Engineers India Limited (EIL)

NSE: ENGINERSIN; BSE: 532178; ISIN: INE510A01028

November 19, 2011. Current Market Price: Rs. 229. Sensex 16372. Nifty 4906.

52 Week High/Low: 352 / 215

Buy for duration of at least 3 to 5 years.        

Investment Summary: A business serving one of the fundamental aspect of human civilization i.e. Energy.

In the Berkshire Chairman’s letter to Shareholders, 2007, Warren Buffett writes: “Charlie and I look for companies that have a) a business we understand; b) favorable long-term economics; c) able and trustworthy management; and d) a sensible price tag”.

Analysis of EIL with respect to the above four filters:

a)    Simple Business to understand:

EIL is a Public Sector Unit. It has two business lines – provide consultancy services and execute Engineering, Procurement and Construction (EPC) contracts.

Consultancy business is a high margin business (Net profit margin of 35% to 40%) and requires negligible capital expenditure. This business contributes approximately 30% to 35% to revenues.

Majority of EIL’s EPC contracts are on an Open Book Estimate (OBE) basis i.e. contracts are open ended for design changes and changes in raw material costs are directly passed-through to the customer. Hence this too is a safe business model and requires minimal capital expenditure. It also protects EIL from escalating raw material costs. Profit margin is 10% to 12% and contributes approximately 65% to 70% to revenues. Since there is minimal capital expenditure, this business too earns high Return on Capital Employed (ROCE).

Excluding Investments, Cash and Fixed Deposits, EIL has a negative working capital.

It is a zero debt company and as on Sep 2011, has net cash of around Rs. 1625 Cr.

Moat (Moat means a competitive advantage over present and future competition):

EIL operates in the Energy and Infrastructure sectors i.e. Petroleum Refining, Petrochemical plants, Offshore as well as Onshore Oil and Gas exploration, Oil and Gas pipelines, Mining and Metal, Strategic Crude Oil Storage, Ports and Terminals etc.

EIL has worked on over 50 refinery projects in India. It has worked on 9 grass root refinery projects from concept to commissioning. It has been involved in the establishment of 7 out of the 8 mega petrochemical complexes in India. It has worked on 205 offshore platforms, 35 oil and gas processing projects, 37 pipeline projects and 26 mining and metal projects. EIL has thus accumulated a vast database of knowledge through is operations since 1965. It is not easy for a big business house with deep pockets to get access to this knowledge database. Thus, there are sufficient barriers to entry.

Also, having worked on the majority of the refineries and petrochemical plants may provide some sort of stickiness from customers for new as well as maintenance and expansion of existing plants. I believe this provides EIL with sufficient pricing power.

b)    Long Term Economics:

Energy is one of the fundamental requirements to sustain human civilization. I believe that five to ten years from now, Indians would be using a lot of petrol, diesel and gas than at present. This would require setting up of new refineries and pipelines as well as expanding the existing ones.

Plastic is one of the major end products of petrochemical plants. Each passing day, we are using more and more plastic which makes me believe that the per capita consumption of plastic is going to increase a lot in the years ahead.

All this shall ensure that there is a steady demand for the services of EIL.

Thus, this is a business earning high ROCE and RONW (Return on Net Worth) and requires minimal capital to keep growing.

c)    Able and Trustworthy Management:

EIL employs some of the brightest minds of India and has one of the lowest attrition rates for a service industry i.e. less than two percent. Being majority owned by Government (80.40%) and there being no stock option plans, there is no incentive for the management to jack up the stock price through fraudulent means.

Management is planning to diversify into energy related sectors like Nuclear, Solar, City Gas Distribution, Water and Waste Management and Fertilizer. While this may sound risky, EIL has a history of successfully diversifying into Mining and Non-Ferrous Metallurgy in 1973 and into infrastructure sectors in 2001.

d)     A Sensible Price Tag:

Excluding interest income and income from investments, Adjusted Profit after Tax (APAT) for the year ending Mar '11 is Rs. 442 Cr.

Average  APAT from Mar ’09 to Mar ’11 is Rs. 341 Cr.

At the current market price of Rs. 229, market capitalization is Rs. 7726 Cr. Net Cash is Rs. 1625 Cr. Therefore, Enterprise Value (EV) of the business is Rs. 6100 Cr.

1.    Using the average APAT from Mar ’09 to Mar ’11 of Rs. 341 Cr, market expects EIL’s APAT to grow perpetually at 4.40%.

2.    Using the Mar ’11 APAT of Rs. 442 Cr, market expects EIL’s APAT to grow perpetually at 2.80%.

Compare this with the actual top line CAGR from Mar ’07 to Mar ’11 of 49%; Operating profit CAGR from Mar ’07 to Mar ’11 of 47%; PAT CAGR from Mar ’07 to Mar ’11 of 38%.

Note: I own shares of EIL. My average purchase price is Rs. 248.

Over long periods, stock price follow the performance of the business.

Divide the amount you want to invest in EIL into at least five parts. Invest the first part and if the price goes down, buy more and so on…

Expect average annual return of 15% to 20% over 3 to 5 years.

The following table indicates the compounded value of 100,000 at 5%, 10%, 15% and 20% for 10, 20 and 30 years. It must be noted that how relatively small differences in rates add up to very significant sums over a period of years:

	5%	10%	15%	20%
10 years	162,889	259,374	404,556	619,174
20 years	265,330	672,750	1,636,654	3,833,760
30 years	432,194	1,744,940	6,621,177	23,737,631

                                                                                                          Priyank J. Sanghavi

                                                                                                          priyankjs1@gmail.com

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