This small cap company is on an uptrend as it looks to capitalise on changing customer preferences

• AIA Engineering met its sales volume guidance for FY23 and expects it to grow by 10% in FY24.
  
• Its EBITDA margins for the fourth quarter expanded by 410 basis points as Covid-time challenges abated.
  
• Company has undertaken brownfield capacity expansion and its negligible leverage and strong free cash flow are positive, say analysts.
  

The stock of AIA Engineering has run up by over 22% in the past month on the back of improved margins and a good volume growth outlook. This rally has coincided with the overall positivity in the small cap space (BSE Smallcap Index is up 8.5% in the same period) but has also beaten it handsomely.

AIA Engineering claims it is the world’s second-largest producer of high-chrome wear, corrosion and abrasion-resistant castings — used in cement, mining and thermal power plants. The company met its sales volume guidance for FY23 and expects it to grow by 10% in FY24. However, that’s not what caused a rally in the stock alone — it’s the improved margin performance.

The margin advantage

Its EBITDA margins for the fourth quarter expanded by 410 basis points to 28.4%. EBITDA is earnings before interest, tax, depreciation and amortisation.

“Management stated that freight-related challenges post-Covid have abated, and the company is now able to pass on freight cost to customers,” said a research report by BoB Caps.

Centrum Broking too opines that an EBITDA margin of 22% is sustainable with good scope for further expansion. However, it also explains that the process of passing through costs of raw material and freight to customers is not an easy process.

“Pass through of raw material and freight cost is a continuous process and it happens as and when prices change, but with a lag,” says Centrum. Nomura, though, is not so confident about AIA Engineering’s ability to sustain margins beyond the second half of the current financial year.

On an expansion spree

The company is also banking on a change in preference for technology that can help it gain traction. The mining industry has been converting from forged media to high-chrome mill internals – which will help the company gain business. It has also planned for capacity expansion to gain from the trend.

“AIA Engineering plans to expand capacity from 440,000mt to 520,000mt by FY24, through brownfield capex of ₹200 crore. The company has a healthy balance sheet (net cash of ₹2,500 crore) with negligible leverage and strong free cash flow generation,” said Bob Caps.

The management expects FY24 volume growth to come from a mix of new and existing customers. The company – which caters to mining, cement and utilities clients across Australia, North America, Latin America and CIS – does not anticipate any major macroeconomic challenges in the next 12 months.

Yet, the business of bagging new clients is fraught with challenges. “The conversion of customers is an agonisingly long process,” the company said in an earnings concall.

What’s beyond the rally?

In spite of the run up that the capital goods sector has been witnessing in the last few weeks, and fairly decent growth prospects ahead — analysts are mixed about the company’s prospects ahead. The BSE capital goods index ran up by 60% in the last one year.

“The capital goods sector has been one of the key outperformers of 2022 and is seen extending its up move after higher base formation in the first four months of 2023,” said ICICI Direct., In a report dated May 30, the brokerage said it expects AIA Engineering to maintain a positive bias and head towards ₹3,410 in the coming months.

Bob Caps, which retained a buy recommendation on AIA Engineering stock, says that it remains positive on the company’s structural growth story, with a revised target price of ₹3,500. The stock closed at ₹3,324 on Thursday on the BSE.

Nomura, however, believes that the company might have hit a peak in terms of profitability in FY23. The stock appears relatively fairly priced given its prospects, it says, adding that a rally in the last one year incorporates its positives.

“AIA Engineering has rallied 43% over the past year and multiples have broadly converged to a mid-cycle level of around 26x. Thus, while risk/reward still has a positive bias, the investment case is less compelling than earlier following the latest rally in the share price,” said Nomura, downgrading it to neutral.

$AIAENG.NSE - Long Setup, Move is ON.. ✅ Gave a breakout at 2068.10 as per pattern shown in chart ✅ Now trading above Resistance of 3426 ✅ Moved 66% since breakout in 55 weeks A close above resistance of 3426 is important for further upmove. About $AIAENG.NSE AIA Engineering Limited manufactures a range of high chromium consumable wear parts (mill internals) for tube mill applications. Pros: ✅ Annual revenue growth of 38% is outstanding ✅ ROE of 18% is exceptional ✅ The company is debt free and has a strong balance sheet ✅ Company has delivered good profit growth of 19.3% CAGR over last 5 years

— (@9amprime) June 16, 2023