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Shakti Pumps - Lacking in Power

Shakti Pumps (India) (Shakti), a fairly unknown scrip, down by about 64 per cent from its peak price six months back, is available at a single digit PE and EV/EBIDTA of 6.10x and 5.9x its FY11 estimates. In a volatile market, a company available at single digit valuations certainly looks up for grabs. But after such a sharp correction in its price and the valuation froth coming off, does it make sense to recommend this scrip at its current levels? We spoke to Shakti’s B R Patidar, Director-Finance, about industry, competition, management initiatives, and financials.

Shakti is a manufacturer of stainless steel submersible pumps and motors ranging from 0.5 HP to 255 HP used in domestic, industrial, irrigation, and fire-fighting. The company is mainly focused on the export market and sup-plies its products to around 50 countries, such as US, UK, Turkey, Spain, Netherlands, Germany, France, Italy, Australia, Sri Lanka, etc. Nearly 58 per cent of its revenues are from exports. Of the balance 42 per cent of domestic revenues, 60 per cent come from supply to farmers, 20 per cent from domestic demand, 12 per cent from government institutions, and the balance 8 per cent from various industrial sectors.

Shakti currently has an installed capacity of 6 lakh pumps and according to Patidar was the first company to get a 5-star rating for its pumps from the Bureau of Energy Efficiency (BEE) for being 40 per cent more energy-efficient than other substitutes in the market. The company is also currently expand-ing its product line and is realigning its focus on the domestic market.

Having said that, there are reasons we believe this scrip may not perform as per the expectations on the bourses. First and foremost, one should note that Shakti is in a business domain that has low entry barriers and the products can be easily manufactured. Currently, Shakti manufactures only steel sub-mersible pumps and though it posi- tions itself as an energy-efficient pump manufacturer, there are other players too who manufacture such energy-effi-cient pumps.

However, the company is increas-ing its product line by adding boost-er pumps, mono-block, and open well pumps to its portfolio. “Shakti is installing a new 65,000 unit per annum capacity for booster pumps at a cost of Rs 35 crore, which is being funded through a combination of debt (Rs 25 crore) and internal accruals (Rs 10 crore). This expansion is expected to come on stream and start generat-ing revenues from FY12 onwards,” Patidar informed. The other expansion for mono-block and open well pump is still at the initial stages, though the management is confident about commissioning these capacities too by FY12.

Besides, to drive its domestic growth, Shakti has already strength-ened its marketing team and domestic dealer network to 650 from 192 just two years back. Though this renewed focus should help generate revenues for Shakti, the new product portfolio isn’t a unique one and is already manufactured across the country. Thus Shakti seems to be a late entrant in these products and therefore one will have to wait and watch the kind of growth it posts in these segments. Besides, there is a huge unorganised market on the domestic front which firstly eats into the market share (according to the management, Shakti’s market share is 3 per cent in the overall pump industry i.e. includ-ing the unorganised market) and sec-ondly, it reduces the pricing power of the organised players, thus impacting realisations and margins.[PAGE BREAK]

Even though Shakti derives 58 per cent of revenues from exports, it is a very small player in the global arena and hence it wouldn’t command the pricing power that a much larger international player such as Grundfos does. Just to give an idea, the prices of Grundfos pumps of similar capac-ity are almost four times to that of Shakti Pumps. Also, though Shakti’s average realisations per pump have improved on a YoY basis by 8.5 per cent to Rs 10,807 per unit, its average production cost based on the closing stock and its value is actually higher at Rs 12,093. However, the management claims that this could have been due to the stock of larger capacity pumps than smaller pumps at the year end, while the revenues might include more sales of smaller pumps. If that is so then this could be a one-off thing.

However, a similar thing is also seen in the results of FY09 where the aver-age production cost comes to Rs 12,250 while the average realisation per pump stands at Rs 9,954 per pump. Thus it seems that the company is actually los-ing money and this obviously reduces our comfort level with Shakti. In fact, going through the balance-sheet fur-ther, we observe that nearly 46 per cent of Shakti’s debtors are outstanding for more than six months. On probing about this, the management claims that this is an arrangement wherein Shakti has offered credit of 180 days to its long-standing clients, who assure them certain size of business in return. Though this is a business arrangement that Shakti has opted for, it is affecting the company’s ability to generate cash, which is important considering its business is working capital intensive.

In fact, the impact could be seen on the creditors’ figure, which has shot up to Rs 10.23 crore (Rs 2.76 crore). But the management claims that the rise in creditors is due to the fact that Shakti has been able to procure raw material from its vendors on credit, which it wasn’t able to do previously. The other thing that caught our attention was the deferred advertisement expenses to the tune of Rs 99 lakhs, which should be a part of the advertisement expenses in its profit and loss account (P&L). The management’s reasoning is that Shakti had used the print and electronic media last year for their increased domestic focus and incurred an overall cost of around Rs 2.5 crore, which is amor-tised over the expected benefit peri-od, while the running advertisement cost was booked to the P&L account. However, we believe that advertising expenses is a recurring factor for a company such as Shakti. Hence, these deferred advertisement expenses should have been a part of the advertisement expenses in the P&L account and the profits should have been lower by that amount.

As for the financial performance, for Q2FY11, Shakti’s revenues increased almost 41 per cent to Rs 44.77 crore (Rs 31.78 crore). This was on account of better performance of export markets, increased efforts on domestic front and price hikes. The profits too grew by 163 per cent to Rs 6.89 crore (Rs 2.62 crore), however, it includes an extraor-dinary item of Rs 5.32 crore on account of revaluation of stock inventory. If we adjust this then profits actually declined 40 per cent to Rs 1.57 crore (Rs 2.62 crore). However, a confident Patidar added, “Shakti’s domestic efforts, price hikes to be undertaken both on the domestic and export fronts, and esti-mated volume growth of around 17-18 per cent would see us achieve revenues of around Rs 200 crore, while the profit margin could be around 9 per cent for FY11.” This looks a bit ambitious though and in our opinion the revenues and profits could be around Rs 160-166 crore and around Rs 13-14 crore. At this estimates Shakti is available at a single digit PE of 6.10x and EV/EBIDTA 5.9x respectively.

This is a bit steep for a company such as Shakti and considering the reasons mentioned above, it also caps the upside potential for the company. Besides, the FIIs who held 6.19 per cent in September 2009 have completely moved out of the scrip, while the private corporate bodies that held 30.79 per cent of stake during the same period are slowly seen to be making an exit. Their stake as on September 2010 was 27 per cent. Besides, the scrip now being tightly held with just 1,344 shareholders, Shakti Pumps India might not give you the kind of returns you may be looking at.

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