Back on the growth path

Engineers India is eyeing a earnings recovery backed by brownfield expansion of OMCs

Had you bought Engineers India (EIL) at the point of maximum pessimism when the stock hit a low of Rs.147 in February earlier this year, you would have made a 90% return in six months as the stock is now quoting at Rs.270.

In February, there was a lot of apprehension in the crude oil and hydrocarbon market where EIL operates. As the crude price had crashed, there was a fear of cancellation of orders, spike in debtors, possible price negotiations in the existing projects along with pressure on operating margins and lack of fresh orders.

But so far, nothing of that sort has come through. In Q1FY17, the company posted a 20% growth in consulting revenue, which contributes 80% of top-line. Its other segment, turnkey projects, continues to slide and reported an EBIT margin of 2.8%. In the past the project business margins have remained in the range of 20-25%, but over the past 4-5 quarters they have fallen to negative or single digit.

What helped the company was a write-back of provisions worth Rs.27 crore, investors are hopeful about more write backs and expect the sales mix to remain tilted towards the high-margin consulting business. Certain project-related additional costs, which are not paid for by clients are written off as project-related provisions thus impacting margins. If these additional costs are recovered later on, the provisions are written back. 

Operating leverage
It's not just write backs. Consulting, which is largely a fixed cost business, has huge operating leverage. After a 4% average growth in the last four quarters, this business saw a 20% growth in Q1FY17. Consulting business is expected to remain buoyant and have a positive impact on margins and earnings.

"High inherent operating leverage in the business will drive a 67% core EPS CAGR over FY16-19. Currently its employee utilisation rate is around 75% and it will be able absorb 20-25% growth in revenues with no increase in the headcount," says Nitin Bhasin, analyst, Ambit Capital. The spurt in earnings is largely backed by improvement in margin (over 20% in FY17 as against 10.7% in FY16).

The other thing that has contributed significantly to its improving outlook is higher revenue visibility. It has upgraded order inflow guidance for the full year FY17 to Rs. 3,500 crore as against Rs.2,000 crore earlier. These kind of inflows were last seen during 2008 and 2010 peak. It is encouraging because its turnkey project business, which has in the past suffered hugely because of low order activities, could at least stop the drag on overall profitability. In FY16, it had order inflows of Rs. 1,600 crore and an outstanding order book of Rs. 3,744 crore, which was 7x its turnkey project revenue. Today its outstanding order book is Rs. 5,500 crore or 11x turnkey sales.

"Lower crude prices and sharp reduction in subsidy have boosted free cash flow for PSU OMCs, triggering capacity expansion announcements of 45 million tonne per annum. We expect Engineers India to be an early beneficiary of a pick-up in the investment cycle of the hydrocarbon space over the next 2-3 years," writes Bhoomika Nair, analyst, IDFC Capital, in a recent report. Apart from the brownfield expansion, the market is closely eying fresh orders because of Euro VI norms adoption by refineries.

Since FY14, EIL’s has fallen from Rs.14.2 a share to Rs. 7.7 in FY16. Even at an average expectation of Rs.15 a share in FY18, its stock is trading at 18x, which is reasonable in the back drop of huge operating leverage, large cash and zero debt. The business does not require capex and currently operates at negative equity capital (equity minus cash). EIL is sitting on cash and cash equivalent of Rs.75 per share, which is almost 30% of its market cap.