CG Power & Industrial Solutions Ltd - Capable management, good business & supportive industry tailwinds

Background
CG Power & Industrial Solutions Ltd (CG Power) is a leading capital goods & engineering company with a diverse portfolio of products across electric motors, railways, transformers, switchgears, drives & automation segments. The company’s products mainly find application in industrial, railway and power sectors.

The company was positioned among top 1-5 players in majority of its product segments. However, it was loosing market share due to lack of management focus, fraudulent activities by its erstwhile promoter’s (Avantha group) and subsequent fund crunch.

CG Power’s lenders-initiated steps under RBI’s Prudential Framework for Resolution of Stressed Assets, leading to Tube Investments of India Limited (TI), a listed company and part of the Murugappa Group acquiring a controlling stake (~53%) in November 2020. TI has infused about Rs.7 bn of equity, besides also subscribing to certain warrants.

Post takeover by TI, a new board has been constituted under the leadership of Mr S. Vellayan (Chairman) and Mr Natrajan Srinivasan (MD), settlement of old lenders has been done, recasting of previous years’ financials has been carried out and liquidation/divestment process of certain overseas subsidiaries has been initiated. Performance is back on track with PBT of Rs.215 crore achieved in H1FY22 as against management’s initial indicative target of about Rs.500 crore of PBT in next 4-5 years.

Business Overview

Historically, about 65-70% of revenue was contributed from domestic markets and rest was from international operations. However, majority of overseas subsidiaries have been liquidated or in the process of liquidation. Now with just 2 operating overseas subsidiaries; about 90% of revenue is from domestic operations.

CG Power re-launched its Fast-Moving Electrical Goods (FMEG) range of products in 2019 such as domestic & agricultural Pumps, and industrial & domestic Exhaust Fans, but the contribution is insignificant. Now, the company has serious plan for the segment and preparing to extend FMEG product range, including ceiling fans.

There is renewed focus on R&D and a number of new products have been developed, EV Motor being most significant one. Details of few such products are as following

Management
Tube Investments of India Limited (TI), a listed company and part of the Murugappa Group now holds ~53% stake in the company, besides certain warrants. Murugappa Group, Headquartered in Chennai, is an Indian conglomerate founded in 1900 and having presence in several segments including engineering, abrasives, auto components, bicycles, sugar, farm inputs, fertilizers, NBFC, Insurance and financial services. Mr. M A M Arunachalam is Chairman and Mr S Vellayan is MD of Tube Investments.
Mr S Vellayan is appointed as Chairman and Mr Natrajan Srinivasan as MD of CG Power.

Growth Triggers
• CG Power has eight decades of lineage with leadership position in many product categories. Strength of its product portfolio is evident from the fact that it was able to sell its products despite significant internal challenges and acute funding crunch during the last few years. Now, with a new promoter group and management team having clear focus on gaining lost ground, expanding product portfolio and range; business performance should improve significantly.

• Focus on R&D, industrial automation, EV motors, FMEG products, application & geographical expansion, improving capacity utilisation are management identified areas to drive revenue and profitability growth. Also, selling of identified non-core assets and FCF generation should help the company in becoming debt free in 2-3 years.

• Industry tailwind are conducive. After a subdued scenario during past many years; capital goods sector is seeing initial signs of recovery. Government impetus on manufacturing through PLI schemes, modernisation initiatives in railways & power sector, private capex driven by improving capacity utilisation and export opportunities, provide visibility for long-term uptrend in the sector.

• New management team has a proven track record. Mr Vellayan has been associated with Murugappa group since 2010 is credited for improved performance of Cholamandalam Investment and Finance as well as Tube Investments. Mr. Natarajan Srinivasan has also been associated with Murugappa group for last 15 years.

• For TI and CG Power’s future business strategy, the group is inspired by a very successful American company, Danaher Corporation; which has a successful track record of acquiring many entities and generating above average returns for shareholders. The management plans to replicate the same under TI as well as CG Power and use these companies as a platform for growth through acquisitions. Besides, there is stated intent of improving revenue growth & profitability, focus on cash flows, improving return on capital employed and pare debt.

• While the management was targeting Rs.5000 crore of turnover and Rs.500 crore of PBT in next 5 years, they seem to be much ahead on the target. During H1FY22, CG Power reported revenue of Rs.2504 crore and PBT (before exceptional items) of Rs.215 crore. With the legacy issues already fixed; enhanced product portfolio, operational efficiencies and industry tailwinds should help in achieving better earnings going forward.

Key Risks
• The Company had received notice of demand under Income Tax Act for Rs.606.30 crores for FY17. While the Hon’ble Bombay High Court has granted interim stay until admission of appeal before the High Court, it remains a major contingent liability.

• There are ongoing investigations by SFIO, ED and CBI pertaining to acts of erstwhile promoter & previous management and the company is also a party in this investigation. The Company believes that the Company or the present Board of Directors and Key Managerial Personnel appointed after the change of Management on 26 November, 2020, cannot be made liable for any violations in respect of certain past. However, risk of any unforeseen development remains.

• One lender has invoked the corporate guarantee amounting to Rs.41.56 crore due to bankruptcy proceedings initiated of Belgium Entities. The Company has not made provision towards this invocation on the assumption that the estimated recoverable value of assets of Belgium entities shall be sufficient to meet this liability.

• Successful expansion of product portfolio and favourable industry environment are key to expected superior growth prospects. Any disappointment on the same can have significant impact on the performance.

• Once CG Power becomes debt free, management has stated plans of driving growth through acquisitions. Acquisitions carry certain amount of risk pertaining to business as well as integration. Nevertheless, competent management with a track record provides comfort.

• Steep increase in commodity prices led by lag in pricing action has impacted the margins by about 2-3% during H1FY222. Large transformer orders have price variation clause, however smaller distribution products or industrial products do not have such clauses. Thus, the company is exposed to the risk of any sudden or steep increase in input prices.

• While probability for most of above-mentioned risks significantly impacting the business is low, however they cannot be completely ruled out.

Financials

• I have not shown historical financials as the company was in a different trajectory during last few years. Also, YoY performance is not comparable due to severe fund crunch impacting operations during H1FY21.
• As visible above, CG Power has reported impressive performance during the first 2 quarters of FY22.
• Exceptional items majorly pertain to cessation of liabilities due to settlement/restructuring of past borrowings, provision for past corporate guarantees and other provision reversals etc.
• Apart from good P&L performance, cash flow generation was also strong with OCF of Rs.177 crore and FCF of Rs.140 crore in H1FY22. Debt level came down by about Rs.3 bn in H1FY22 and net debt stands at about Rs.7 bn now.

Valuation

Stock has multiplied from a low witnessed in the phase when the company had bankruptcy risk and post management change also; as no one had expected such fast and significant turnaround. At the CMP of Rs.178, market cap is Rs.240 bn and diluted market cap (on conversion of warrants) is around Rs.272 bn. At the annualised PBT of Rs.430 crore (H1FY22 x 2), stock is trading at about 63x. I have used PBT due to significant amount of one-offs and income tax is majorly deferred tax during H1FY22. One of the leading broking firms estimates PAT of more than Rs.7 bn in FY24, which gives forward PE of 39x.

Capital goods majors such as ABB, Honeywell, Siemens, Thermax are trading between 40-65x FY24 estimated earnings. While these multiples optically look high, there could be earning surprises as witnessed during previous capital goods up-cycle during 2003-2008 (led by high revenue growth and margin expansion).

While the turnaround as well as near term performance appear to be already discounted; compounding of earnings which can happen over a period under the capable new leadership is probably not discounted. An investor should look forward for only this now.

Philip Fisher writes “In evaluating a common stock, the management is 90%, the industry is 9% and all other factors are 1%”. Only time will tell if CG Power is a perfect 100% combo of this.

Disc: Invested. I am not SEBI registered Advisor/Analyst. The information provided above is for education purpose only.

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Suggested readings/videos
(Bit dated but helpful in understanding management’s vision and sector prospects)

  1. Mr S. Vellayan’s interview post acquisition
    Tube Investments Takes Over Majority Stake In CG Power, Here's What MD S Vellayan Has To Say - YouTube

  2. 2QFY22 concall transcript
    Transcript_Q2_FY_22_Final.pdf (321.1 KB)

  3. Mr Unnikrishnan’s (Ex Md of Thermax) discussion with DSP team - To understand sector prospects
    Engineering A Better Tomorrow | India's 'New Industrial Revolution' | #ExpertSpeak | DSP Mutual Fund - YouTube

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3QFY22 results
Good performance on all counts; revenue growth, margins, profit, free cash flows and order book.
Mention of FCF in every result press release clearly indicates management’s focus on cash generation.
CG has already become net debt free through sale of non core asset (one land parcel) and internal accruals.

Consolidated Financials
2QFY23

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I attended concall today. Although I did not take any notes, I came back feeling quite content as a shareholder. This seems like solid, conservative management doing all the right things but without much fanfare. They were tight lipped about giving any forward guidance on top line, margins, productwise sales breakup, new product development etc. due to competitive reasons but I am ok with that (rather than giving big targets). Company is ticking all the boxes like debt reduction, slow entry into FMEG sector, showing interest to diversify in EV motors etc while maintaining focus in their core products. Upcoming budget should provide additional push to the infrastructure sector.

Disclosure - invested post today’s results

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New Management is really great.
After taking over , they started with re-audit and clearly declared the holes in the books and quantified the actual magnitude of fraud conducted by previous management.

In last one year, they have closed loss making subsidiaries and settled the dues where company was backer for the loans (with STD CH bank)…

Moat of the company is its Motor heritage. With TII, they can make a play for 2W electric ride.

Disc: Invested and biased.

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d132c5d3-48e2-4f12-abd5-a0a781dedc09 (1).pdf (128.4 KB)

Another income tax demand of significant amount.

IT demand is based on old financials, which are no longer valid as NCLT had directed the company to recast the financials of previous years, which were taken into record by NCLT in October 2021. The Company had brought to the notice of IT Department about the recast of the financial statements and disputed the proposal of the Income Tax department to include additional income based on assessment of old financial statements, which ceased to be valid and that assessment has to be done only on the basis of recast accounts.

While IT department’s case seems to be weak and the demand is unlikely to sustain in the court , CG power’s contingent liabilities have increased for the time being.

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4QFY22 Results – Below market expectations; long-term story intact

CG Power’s 4QFY22 performance was subdued with Q-o-Q decline of 3% in net sales, 18% in EBITDA and 20% in PBT. Impact of Covid 3.0 during Jan and Feb 2022 and subdued off-take from agri & irrigation segments were the key reasons for muted revenue. EBITDA margin during the quarter was impacted due to adverse sales mix, warranty provisions (~Rs.6-7 cr) and commodity inflation. FCF declined from Rs.158 crore in in 3QFY22 to Rs.86 crore in 4QFY22.

However, Rs.528 crore PBT and Rs.392 crore of FCF for FY22 (first full year of operations under the new Management) are remarkable achievements. Also, the management has indicated improved traction from start of March.

Negative takeaways

  • Performance was subdued in a quarter, which is traditionally strongest for the industry.
  • Steep inflation in commodity prices remains a key challenge. While the management expects to maintain the margins if commodity prices remain at current level; any steep fluctuations can impact both demand and margins.

Positive takeaways

  • During FY22, the company settled the obligations pertaining to guarantees issued to its subsidiaries abroad and these loss-making subsidiaries have been closed / under closure. The company has also completed the recasting and audit of the past Accounts. With these, there is much lesser uncertainty with respect to contingent liabilities.
  • The company generated Free Cash Flow of Rs.392 crore during FY22 and has become net debt free (has a debt of Rs. 302 crore and cash & cash equivalents of Rs. 452 crore). During 4QFY22 itself, the company prepaid term debt of Rs.235 crore. Management focus on cash flow should help the company in achieving quality growth.
  • Order book, with a 15% Q-o-Q and 35% Y-o-Y growth, stands at Rs.3,686 crore now.
  • Volume growth in motor segment was at a very strong level (~59% as against industry growth of ~40% in April 21-Jan 22), supported by strong demand from user industry, voluntary adoption of energy efficient motors by the users and market share gain from smaller players. Management expectation for the future growth is 2-3x GDP growth and capacity expansion is on cards.
  • The company has gained significant market share in transformer & switchgear products on a low base of FY21. It is also expanding its capacity at both Bhopal and Gwalior plants to cater to demand. Traction is also strong in railways segment and order inflow is likely to be healthy over medium term.
  • The company has secured development order (propulsion system) of Vande Bharat train from Indian Railways. However, this can only be a long-term trigger as the company would qualify for regular orders on successful completion of development order, which can take about 2 years’ time.
  • While the company has capabilities in EV motor segment, its products are yet to be commercialized.

Outlook

While the Q-o-Q performance was below market exceptions, there was no major blip. On the other side, the new management has demonstrated remarkable performance during FY22 with significant growth in revenue & profits, cleaning-up and strengthening of balance sheet, strong cash flow generation, order book built-up and giving a strong direction to overall business.

Improved capex traction in the private sector after many years of subdued period, PLI led capex and its cascading impact on the related industries and government impetus on capex in railway & power segments, should augur well for the capital goods industry over the next few years. Players like CG Power can disproportionately benefit from such opportunity due to strong legacy, focused management and various initiatives to expand capabilities. Based on these factors, leading brokerage houses expect its revenue to grow at ~20% CAGR and EPS to grow at ~30% CAGR during FY22-FY25E.

Disc: Invested. I am not SEBI registered Advisor/Analyst. The information provided above is for education purpose only.

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Good Point

Interesting set of results.

  1. CG Power in the 4th quarter willfully reduced inventory and Sales. Invoicing was stopped by 15/3/22
  2. Sales was curtailed probably because the target of Rs 5000 Crores was achieved.
  3. There is an aggressive price increase announced by the company with effect from 1/4/2022 ( for MOTORS).
  4. The above will show up only from Q2 FY22-23.
  5. My own estimate is that the company will look at at least Rs 6000 Crores turnover for this year for legacy businesses.
  6. There is increased focus on FANS and PUMPS. After the test launch, the company has gone live with the product in most metro locations.
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The Management has very ably demonstrated fast revival of the company’s fortunes… Strong infusion of funds to manage working capital and other constraints, working with lenders (of all hues) to clear legacy issues, cleaning up global web of companies… keeping what is needed and shutting the rest

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On the subject of valuations, market has very adroitly responded to the management’s cleaning up and revival efforts and the company seems to be now fairly valued
With the company’s business having broadly reached its pre-disturbance level, to determine the valuation trajectory going forward, I believe, market will seek insights on the
(1) management’s ability in growing the revenues of the legacy business above the 2-3X GDP, rather than the margins at which this growth is attained
(2) Traction on the company’s new initiatives on
i. branded consumer durables – fans and pumps and
ii. EV motors
(3) Corporate action in terms of leveraging company’s healthy valuations for inorganic growth

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