Can this mid cap ace its big goals?

India's rapid infrastructure push is accruing benefits for several Indian construction equipment manufacturers. One such infrastructure play is Action Construction Equipment or ACE . The mid-cap company operates in four segments namely - cranes, construction equipment, material handling and agricultural equipment. The company derives nearly 70 per cent of its revenue from the cranes segment. It holds a 63 per cent share in the mobile cranes market and 60 per cent in tower cranes market domestically.

ACE's profit after tax has grown nearly 26 times over FY15-23, led by operating leverage, evident by a decline in major costs as a percentage of revenue. It has also managed to reduce its power and fuel costs, and repairs and maintenance expenses (both as a percentage of revenue). Return on capital employed (ROCE) has leapt from nearly 6 per cent in FY15 to close to 29 per cent in FY23.

The surging financial and industry tailwinds have surely caught the market's attention. However, there are certain factors investors must consider.

Future outlook

• Tapping growth opportunities beyond India. ACE has also been deepening its business overseas to keep the growth momentum going. Over 25 years, it has expanded its export market to 12 more countries, taking the total to 37 (as of Q3 FY24). As of March 2023, revenue from exports contributed just 6.7 per cent to its total revenue. But, this has risen to 12 per cent as of Q2FY24, and the management plans to increase it further. In Q3FY24, the management further said they intend to make an acquisition in Europe.
• Big goals on the radar. The management is confident in the company's growth trajectory and its goal to double the revenue in the next three years to Rs 4,400 crore by FY26, helped by the government's focus on infrastructure and manufacturing.

Risk factors

• Large fish in a small pond. According to ACE's annual report, the size of the Indian crane market was $1 billion (around Rs 8,300 crore) in FY23. It is expected to grow around a modest 5 per cent annually in the next four years. The company already commands about one-fifth of the market share. A small, slow-growing market in which the company already holds a big share may leave little room for faster growth.
• Long sales cycle. The company's fortunes are tied to the infrastructure cycle, more specifically, the cranes segment. Analysis reveals that a single crane has an expected life of about eight to 10 years. Many infra players opt for a lease rather than an outright purchase of a crane. So, the repeat sales cycle is rather long. This means the company has to keep its costs in check and be as efficient as possible to maintain or improve profitability.
• Regulatory risks. As the company steadily increases its export revenue and targets more markets, the risk of imposition of trade restrictions by its target countries persists. We say this because ACE has itself benefitted from India's import duties of 7.5 per cent on large cranes.
• Heated up valuations. The stock's P/E has jumped from 23 times to 60 times in the last two years, reflecting expensive valuations. Currently, the company trades at 67 times TTM earnings, more than twice its five-year median P/E of 26 times.

Conclusion

The market is betting on a sharp jump in private capex after years of stagnation, which can bolster the company's growth. There are currently no signs of a decline in revenue growth and perhaps the export opportunity can be a game-changer. However, the risk factors mentioned above should not be ignored. Its valuations also work against it.

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