter of Credit (LC) backing. Its project orders have altered over the past 6-7 years— pump content accounts for almost 80% compared to mere 25- 30% earlier. Change in the order portfolio is likely to improve the company’s balance sheet and boost EBITDA margin to 10% over the next 2-3 years.

Current executable project orders of INR1,100cr are likely to have product content of over 40%. With slower additions to the order backlog from irrigation/power and the company’s cautious stance on order booking, we estimate project segment’s contribution to remain in the 20-25% range of total revenue over FY17-19.

Products business order book steadily improving Projects business order book scaling down 400

300 976

616 376 521 200 243 395 395 324

218 275 234

(INR cr) (INR

(INR cr) (INR 178 324 280

303

100 189 196 163

1421

1310

1149

1026

776 747

0 668

FY11 FY12 FY13 FY14 FY15 FY16

FY11 FY12 FY13 FY14 FY15 FY16 9MFY17 Oil&Gas Marine&Defense Irrigation Water Resource Mgmt 9MFY17 Industry Building Construction Power Work kept on hold KOV Distribution Customer Support & Spare Work not started Valves Export Excellence Cell

Source:Company data, Edel Invest Research.

Of the total order backlog, KBL has retained a few orders where work has not commenced as yet (INR324cr) and where clients have requested it to stop work (INR234cr). As the company has spent negligible amount on these projects, its balance sheet will remain insulated even if they do not start.

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Strong focus on product business to drive domestic margin We estimate KBL’s small products (made to stock) segment to post 11.3% CAGR fuelled by healthy demand in domestic and agriculture pumps. Both these segments are expected to be beneficiary of government’s thrust on rural development, especially on irrigation and affordable housing.

Assumptions of standalone revenues INR Cr FY16 FY17E FY18E FY19E a) Made to Stock 734 788 893 1013 % growth 7.3% 13.4% 13.4% % of total revenues 45.0% 45.4% 47.0% 48.5% b) Assembled to order 495 520 566 615 % growth 5.0% 8.8% 8.8% % of total revenues 30.3% 30.0% 29.7% 29.5% 1) Total Products 1229 1308 1459 1628 % growth 6.4% 11.6% 11.6% % of total revenues 75.3% 75.4% 76.7% 78.0% 2) Projects(large enegineered pumps) 403 427 442 458 % growth 6.0% 3.6% 3.6% % of total revenues 24.7% 24.6% 23.3% 22.0% Total Standalone Net Revenues 1632 1735 1901 2087 % growth 6.3% 9.6% 9.8% Source: Company data, Edel Invest Research

With healthy order booking in the products business and continued traction in the small pumps business, we forecast KBL’s standalone products business to register CAGR of 9.8% over FY16-19. This business is expected to account for 78% of revenue in FY19E from 75.3% in FY16. We believe, the products segment can sustain ~10% EBITDA margin over the next 3 years as the company continues to benefit from operating leverage and higher volumes.

Products business to be the driver of standalone business 100% 90% 42% 30% 25% 25% 23% 22% 80% 70% 60% 50% 40% 78% 70% 75% 75% 77% 30% 58% 20% 10% 0% FY14 FY15 FY16 FY17E FY18E FY19E Products Segment Projects Segment

Source: Company data, Edel Invest Research

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EBIDTA margins are expected to trend towards a pure play product business margins During the previous capex cycle (FY02-08), KBL was predominantly a products company, clocking EBITDA margin of 8-13%, with peak margin of 13.3% in FY06. During FY11-16, the company wrote off debt of INR205cr, appointed consulting companies for restructuring (~INR18cr) and invested ~INR40cr in integrating all the facilities with planning, procurement and sales functions through robust IT systems.

As the company made sustained efforts to increase the contribution of the products business, raw material cost has gradually reduced from 70.9% in FY10 (products business at 51% of sales) to 59.4% in FY16 (products business accounting for 76% of revenue). Taking into consideration the higher contribution of the products business, lower provisioning and zero one-time restructuring expenses, EBITDA margin is estimated to trend closer to 10% in the near future.

Gross margin improves; EBITDA margin was impacted by write-offs and one-time charges

80% 13.3% 14% 12.0% 70% 70.9% 63.1% 59.4% 12% 60% 9.8% 9.8% 8.4% 10% 50% 8.0% 7.8% 7.9% 6.8% 8% 40% 5.2% 6% 30% 4.0% 26.1% 19.9% 20% 14.9% 3.5% 4% 8.8% 4.4% 2% 10% 11.0% 0% 0% FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16

EBITDA margin (%)(RHS) RM cost as % of sales Empl cost as % of sales Other expenses as % of sales

Source: Company data, Edel Invest Research.

Higher GM & lower restructuring expenses will lead to margin improvement 70% 10.8% 12% 59.4% 58.0% 57.5% 60% 10% 50% 9.0% 56.0% 7.0% 8% 40% 26.1% 6% 30% 23.0% 21.4% 21.1% 3.5% 4% 20% 10% 2% 11.0% 12.0% 12.0% 12.0% 0% 0% FY16 FY17e FY18e FY19e

EBITDA margin (%)(RHS) RM cost as % of sales Empl cost as % of sales Other expenses as % of sales

Source: Company data, Edel Invest Research.

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Year of Company III. International business: Diversifying exposure, sharpening profitability focus Acquisition Kirloskar Brothers International BV, holding company for KBL’s international businesses, clocked CAGR of SPP Pumps, UK 2002 16.3% to INR975cr during FY10-15 propelled by entry in new markets, growth in core business and inorganic Aban Constructions, 2006 India spurt via acquisitions. But, the sharp fall in crude prices dented the company’s international business as the Kolhapur Steel, 2007 beleaguered oil & gas sector contributes 30% to revenue. KBL’s international business is a reasonably India profitable business, with ~10% operating margin. However, due to acquisition of sick companies, losses Braybar Pumps, 2010 Africa from these acquired companies are pulling down overall margin. Syncroflo,USA 2014 Under the leadership of Mr. Alok Kirloskar, Managing Director of SPP Pumps, KBL is diversifying its Rodelta,Netherlands 2015 international business into different industries—onshore exploration, desalination and downstream petrochemicals—and varied geographies—US, South Africa, South-East Asia. The company is also looking to expand its spares & services business in the international market to derive higher profitability and annuity income. In FY14, this business accounted for INR150cr, which fell to INR90-95cr in FY15 and FY16 in the absence of demand from the oil industry. However, as oil prices are settling at USD55/barrel, KBL anticipates to regain the INR150cr level over the next 2 years.

International Business - Region Wise (FY16) Orders impacted by lower O&G capex 1400 South Thailand, Africa, 5.3% 3.3% 1200 1000 800 USA,

15.0% Cr INR 600 400 200 UK, 76.4% 0 FY13 FY14 FY15 FY16 9MFY17

Orders received Order backlog

Source: Company Data, Edel Invest Research.

Operating margin is expected to get back to 8% in FY19E 1,400 10.0%

1,200 8.0%

1,000 6.0%

800 4.0%

(INR cr) (INR 600 2.0%

400 0.0%

200 -2.0%

- -4.0% FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17E FY18E FY19E

Net Revenues EBIDTA Margin(RHS)

Source: Company Data, Edel Invest Research.

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IV. Balance sheet stress to wane as projects move to closure stage Despite the projects business dragging down profitability and stretching the execution cycle, KBL has commendably managed to limit stress on net working capital and reduced debt-to-equity (D/E) below 0.3x. Existing INR255cr debt on standalone basis is entirely related to the projects business and expected to gradually reduce to zero as the projects business’ contribution to overall revenue falls.

Over the past 4-5 years, project execution has also picked up pace, with a few even achieving 100% completion. Increase in retention money (current level of INR400cr) as a proportion of total debtors and other current assets from the lows of 27% in FY12 to the current ~57% (H1FY17) is an indicator of traction in execution, with the possibility of recovering the entire retention amount of INR400cr over the next 3-4 years.

High retention with Govt – Hoping to recover in 3-4 years

3000 75%

2500 65%

2000 55% 1500 (INR cr) (INR 45% 1000 500 35%

0 25%

FY10 FY11 FY12 FY13 FY14 FY15 FY16

H1FY17 Projects Revenues Projects order backlog Retention money as % of debtors & other CA(RHS)

Source: Company Data, Edel Invest Research.

We forecast KBL to recover INR250cr retention money over the next 3 years, which will be used to repay entire debt of INR250cr in domestic business. Based on current status of legacy orders and political willingness to complete these orders, management is confident of recovering retention money over the next 3 years.

With robust spurt in products business, the working capital cycle will improve significantly, while execution of stuck projects will free up further capital, thereby materially reducing stress on KBL’s balance sheet.

Standalone D/E and NWC remain in control 50% 40% 30% 20% 10% 0% -10%

-20%

FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16

FY17E FY18E FY19E

Net Debt/Equity Net Working Capital as % of sales Source: Company Data, Edel Invest Research.

13 Edel Invest Research

Kirloskar Brothers Ltd

Peer comparison on NWC – KBL fares better than most 230.0

180.0

130.0 98.9 94.6 94.1

80.0 No of Days of No 30.0

-20.0 FY08 FY12 FY16

CRI KSB Sulzer WPIL Shakti KBL(standalone)

Source: Edel Invest Research.

Despite the projects business being a drag on KBL’s working capital, it has managed to maintain NWC cycle (Debtors + Inventory + Retention – Payables) at a respectable 94 days. Leaner operations and decision to work on orders with favourable payment terms have resulted in a tight leash on investments in working capital. Being the largest player in the pumps market, KBL has been able to get favourable terms of payment from suppliers.

Most importantly, higher volume and value growth in made to order pumps has resulted in strong cash flow generation. Made to stock is inherently a negative working capital business with RoCE of ~40%. Currently, this segment is operating at only 55-60% capacity utilisation, which opens up potential of doubling the turnover with the same asset base (optimal asset turnover of 6x) and enhancing RoCE beyond 50% for this segment.

Growth in products business will lead to RoCE expansion 20.0 15.0 10.0 15.0 5.0

10.0 0.0 (5.0) 5.0 (10.0) (15.0) 0.0 FY12 FY13 FY14 FY15 FY16 FY17E FY18E FY19E (20.0) (5.0) (25.0) ROAE (%) Cash Conversion Cycle(Days)(RHS)

We believe, as the domestic products business starts contributing higher to total revenue (78% of standalone & 50% of consolidated), RoCE will expand. We estimate consolidated RoCE at 10.3% in FY19 from negative 1% in FY16. While adjusting for cash, the company’s RoCE is likely to expand to 12.1% in FY19E from negative 1% in FY16.

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Kirloskar Brothers Ltd

Valuation 1 year forward P/E band

700

600

500

400

300

200

100

03 04 05 06 07 08 09 10 11 12 13 14 15 16

03 04 05 06 07 08 09 10 11 12 13 14 15 16 17

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-100 -

Sep Sep Sep Sep Sep Sep Sep Sep Sep Sep Sep Sep Sep Sep

Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar -200 Mar

KBL 5x 10x 15x 20x 25x

Peer Comparison – Relative Valuation

P/E P/S Sales CAGR PAT CAGR RoE

FY18E FY19E FY18E FY19E (FY16-19E) (FY16-19E) FY18E FY19E KSB Pumps 27.1 24.7 2.4 2.2 5.8% 8.3% 10.6% 11.3% Cummins 28.6 24.5 4.3 3.8 9.0% 11.4% 23.7% 24.7% Kirloskar Oil Engines 23.8 18.1 1.7 1.5 10.6% 25.7% 13.8% 16.5% Kirloskar Brothers 22.8 11.4 0.6 0.6 7.7% NA* 8.10% 14.9% *-Consolidated net profits are expected to grow to INR160cr in FY19E from a loss of INR33cr in FY16

15 Edel Invest Research

Kirloskar Brothers Ltd

Company Description KBL is a world-class pumps manufacturing company with expertise in engineering and manufacture of systems for fluid management. Established in 1888 and incorporated in 1920, KBL is the flagship company of the USD2.1bn Kirloskar Group. KBL provides complete fluid management solutions for large infrastructure projects in water supply, power plants, irrigation, oil & gas and marine and defence. The company engineers and manufactures pumps (industrial, agriculture and domestic), valves and hydro turbines. It also undertakes turnkey projects in large irrigation and infra projects involving design/system engineering, product supply and site erection, besides various other services involved in a large project.

In 2003, KBL acquired UK’s SPP Pumps and eventually established subsidiary operations in US, Netherlands and Thailand. In 2008, it incorporated Kirloskar Brothers Europe B.V. (Kirloskar Pompen B.V. since June 2014), a joint venture (JV) between Kirloskar International B.V. and Industrial Pump Group, Netherlands. In 2010, KBL further consolidated its global position by acquiring Braybar Pumps, South Africa. SPP MENA was established in Egypt in 2012. In 2014, KBL acquired SyncroFlo, the largest independent fabricator of commercial and municipal domestic water booster pumps in the US.

Locations of Facilities

Landmark Orders Received and Executed Domestic Market International Market Client Description Client Description 27 pumps for the maintenance Saudi Aramco Base Oil Company (Luberef)- Saudi High speed & high pressure API Mumbai International Airport - T2 Terminal systems at the airport Arabia BB5 pumps 12 pumps for its district cooling 230 Megawatt Gardabani Gujarat International Finance Tec-City (GIFT) systems Calik Enerji, Turkey Combined Cycle Power Plant KBL’s concrete volute pumps and project Sardar Sarovar Narmada Nigam Ltd (SSNNL) vertical turbine pumps support CW Pump-sets in special material of construction for sea water the world’s largest pumping Toshiba, Philippines system application to Toshiba for Thermal Power Project Nuclear Power Corporation of India Ltd Sodium liquid pump Boiler feed pumps and Hyundai Engg, UAE Condensate Extraction pumps KBL’s 10 concrete volute pumps Coastal Gujarat Power Ltd. (CGPL) supports world’s largest circulating water system ST pump of KEPL supplied in Bharat Petroleum Corporation Ltd, Mahul-Mumbai 1989, which is still running satisfactorily KBL pumps used for French Reliance Industries Ltd Hazira-Gujarat water application

16 Edel Invest Research

Kirloskar Brothers Ltd

KBL Product Line

Agriend suction canned motor db fire-fighting

monoblock Pressure Booster System Process Pump Self Priming

Solid Handling Pump Split Case Submersible vertical turbine

17 Edel Invest Research

Kirloskar Brothers Ltd

Quarterly Numbers -

Standalone

(INR cr) Q3FY17 Q3FY16 %Change Q2FY17 Q1FY17 9MFY17 9MFY16 %Change Net Sales 429 397 7.9% 367 354 1150 1123 2.5% Other operating income 5 3 33.8% 3 2 10 10 0.2% Total Income 433 401 8.1% 371 356 1160 1133 2.4% Cost of goods sold 280 281 -0.1% 218 236 735 752 -2.3% Employee expenses 54 43 26.0% 51 48 153 133 15.2% Other expenses 80 73 8.5% 69 61 210 215 -2.6% Operating Expenses 414 397 4.3% 338 345 1097 1100 -0.2% EBITDA 19 3.6 428.6% 32 11 63 33 92.2% Depreciation 9 10 -4.5% 11 10 30.4 30.0 1.4% Net Interest & Other Income -6 -7 NA 0 6 -17 -19 NA PBT 3 -12 NA 22 -4 18 -9 NA Tax Payment 1 -1 NA 5 0 5 -3 NA Net Profits 2.2 -12 NA 17 -3 13.1 -6 NA Equity Capital 15.9 15.9 15.9 15.9 15.9 15.9 No of Shares 7.9 7.9 7.9 7.9 7.9 7.9 EPS 0.3 -1.5 2.1 -0.4 1.6 -0.8 EBITDA Margin 4.4% 0.9% 8.7% 3.2% 5.4% 2.9% PAT Margin 0.5% -2.9% 4.5% -0.9% 1.1% -0.5% Tax Rate 37.2% 6.0% 23.5% 12.1% 27.8% 36.7%

(INR cr) Q3FY17 Q3FY16 %change Q2FY17 Q1FY17 9MFY17 9MFY16 % change Segmental Revenues (INR cr) Project Sectors 133 115 15.4% 84 67 285 270 5.5% Product Sectors 317 303 4.7% 304 306 928 913 1.6% Total Segment Revenue 450 418 7.6% 388 374 1212 1183 2.5% Segmental EBIT (INR cr) Project Sectors 7.7 -17 NA 6.8 -12.7 1.9 -30.1 NA Product Sectors 30 32 -8% 43.3 40.7 116 115 1% EBIT 38 15 150% 50.1 28.0 118 85 39% Other Un-allocable Expenditure 26 18 44% 20.77 23.87 70 63 12% EBIT(including unallocable) 12 -3 NA 29.3 4.2 47 22 119% Less : Interest 9 9 -10% 8.14 7.87 25 28 -11% Net Profit/Loss Before Tax 3.3 -12.4 NA 21.2 -3.7 22.7 -6.0 NA EBIT Margins Project Sectors 5.8% -15.1% 8.1% -18.8% 0.7% -11.2% Product Sectors 9.4% 10.7% 14.2% 13.3% 12.5% 12.6% EBIT(including unallocable) 2.6% -0.7% 7.5% 1.1% 3.9% 1.8%

18 Edel Invest Research

Kirloskar Brothers Ltd

Financials Income statement (Consolidated) (INR cr) Year to March FY15 FY16 FY17E FY18E FY19E Income from operations 2728 2594 2707 2960 3244 Direct costs 1481 1402 1434 1559 1666 Employee costs 416 440 480 493 516 Other expenses 640 687 691 704 753 Total operating expenses 2537 2529 2605 2755 2935 EBITDA 190 65 102 204 308 Depreciation and amortisation 95 77 82 86 89 EBIT 96 -12 20 118 219 Interest expenses 50 52 37 23 12 Profit before tax 63 -34 -2 121 241 Provision for tax 17 -2 -1 41 82 Core profit 45 -32 -2 80 160 Minority Interest -4 0 0 0 0 Profit after tax 41 -33 -2 80 160 Adjusted net profit 41 -33 -2 80 160 Equity shares outstanding (mn) 7.9 7.9 7.9 7.9 7.9 EPS (INR) basic 5.2 -4.1 -0.2 10.1 20.1 Diluted shares (Cr) 7.9 7.9 7.9 7.9 7.9 EPS (INR) fully diluted 5.2 -4.1 -0.2 10.1 20.1 Dividend per share 0.5 0.7 -0.1 3.0 5.9 Dividend payout (%) 9.0 NA NA 25.0 25.0

Common size metrics- as % of net revenues (INR cr) Year to March FY15 FY16 FY17E FY18E FY19E Operating expenses 93.0 97.5 96.2 93.1 90.5 Depreciation 3.5 3.0 3.0 2.9 2.8 Interest expenditure 1.8 2.0 1.4 0.8 0.4 EBITDA margins 7.0 2.5 3.8 6.9 9.5 Net profit margins 1.5 (1.3) (0.1) 2.7 4.9

Growth metrics (%) Year to March FY15 FY16 FY17E FY18E FY19E Revenues 1.4 (4.9) 4.3 9.3 9.6 EBITDA (4.5) (65.7) 56.2 100.4 50.9 PBT (40.6) NA (92.6) NA 99.3 Net profit (30.8) NA (94.4) NA 98.8 EPS (37.1) NA (94.5) NA 98.8

19 Edel Invest Research

Kirloskar Brothers Ltd

Balance sheet (INR cr) As on 31st March FY15 FY16 FY17E FY18E FY19E Equity share capital 16 16 16 16 16 Preference Share Capital 0 0 0 0 0 Reserves & surplus 996 952 950 1,001 1,103 Shareholders funds 1,012 968 966 1,017 1,118 Short term borrowings 296 306 306 236 86 Long term borrowings 52 45 35 0 0 Borrowings 348 351 341 236 86 Minority interest/other liabilities 133 170 170 170 170 Sources of funds 1,492 1,489 1,477 1,423 1,374 Gross block 931 971 1,039 1,099 1,159 Depreciation 432 484 566 652 742 Net block 499 487 472 446 417 Capital work in progress 12 7 0 0 0 Total fixed assets 511 494 472 446 417 Intangibles 72 77 77 77 77 Investments/Deferred Tax Assets 267 297 297 297 297 Inventories 339 370 383 369 376 Sundry debtors 788 654 690 660 680 Cash and equivalents 64 61 30 145 268 Loans and advances 148 186 182 194 212 Other current assets 421 384 350 280 180 Total current assets 1,758 1,656 1,634 1,648 1,716 Sundry creditors and others 625 557 555 594 641 Provisions 507 503 473 476 517 Total CL & provisions 1,132 1,060 1,029 1,070 1,158 Net current assets 626 596 606 577 558 Net Deferred tax 16 25 25 25 25 Misc expenditure 0 0 0 0 0 Uses of funds 1,492 1,489 1,477 1,423 1,374 Book value per share (INR) 127 122 122 129 143

Cash flow statement (INR cr) Year to March FY15 FY16 FY17E FY18E FY19E Net profit 49 -32 -2 80 160 Add: Depreciation 95 77 82 86 89 Change in other assets 17 8 129 0 0 Change in deferred tax -14 -9 0 0 0 Gross cash flow 147 45 210 166 249 Less: Changes in W. C. 100 -24 5 -173 -142 Operating cash flow 47 69 205 340 391 Less: Capex 131 138 -17 60 60 Free cash flow -84 -69 222 280 331

20 Edel Invest Research

Kirloskar Brothers Ltd

Ratios Year to March FY15 FY16 FY17E FY18E FY19E ROAE (%) 4.1 -3.3 -0.2 8.1 14.9 ROACE (%) 6.3 -0.6 0.9 5.4 10.3 Debtors (days) 106 90 95 85 80 Current ratio 1.6 1.6 1.6 1.5 1.5 Debt/Equity 0.3 0.4 0.4 0.2 0.1 Inventory (days) 83 96 100 90 85 Payable (days) 154 145 145 145 145 Cash conversion cycle (days) 36 41 50 30 20 Debt/EBITDA 1.8 5.4 3.3 1.2 0.3 Adjusted debt/Equity 0.3 0.3 0.3 0.1 -0.2

Valuation parameters Year to March FY15 FY16 FY17E FY18E FY19E Diluted EPS (INR) 5.6 (4.2) (0.4) 10.0 20.0 Y-o-Y growth (%) (32.4) NA (91.6) NA 100.1 CEPS (INR) 18 6 10 21 31 Diluted P/E (x) 47.5 NA NA 24.3 12.2 Price/BV(x) 1.9 2.0 2.0 1.9 1.7 EV/Sales (x) 0.8 0.9 0.8 0.7 0.6 EV/EBITDA (x) 11.8 34.8 22.5 10.1 5.8 Diluted shares O/S 7.9 7.9 7.9 7.9 7.9 Basic EPS 5.2 (4.1) (0.2) 10.1 20.1 Basic PE (x) 47.5 NA NA 24.3 12.2 Dividend yield (%) 0.2 0.3 (0.0) 1.0 2.0

21 Edel Invest Research

Edelweiss Broking Limited, 1st Floor, Tower 3, Wing B, Kohinoor City Mall, Kohinoor City, Kirol Road, Kurla(W) Board: (91-22) 4272 2200

Vinay Khattar Head Research

[email protected]

Rating Expected to

Buy appreciate more than 15% over a 12-month period

Hold appreciate between 5-15% over a 12-month period

Reduce Return below 5% over a 12-month period

Kirloskar Brothers 5 years price chart 350

300

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150

100

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12 13 14 15 16 17

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22 Edel Invest Research

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23 Edel Invest Research