Buy Diffusion Engineers Ltd For Target Rs.510 by InCred Equities
Strong execution and higher backlog; pricing pass-through holds the key
Diffusion Engineers Ltd (“Diffusion”) delivered strong revenue growth of 50.7% YoY, supported by industrial demand, higher execution and a growing order book. EBITDA grew a slower 34.5%, weighed down by RM cost inflation pressure (which is usually passed on with one-quarter lag). The sequential PAT decline masks an improvement in operating EBITDA, with lower associate/JV contribution and treasury income affecting the bottom line. Customers are receptive to price revisions, and newer orders are being booked at revised prices, which should help restore margins to prior levels from 4QFY27 onwards, subject to stable RM costs. With a healthy order backlog and sufficient capacity to absorb industry demand, management expects a 20-25% revenue CAGR over the next 3-5 years. We view this growth outlook positively, but margin recovery unproven execution tests. We build in a Revenue/EBITDA/PATAMI CAGR of 23%/31%/23%. We maintain BUY with a TP of INR 510.
Key Business Highlights
* Pricing and Margin Recovery: Prevailing RM price pressure in tungsten and specialty ferro-alloys, alongside higher energy and logistics costs, has compressed GM% (29.9% vs 37.0% YoY and 31.6% QoQ) ; EBITDA% nonetheless improved marginally QoQ to 13.2% (vs 12.9%), aided by robust execution, with revenue up 14.4% QoQ to INR 125.9Cr (vs INR 110.1Cr). The Tungsten prices have eased from their peaks but remain above earlier levels. Shorter-cycle orders (<6m) carry exposure to fixed-price risk, while longer contracts include price-variation clauses. Most of the current order book has been re-priced and quotation validity has been shortened.
* Orderbook (OB) and Execution Visibility: 2QFY27 backlog was INR 227Cr (vs INR 174.1Cr as of 4QFY26), up 30.3%. Heavy Engineering dominates backlog visibility with INR 178Cr OB, while consumables turn faster and are less fully represented in OB (INR 25Cr). Wear Plates/Wear Parts OB at INR 24Cr.
* New product development to scale up revenue: New products currently contribute about 1-2% of revenue. Diffusion targets a 10-15% revenue mix from new products on an expanded revenue base. The first vertical roller mill order has been executed for a leading cement manufacturer. The company has closed or is on the verge of closing orders for steel-mill rollers (JSW and JSPL), alternative-fuel shredders and roller presses. Apron feeder conveyors, centrifugal fan casings, hammer mill crushers, tilting runners and vertical roller mill housings are newly commercialised products, where the company sees order traction from core industries such as sugar, steel, power and mining.
* Railways, Defence and Overseas Expansion: Diffusion is qualified to manufacture locomotive shells for Indian railways which gives it access to bid for tenders. Defence opportunities are being explored (alongside Tejorup acquisition); however, both these opportunities are long-gestation and would drive growth beyond FY28. The Abu Dhabi facility is moving towards commencement of operations. Turkey is stabilizing and the Philippines remains consistent. Cement customer breakthroughs in Ghana and Nigeria.
* Capacity, Capex and Sourcing: Major capex is nearing completion, with phased commissioning expected to add capacity and operating efficiency. 1H capex stood at INR 24.2Cr. Most of the RM sourcing is domestic (85-90%) with certain roller-press forgings/castings imported from China and Europe.
Valuation at a Glance
* We value Diffusion at 25x FY28F EPS of INR 20.4. We expect price revisions and operating leverage from higher utilisation to drive margin recovery. Margin pressure is likely to persist in 2H. We have revised our EBITDA margin estimate down by 70bps for FY27F.
We maintain a BUY rating with a revised TP of INR 510, based on 25x FY28F EPS of INR 20.4. Our FY28F EPS is based on:
* Revenue of INR 617.5Cr driven by stronger execution with newly commissioned capacity and a healthy order backlog providing visibility (23% CAGR).
* EBITDA of INR 97.3Cr (15.8% margin). With price-revision and operating leverage from existing capacity, we expect a 170bps margin expansion over FY26 (14.2%), subject to RM price stability. The FY27F EBITDA margin has been revised down by 70bps to 13.9% on GM pressure
* PATAMI of INR 76.3Cr (12.4% margin). Higher depreciation to weigh on the bottom line.
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