GEI Industrial Systems. CMP: Rs.138.

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Management Interaction Note July, 19 2010

HDFC Sec
Industry CMP Recommended Action Averaging Price Band Target Time Horizon
Scrip code
GEIHAME Capital Rs. Buy at CMP and add Rs.159 &
Rs. 116-124 1-2 quarters
Goods 138.20 on dips 175

Company Background
GEI Industrial systems (GIS) was founded in 1970 with its manufacturing facility located in Bhopal (Madhya Pradesh). The company
was incorporated as General Engineering Industries. Later on in 1993 the company was converted in to a joint stock company. In 1997-
98 Hammon industries, France bought a 30% stake in the company (29.95 lakh shares) and hence the name of the company was
changed to GEI Hammon Industries. Hammon sold 25 Lakh shares in August 2008, post disagreements between the two parties. It
continues to hold on 4.95 Lakh shares in GIS. Initially the company was formed as an ancillary unit of BHEL (Bharat Heavy Electricals
Limited). GIS is one of the leading players in the heat transfer industry (cooling media) and primarily caters to the requirements of the
energy sector i.e. oil & gas sector and power sector.

Share holding Pattern:

The promoters stake as of June 2010 stands at 41.4%, which has been steady since the past four quarters. The total Non- promoters
(institutional) stake has gradually increased to 8.1% as of June 2010 from 6.13% in June 2009. The following table depicts the changes
in the share holding structure of the company.
Share Holding %
Description as on Jun-10 Mar-10 Dec-09 Sep-09 Jun-09
Indian (Promoter & Group) 41.41 41.41 41.41 41.41 41.92
Non Promoter (Institution) 8.1 7.68 5.27 5.27 6.13
Non Promoter (Non-Institution) 50.49 50.91 53.32 53.32 51.94
Grand Total 100 100 100 100 100
(Source: Capital-line, HDFC Sec)

Amongst the institutional shareholders Banyan tree Growth capital LLC owns 8.72% stake in the company (allotted in August 2009 at
Rs 75 per share), while the Compagnie Financiere Hamon owns 2.98% stake, PCA India infrastructure Equity open fund Ltd holds
5.25% stake and Premier investment fund holds 2.08% stake in the company.

Business and Operations:

GIS is one of the leading players in the heat transfer industry (cooling media). It manufactures various types of heat exchangers. The
company has two manufacturing plants based in Bhopal. The two key products from the company are Air cooled heat exchangers
(ACHE) and Air Cooled Steam Condensers (ACSC), which are used in the Oil & Gas companies and power plants respectively. GIS
undertakes design, manufacture, fabrication, erection, commissioning and maintenance of the heat exchangers and condensers. The
following charts show the products manufactured by the company and their respective applications.
Products

Air-cooled Steam Air-cooled Heat

Condensers Exchangers

Thermal
Power Plant

Utilities Exploration Refining Process LNG

Terminal

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GIS has an installed capacity of ~1000 MW (for power plants) towards the ACSC and ~2000 bundles (for oils and gas) towards ACHE.
GIS commenced the supplies of ACSC by catering to the requirements of smaller power plants in the range of 20MW. Since than it has
augmented its capabilities and currently caters to the requirements of power plants upto 300 MW. GIS is a market leader in the ACSC
segment in India with a market share of 80%. Simultaneously, the company supplies ACHE to the Oil & Gas companies. ACHE used to
cool off a distillation column during the refining process. GIS has a market share of ~55% in ACHE industry. GIS faces competition from
players like Paharpur (water and air based cooling systems), BGR Energy, Jord, GEA, PCT etc in both the segments. The company
supplies its products in the domestic as well as international markets. Following table depicts the client list for the company:

Gas Terminals & Gas

Oil Refining Power Equipments EPC Contractors Abroad
Compressors
GAIL IOC ABB India Chemtex, USA AGIP, Tunisia
IGL BPCL Alstom India Daelim, Korea Britannia Thermal, Australia
ONGC HPCL BHEL EIL, Delhi Caltex, Indonesia
Oil India Chennai Petroleum Crompton Greaves L&T, Mumbai Dresser Rand, France
Petronet Reliance Petroleum NTPC Linde, Germany General Electric, USA
Atlas Copco Mangalore Refinery Tata Power PDO, Oman GE EPE, France
Kirloskar Pneumatics Essar Refinery Siemens India Samsung, Korea Nuovo Pignone, Italy
Ingersoll Rand HPCL-Mittal Energy Technip, Italy
Bharat Compressors Bharat Oman Refinery Toyo, Japan
(Source: Company Reports, HDFC Sec)

As is evident from the table above the company has an esteemed and a wide client base. Most of the clients are MNC companies,
which own a sizeable market share in their respective areas. This enhances the revenues visibility for GIS going ahead.

GIS classifies its revenues from the sales of heat exchangers as project sales and direct sales. Under the direct sales the company only
sells its equipment to the clients, while in the project sales, GIS does the EPC part for its equipment as well. The share of project-based
revenue is on a rising trend. The following chart depicts the revenue mix for the company:

Revenue Mix

100%

80%

60%
%

40%

20%

0%
FY07 FY08 FY09

Heat Exchangers-Direct Sales Heat Exchangers-Project Sales

Finned Tube Power Transmission
Direct Sales Others

(Source: Company reports, HDFC Sec)

The margins from the project business are marginally lower than the direct sales segment. Hence going ahead if the share of revenues
from the project sales segment rises further it will need to be complimented by the higher sales growth.

Some of the key raw materials required for manufacturing the heat exchangers is Aluminium (consumed in the form of strips and
tubes), Mild Steel (MS; consumed in the form of plates, angels and sheets), steel tubes, SS brass plates and other miscellaneous
items. The following tables depicts the raw material cost break up for the past three years:

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 Revenue Mix

100%
21.3%
29.0% 31.7%
80%
6.0%
0.4%
1.1%
60% 16.9%
30.8% 17.0%
%

18.5%
40% 24.3%
17.4%

20% 35.2%
24.4% 25.9%

0%
FY07 FY08 FY09

Aluminum Stripes / Tube MS Plates / Angels / Sheets Steel Tubes

SS Brass Plates Other Misc Items

(Source: Company reports, HDFC Sec)

Aluminium and steel are the key raw materials required for manufacturing the heat exchangers. The company imports ~12% of its total
raw material requirement (by value). The price of these commodities fluctuates a lot and therefore the company is exposed to the risk of
raw material price fluctuation. In order to tide over the situation GIS has a back-to-back arrangement with its suppliers for procurement
of raw materials. The back-to-back arrangement to a certain extent protects the operating margins from raw material price fluctuations.
GIS does not have a price variation / escalation clause in its agreements with its customers.

Investment Rationale:
 Strong Position in the ACHE and ACSC segment in the domestic markets
GIS is a leader in heat transfer technology and manufactures ACHE and ACSC primarily for Power and Oil & Gas sector. GIS has a
full-fledged engineering and design department located at Bhopal, which is constantly engaged in the development of new and better
technology for manufacturing the products. Also in the past GIS had a tie up with Birwelco UK to vet its in-house developed
technology. During the initial phases the ACSC were manufactured to cater to the requirements of small power plants with a
generation capacity of 20 MW. Currently the company caters to the power plants with a generation capacity of up to 300 MW. The
company has developed the technology required to manufacture ACSC for a 300 MW plant in house. Furthermore GIS has a market
share of ~55% in the ACHE industry while it commands a markets share of ~80% in the ACSC industry in the domestic market.
Collectively, the in-house technology development centre facilitates consistent introduction of new products and a robust market
share augurs well for the company as it exhibits the company’s strong technology muscle.

GIS was initially promoted as an ancillary unit to BHEL and is currently also a preferred supplier to the company. This suggests that
the company has strong relations with major players in the power sector like BHEL, which have huge order book positions. (For FY10
BHEL had an order inflow of Rs 590 bn). The huge order book of the clients offers a strong revenue visibility for GIS as it is a
preferred supplier. Therefore a full fledged engineering and design department capable of developing advanced technology coupled
with a commanding market share in both the product segments and strong relations with major clients could drive the company’s
revenues in future.

 Structural shift from water cooled condensers to ACSC to a major trigger

With the overall economy looking buoyant the demand for power is also bound to rise, as power forms the backbone of any economy.
Increase in demand for power would also translate in to increased demand for water, as water is used for cooling various equipments
used in power generation and ash handling. Around 60-70% of the water used for industrial purpose is used for thermal power plants,
wherein it has two major applications viz; ash handling (40% of the requirement) and cooling tower (30% of the total requirement).
th
The total capacity addition for the Thermal power plants in the 11 Fiver year plan is ~ 59000 MW. This signifies the expected
demand for water in the future by TPPs. In an era of fast depletion of ground water table, substituting water requirement in TPP
becomes important. This is all the more important as few of the states have banned the use of ground water / rain water for industrial
purposes. In order to tide over the situation, GIS has introduced Air-cooled steam condensers, which are a substitute to the
conventional water-cooled condensers. Shortage of water in future would necessitate a shift from the conventional water-cooled
condensers to ACSC. This could prove to be a major trigger for the company as can substantially boost the revenues for GIS in the
future.

 Improved traction in demand from end user industries:

GIS primarily caters to the requirement of the Power and Oil & Gas sectors. As of June 2010 the company has an order book position
of ~ Rs 4000 mn, which is executable over the next 1-1.25 years, thereby enhancing the revenue visibility for the company. In the
th
11 five-year plan around 59000 MW of power generation capacity is likely to be added in India and much more than this is targeted
th
in 12 five-year plan. Almost 5-6% of the total cost of a thermal power plant goes towards ACSC. In addition to this the DGH (Director
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 General of Hydrocarbons) has put up another 70 oil blocks for exploration and has allotted 35 gas blocks for explorations under the
NELP VIII. Further there is also a scope from investment in new refineries as well as in modernisation/ up-gradation of existing
refineries. Collectively, this suggests that the end user industries are on a good wicket, which could translate into higher demand for
heat exchangers. This is likely to benefit GIS and could boost the top line and the over all performance of the company.

 Finned tube manufacturing to provide advantage in terms of lower operating expenses

One of the key components required to manufacture a heat exchanger is finned tube. The function of a finned tube is to enable the
transfer of heat. The tube has fins on its surface, which facilitate the transfer of heat from the radiator and thereby cool the
equipment. GIS is in an advantageous position as it manufactures these tubes in-house, thus resulting in a lower cost as compared
to external sourcing. On the other hand its competitors source their entire requirement of finned tubes externally (primarily imported
from the US or the UK), which inflates their cost. The company had augmented its finned tubes capacity in FY08 by 43%. The
following chart depicts the installed capacities and capacity utilisations for the finned tubes;

F inne d T ube s

6.00 120%
4.92 4.92
5.00 102% 100%

4.00 80%

3.00 60%

2.00 36% 40%

1.05 31%
1.00 20%

- 0%
FY07 FY08 FY09

Installed Capacity (M n. M T) Capacity Utilisatio ns (%)

(Source: Company Reports, HDFC Sec)

As is clear from the chart above the company has increased its installed capacity for finned tubes so as to cater to the incremental
requirements for the heat exchangers. The current capacity utilisation stands at 36%, leaving further scope to ramp up the
production. Ample headroom to ramp up production augurs well for the company, as the demand for heat exchangers is likely to
remain buoyant, which would result in higher demand for the finned tubes. Internal procurement of this key component would
translate into higher margins for the company. GIS has the largest single location Finntube manufacturing facility in Asia. The
company has a current installed capacity of 15 kms per day for finned tubes and is further in the process of expanding the same. GIS
requires almost the entire portion of the finned tubes for captive consumption except a small portion, which is for external sales to
BHEL.

 Expanding capacities…to aid volume growth:

GIS has a wholly owned subsidiary, GEI power limited (GPL), which it acquired during FY10. GIS bought 82% stake in GPL for a
consideration of Rs 130mn and topped up its total stake to 100% for a total consideration of Rs 150 mn. The main objective of
acquiring GPL is to transfer the production of ACSC for power plants to GPL. The purpose of this shift is to focus on the power
segment through a separate company. Currently the company is in the process of transferring the production of ACSC for power
plants up to 150 MW to GPL. Further to this the company has also incurred ~Rs 200 mn as capex at GPL in FY10. Additionally, GIS
has lined up a capex program of Rs 350 mn and 400 mn in FY11 and FY12 for GPL. This would be primarily towards expanding the
existing facilities. In future through GPL the company has plans to enter the BOP (balance of plant) space and thereby cater to the
requirements of the power sector. The funding for the same would be through a mix of internal accruals and debt. It has begun the
manufacturing of deareators, HP heaters, LP heaters etc being the other equipment required in BOP operations. Incremental
capacities would enable the company to cater to the requirements of a wider customer base and in the process augment its
revenues. In October 2009 GPL allotted 1000 compulsorily convertible debentures of Rs 1 lakh each amounting to Rs 100 mn to
Banyan tree growth capital LLC.

 Robust and growing order book:

As of March 2010 GIS has a strong order book of Rs 4000 mn executable over 1-1.5 years. The order book position for the company
has been growing steadily over the years. The following table depicts the order book position for the past three years

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 Order Book (Rs mn)
4500
4000
4000
3500
3000 2600
2500 2200
2000
1500
1000
500
0
FY08 FY09 FY10
(Source: Company reports, HDFC Sec)

As is clear from the chart above GIS has a strong and a growing order book position. Of the Rs 4000 mn order book ~65% are from
the power sector while the balance from the oil and gas sector. Hence a strong order book position provides revenue visibility for the
future. Typically Q3 and Q4 quarters witness a higher order inflow during the year

Risks & Concerns:

 Over dependence on the power sector:

GIS caters to the requirements of the Power and the Oil & gas sector. The fortunes of the company are linked to that of the Power
sector as around 60-70% of its order book and sales is from the power sector. Therefore any slow down in the power sector could
have an adverse impact on GIS in the form of lower demand for its products, which could impact the top line and the over all
performance.

 Higher working capital required.

As per the industry GIS is entitled to receive 10% of the amount as upfront payment on receipt of the order while the last leg of 10%
is received after 6-8 months of the delivery of the product. Hence this is reflected in high debtors thereby impacting the working
capital cycle. Also the company maintains a higher level of inventory (around 6 months) as a practice. Collectively this inflates the
working capital cycle. As of March 2009 Rs 1500 mn was locked up in inventories and debtors compared to the sales of Rs 2380 mn
for FY09. Debtors in excess of 6 months amounted to Rs 30 mn as of March 2009. The high amount of working capital requirement is
partly funded by debt. Hence any change in the interest rates also would impact the financial performance of the company adversely.

 Sharp variations in the prices of raw materials:

Aluminium and steel are the key raw materials required for manufacturing heat exchangers. The price of the same has firmed up in
the past and is expected to remain on an upward trend. Collectively both the metals account for ~ 67% of the total raw material cost
for FY09. Any adverse movement in the prices of aluminium and steel could adversely impact the operating margins of the company
in the future, as there is no price variation clause on sales contracts. While GIS does try to minimise the impact of price variation by
entering in to back-to-back arrangements with its suppliers, there could still be an impact on its performance in case of a sharp
variation in the prices of raw materials.

 Ambiguity in GEI power:

GIS acquired 100% stake in GPL in August 2009 for Rs 150 mn and GPL consequently became a subsidiary of the company. Post
acquisition the company has not reported any financials of the company nor has disclosed any basis of valuation for acquisition.

 Execution could be a problem:

GIS has a huge outstanding order book of around Rs 4000 mn. This gives a strong revenue visibility for the company in the future.
However, its Q1 FY10 performance was affected as one of its customers continued to hold dispatches. Going ahead the company
could lose its revenues if any of its customers delay execution.

Conclusion:
GIS is a leading manufacturer of heat transfer equipments in India. GIS is a market leader in the ACSC with an 80% market share in
domestic markets and has ~ 55% of market share in the ACHE segment. The company primarily caters to the requirements of the
energy sector. With the end user industries on a good wicket the demand for heat exchangers is expected to remain buoyant going
ahead. In order to support the incremental demand, GIS is also expanding its existing capacities. Furthermore it plans to transfer a part
of its production (towards power sector) to its subsidiary GPL, which could cater to only power sector in the future. Simultaneously the
demand from the oil and gas sector is also expected to be buoyant with the increase in the exploration activities. Therefore cumulatively
the above could drive the revenues for the company in the future.

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Aluminium and steel are the key raw materials required by GIS. The company has a back-to-back arrangement with its suppliers, which
shields the operating margins from exposure to volatile raw material prices. Also Finned tubes, another key ingredient of the company
is manufactured in house, which results in a lower operating cost, thereby boosting the operating margins for the company and giving
GIS a competitive advantage vis-à-vis its competitors.

GIS is placed in a sweet spot in an era where water is becoming a scarce and a precious commodity.

We feel that the stock can be bought at the CMP and can be added on further dips in the range of Rs 116-124 for sequential price
targets of Rs 159 (10.5x FY11E EPS) and 175 (11.5x FY12E EPS)

Quarterly Financials:
Particulars (Rs mn) Q4 FY10 Q4 FY09 % YoY Q3 FY09 % QoQ H1 FY10 H1 FY09 % YoY
Net Sales 840.1 672.367 24.95 612.928 37.06 983.8 894.77 9.95
Total Income 878.5 712.59 23.28 622.268 41.18 1013.783 912.78 11.07
Operating Expense 767.9 614.87 24.89 528.69 45.25 850.401 770.253 10.41
EBITDA (Inc OI) 110.6 97.72 13.18 93.578 18.19 163.382 142.527 14.63
Depreciation 5.5 5.719 -3.83 5.57 -1.26 9.164 8.124 12.80
Interest 33.2 47.6 -30.25 28.6 16.08 57.38 41.972 36.71
Exceptional Item 0.712 -2.586 -127.53 0.606 17.49 2.745 2.592 5.90
PBT 71.188 46.987 51.51 58.802 21.06 94.093 89.839 4.74
Tax 29.39 34.89 -15.76 19.46 51.03 26.3 25.45 3.34
PAT 41.798 12.097 245.52 39.342 6.24 67.793 64.4 5.29
EPS 2.51 0.85 196.75 2.37 6.24 4.08 4.51 -9.58
OPM (%) 12.39 13.25 14.91 15.80 15.47
NPM (%) 5.0% 1.8% 6.4% 6.9% 7.2%
(Source: Company reports, HDFC Sec)
Annual Financials:
Profit & Loss Account:
P/L (Rs MN) FY08 FY09 FY10-SA FY10-Cons FY11E Cons FY12E Cons
Net Sales 1,867.5 2,134.9 2,507.8 2,507.7 3,425.0 4,590.0
Total Income 1,871.6 2,145.4 2,514.5 2,529.4 3,432.3 4,597.9
Operating Expense 1,589.6 1,842.6 2,147.1 2,112.9 2,931.9 3,965.9
EBITDA (EX OI) 277.9 292.3 360.7 394.9 493.2 624.1
EBITDA (Inc OI) 282.0 302.8 367.4 416.5 500.4 632.0
Depreciation 16.1 18.1 20.2 24.3 36.2 58.0
Interest 68.7 112.7 119.2 137.9 152.0 186.0
PBT 150.6 171.0 223.9 250.0 312.2 388.0
Tax 60.9 67.4 75.2 79.1 109.0 135.0
PAT 89.7 103.7 148.7 170.9 203.2 253.0
EPS 6.3 7.3 8.9 10.3 12.2 15.2
OPM (%) 14.9 13.7 14.4 15.7 14.4 13.6
NPM (%) 4.8 4.9 5.9 6.8 5.9 5.5
Equity Capital (FV Rs.10) 142.7 142.7 166.2 166.2 166.2 166.2
Figures for FY08 & FY09 are standalone. (Source: Company reports, HDFC Sec)

Analyst: Harshal Patil. (harshal.patil@hdfcsec.com)

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