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Cost pressures hit margins; execution muted

ISGEC Heavy Engineering (ISGEC) reported a standalone revenue growth of 11% YoY to Rs11.5bn in Q2FY22. Standalone EBIDTA margin shrunk by a significant 550bps YoY to 3.1% due to higher cost overheads. Management guided margins are likely to remain subdued till Q4FY22 as cost challenges persist. Due to increased commodity prices, management has been judicious in bidding for orders, and this led to a weak consolidated order intake of Rs8.5bn during the quarter. However, the current consolidated orderbook is strong at Rs75bn (1.7x TTM sales). Factoring-in near term margin stress, we marginally cut standalone earnings by 27% and 15% for FY22E and FY23E respectively. Given the healthy orderbook and a strong pipeline of orders, we maintain our BUY rating on the stock with a revised SoTP-based target price of Rs756 (earlier: Rs869).

Cost pressures hit margins:

Q2FY22 standalone revenues grew 11% YoY to Rs11.5bn led by 34% YoY growth in the product business to Rs3.3bn, while EPC revenues grew by a marginal 1% YoY to Rs8.6bn. Product margins contracted sharply by 630bps YoY to 8.2% and EPC margins shrunk by 410bps YoY to 1% resulting in a standalone EBIDTA margin decline of 550bps. Impacted by lower margins, standalone PAT dipped 55% YoY to Rs272mn.

Strong orderbook despite low intake in Q2FY22 provides growth visibility:

The overall orderbook stands at Rs75bn (1.7x TTM sales). Power, steel, cement, railways, metals along with oil & gas and refinery are the major segments in which the company is getting strong order enquiries. Since it has a healthy orderbook, it will be judicious in bidding for further orders given the current volatility in commodity prices and higher proportion of fixed-price contracts in the order mix.

Company to continue operating the Philippines plant:

ISGEC has decided to complete the pending work and run the plant, with the option of selling it if and when it finds a suitable buyer. Company’s overall exposure in the Philippines entity currently stands at US$38mn and it is confident that it can be run profitably.

Maintain BUY due to healthy orderbook:

Despite the challenging environment and higher mix of EPC work, the liquidity situation is under control. The Philippines asset continues to be an overhang on valuation. We value the stock at a standalone target P/E multiple of 20x at Rs698 per share, ISGEC Hitachi Zosen at Rs30 per share (25x FY23E earnings) and the sugar subsidiary at Rs27 per share (5x FY23E earnings). Maintain BUY with a revised SoTP-based target price of Rs756 (previously: Rs869).

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