Improved fundamentals with focus on high value business

Kirloskar Brothers (KBL) plans to re-focus on the product business by reducing its exposure to underperforming project business and being extremely selective in bidding. Over the next two years, we expect contribution from the project business to descend to ~20% from 35% currently. Resultantly, profitability for the overall company is likely to improve with larger contribution from the high margin product business. That apart, lower working capital intensity for the product business compared to project business would mellow down working capital concerns and thereby result into decline in debt levels.

Strong distribution & brand recognition; an edge over competition

KBL, over the years has developed strong dealer network with close to 950 dealers in India along with 350 service centers and 15 regional offices. In the international business, the company has 10 offices and around 45 dealers. In India, there are 800+ pump manufacturers, with large number of unorganized/mid size players and relatively few large players like KBL. Strong brand recognition and well established distribution network are the most vital factors which give any player an edge over competition in this industry, where entry barrier is relatively low.

Valuations not factoring the improved fundamentals

Sluggish revenue growth in the project business is expected to partially offset strong growth in the product business and hence we foresee 10.5% revenue CAGR for the company over the next two years. However, with increasing contribution from the product business, margins are expected to expand by 220bps over the same period. Furthermore, we believe, decline in working capital intensity led by change in revenue mix would facilitate reduction in the current debt levels. Margin expansion, lower working capital requirement and debt levels would translate into better return ratios for the company over the next two years. We believe, current valuations do not factor in the improved fundamentals and recommend BUY with a target price of Rs175.