The Indian Transformers Sector: Identifying the Outlier

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Its incredible to deep dive into a sector when around 9 listed companies (of which 5 are pure play) are in the same business. Lot of numbers, different commentaries, and the ability to have an all round view. Here I try and outline how the transformer industry functions, and how it has evolved over last 2 cycles. This was rewarding, since in the end, I did bump into a potential investment idea.

Transformers are used to regulate the voltage (the pressure applied on charged electrons) of electricity as it flows from source to its destination appliance / machine to avoid mismatch of current. They can be used as both step up and step down regulators of voltage and are of 2 types – Power transformers and Distribution transformers. While both have the same modus operandi, power transformers are designed for high voltage load (33kv to 400kv), are built for 100% efficiency and are used in nationwide power grids. Distribution transformers, on the other hand, have smaller capacities (less than 33kv) and are used by industries to align their electric equipment (furnaces, Lighting, Motors) with the power from grid. These are generally utilised at 70% efficiency and are customized. In India, power transformers make up 45% of INR 137 bn industry, while distribution transformers (incl. industrial) make up the 55%

Consideringthe above, companies in the business of transformer manufacturing rely on capex by State Electricity Boards, State transmission cos., and PGCIL – Power Grid Corporation (for power and distribution transformers) and higher industrial capex (for industrial transformers).

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Significant transmission capacity was added by India from 2006 to 2010, which led to rising demand for transformers. With sizable profits earned by all industry players, additional capacity came into the industry rapidly, as can be seen from below –

Installed Capacity (GVA) FY07 FY09 FY16
ABB 10 17 20
Alstom T & D India 15 15 25
CG Power 23 25 40
Siemens 15 15 15
TBEA Shenyang 15
Bharat Heavy Electricals 18 20 45
TRIL 7 7 33
Bharat Bijlee 8 11 15
Emco 10 20 20
Indo Tech Transformer 3 7 7
Voltamp Transformers 7 9 13
Schneider Electric 7
Vijay Electricals 13 20 20
Sub -Total 130 167 276
Organized as a proportion of total 96% 93% 69%
Total Industry capacity 135 180 400
Source – Edelweiss Sector report of Sep 2016

Not only did the above players of the organized sector add capacity, but even the unorganized sector added significant capacity such that, while in FY09 the organised sector contributed 93% to overall capacity, by FY16 its contribution had fallen to 69%. (unorganized sector moving from 7% to 31%). What has helped unorganised sector flourish is the lax quality standards by State companies in procuring transformers. CRGO (Cold Rolled Grain Oiled Steel) is an important component in a transformer and makes up almost 25% of the total cost. All of CRGO is imported and is incredibly expensive. Many players, both unorganised and organised, import scrap quality CRGO and bid for tenders at a very low price. They won the tenders too since its impossible to know the quality of CRGO without extensive quality testing. The L1 (lowest cost) system of procurement crowds out quality producers and has led to India having one of the highest transformer failure rates, with estimated 70% of all CRGO used being of scrap quality, negating the capacity gains. A shit show that is the Indian power sector continues to play out.

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This overcapacity was expected to be utilised in 2 ambitious Central Government Schemes – Deendayal Upadhyaya Gramin Jyoti Yojana (DDUGJY) for rural areas and Integrated Power Development Scheme (IPDS) for urban areas. Although these schemes have increased the capex in the transformer sector, the over capacity in the sector continues to persist. It has led to higher fixed cost structures, drying up of orders and price competition among the major transformer players, due to which a lot of these companies have found themselves in financial doldrums –

Sales 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Voltamp 535 570 516 445 517 563 611 639 829          859
TRIL 543 519 512 732 553 657 821 716 855          701
BBL 695 717 541 485 610 638 677 774 932          929
IMP   282 207 264 331 362 395 446 413          267
Indo tech 113 115 114   94 157 190 149 220 213          205
In INR Crores. Source: Screener
PAT Margins 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Voltamp 10% 6% 6% 6% 5% 8% 12% 12% 10% 10%
TRIL 8% 2% 1% 1% -1% -1% 3% 1% 1% 0%
BBL 11% 7% -1% -2% -6% 1% 2% 8% 4% 5%
IMP   2% 1% 0% 1% 1% 1% 1% 1% -5%
Indo tech -20% -35% -44% -20% -2% 2% -8% -2% -4% 1%
PAT Margins. Source: Screener

Over the span of 17 years, one can trace the profitability of the industry players, the up cycle with high margins in 2007-2010, the subsequent down cycle due to drying up of orders and overcapacity, and the renewed pick up in orders from 2019. It can be observed that players like Indo Tech (Dark Green) and IMP Powers (Yellow) only made profits during the upcycle, bleeding red thereafter.

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Although some of the largest players are BHEL, ABB, Siemens and CG Power, we have not included them in the above charts and tables since they are not pure play transformer companies and thus numbers pertaining to this segment are not available. However, while CG Power is embroiled in corporate governance issues, BHEL has been scaling down its operations. Other diversified [players like EMCO and Prolec GE are struggling with high debt. ABB and Siemens, with MNC parentage and their ensuing tech support continue making in roads in the Indian transformer sector, but margins wise ABB is struggling.

Companies in chart above are pureplay midcap transformer companies, among which, the numbers of Voltamp Transformers, while significantly volatile, have shown more resilience than other players. In fact, from the above cohort, only Voltamp and Bharat Bijlee (BBL) are net cash as of Mar 20. I therefore analyse the numbers of Voltamp Transformers in the next post, and see how it has been able to sustain itself, and as we will find out, thrive.

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Umang Shah

Umang Shah

Through his writing, Umang shares his perspectives on how he thinks of investing, decision making, books and life in general.
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