Anand Rathi Financial Services, its affiliates and subsidiaries, do and seek to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Disclosures and analyst certifications are located in Appendix 1. Anand Rathi Research India Equities India I Equities Auto Components Sector Report 22 February 2011 India Auto Components Overseas sales – Paving growth Overweight Nifty/Sensex: 5459 / 18212
183
Embed
India Auto Components Overweight - Myirisbreport.myiris.com/ARSL/AMTAUTO_20110222.pdf · Anand Rathi Financial Services, its affiliates and subsidiaries, do and seek to do business
This document is posted to help you gain knowledge. Please leave a comment to let me know what you think about it! Share it to your friends and learn new things together.
Transcript
Anand Rathi Financial Services, its affiliates and subsidiaries, do and seek to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Disclosures and analyst certifications are located in Appendix 1. Anand Rathi Research India Equities
India I Equities
Auto Components
Sector Report
22 February 2011
India Auto Components
Overseas sales – Paving growth
Overweight
Nifty/Sensex: 5459 / 18212
Anand Rathi Financial Services, its affiliates and subsidiaries, do and seek to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Disclosures and analyst certifications are located in Appendix 1. Anand Rathi Research India Equities
India I Equities Auto Components
Sector Report
22 February 2011
India Auto Components
Overseas sales – Paving growth
The Indian auto components sector is primed to benefit from recovery in overseas sales and continuing growth in the domestic auto sector. Streamlining of costs and improving productivity have led to healthier financials; also, diversification in non-auto segment and wider exports coverage are new revenue drivers.
Overseas sales to strengthen. On the ongoing recovery in US and Europe, we expect a rise in auto demand from OEMs/ tier-1 suppliers, fueling overseas revenue for Indian auto-part players. We expect a 28.1% CAGR in standalone exports over FY11-13e for our auto-parts coverage vs. 19.7% for domestic sales.
Steady growth in domestic auto sector. After two years of swift growth, the Indian auto sector has now entered a steady growth phase. We expect a 13.7% CAGR in industry volumes over FY11-13e, thereby providing firm support to auto components.
Improved efficiencies, de-risking. Auto-parts companies are benefiting from efforts to conserve cash, reduce costs and raise productivity. Also, de-risking via entry into the non-auto segment and prudent investments would lead to 21.5% sales CAGR in FY11-13e vs. 15% for the auto industry.
Stock picks. Our top picks: Motherson Sumi (diversified), Setco (replacement demand), Gabriel (demand growth), Bharat Forge (good business model), and Amtek Auto (overseas recovery, attractive valuations). Risks are demand slowdown, commodity cost pressures, delay in export ramp-up due to slowdown.
Overweight
Nifty/Sensex: 5459 / 18212
Auto sector vs Sensex
BSE Auto
Sensex
90
100
110
120
130
140
150
Feb-
10
Apr-1
0
Jun-
10
Aug-
10
Oct
-10
Dec
-10
Feb-
11
Source: Bloomberg
Valuation matrix - India auto components Amara Raja Amtek
Auto* Banco
Products Balkrishna
IndsBharat Forge*
Exide Inds
Gabriel India
Mahindra Forgings*
Motherson Sumi*
NRB Bearings*
Phillips Carbon
Setco Auto*
Rating Buy Buy Buy Hold Buy Hold Buy Buy Buy Buy Buy Buy
Gabriel .............................................................................................153
Phillips Carbon Black .......................................................................169
22 February 2011 India Auto Components – Overseas sales – Paving growth
Anand Rathi Research 3
Investment Argument and Valuation The Indian auto components sector is primed to benefit from continuing growth in the domestic auto sector and recovery in overseas sales. Streamlining of costs and improving productivity have led to healthier financials; also, the non-auto segment and wider exports coverage are new revenue drivers. Our top picks are Motherson Sumi Systems, Bharat Forge, Gabriel India, Amtek Auto and Setco Auto.
Overseas sales to strengthen A steady revival in auto-component exports and overseas revenue improvement from end-FY10, despite overseas demand (excluding incentive schemes) not significantly improving, has been a notable feature of FY11. Ahead, we expect the nascent recovery in export demand to gather steam as auto demand in the US/EU picks up, after having hit bottom through CY08 to CY10.
We expect the recovery to benefit dually – first, by driving exports and second, by improving growth in overseas subsidiaries. We expect our auto-parts universe to see a 28.1% standalone exports CAGR over FY11-13e vs. 19.7% CAGR for domestic sales.
Moreover, with skilled manpower readily available, India continues to retain its edge as a low-cost manufacturing base. A key area where India scores over China is in the better protection afforded to intellectual property rights (IPRs).
Fig 1 – India among the lowest labour-cost countries
0
10
20
30
40
50
60
Indo
nesi
a
Philip
pine
s
Indi
a
Thai
land
Mex
ico
Chi
na
Rom
ania
Arge
ntin
a
Mal
aysi
a
Hun
gary
Indonesia Philippines India Thailand MexicoChina Romania Argentina Malaysia Hungary
Source: globalproduction.com, Note: on a scale of 1 to 100;m as of CY09
Steady domestic auto growth After two years of rapid growth, the Indian auto sector has now entered a sturdy growth phase. We expect industry volumes to see a 13.7% CAGR over FY11-13e, providing a firm backbone to the sector.
Likely key growth drivers are:
1. Sustained two-wheeler demand: We expect two-wheeler demand in India to continue to swell, while penetration and expansion into new areas globally would boost export growth. In the two-wheeler sector, we expect a 13.7% volume CAGR over FY11-13e.
22 February 2011 India Auto Components – Overseas sales – Paving growth
Anand Rathi Research 4
2. India, a global small-car hub: India has emerged as a small-car-manufacturing hub as all major global auto companies have set up manufacturing bases here (VW, Skoda and Nissan among the latest) with the dual aim of capturing local demand and benefiting from the low-cost manufacturing facilities here. Hence, they are likely to use India as an export base. We expect a 13% CAGR over FY11-13e in India’s passenger vehicle sales.
3. Replacement demand: Replacement demand would continue to fuel non-cyclical demand for auto-component companies, especially for batteries and tyres. The replacement demand trajectory would follow an increasing trend due to the robust 14% CAGR in India’s auto sales over FY02-11e.
Fig 2 – Auto sector: volume CAGR over FY02-11
0.0
5.0
10.0
15.0
20.0
25.0
PV LCV M&HCV 2wh 3wh Total
(%)
Source: SIAM
Improved efficiencies, diversification Lower demand in 2HFY09 and spiralling raw material costs just prior to this period led to companies rapidly adopting measures to conserve cash, reduce costs and improve productivity. These steps helped auto-component companies survive the downturn; this augurs well for enhanced profitability ahead. Hence, as compared to a revenue CAGR of 21.5% over FY11-13e, we expect a higher profit CAGR of 28.4%.
Given the cyclical trends in the auto industry, players are diversifying/de-risking their business models; Bharat Forge, Amtek Auto, Rico Auto and MSSL have already taken such measures in the past two years. We expect this to be an even more widespread trend.
We believe that diversified companies would be better performers. Diversifying into the non-auto sub-segment, upgrading to non-commoditised products and broadening the product range would lead to companies emerging stronger.
Also, de-risking via entry into the non-auto segment and prudent investments would lead to 21.5% revenue CAGR in FY11-13e vs. 15% for the auto industry.
22 February 2011 India Auto Components – Overseas sales – Paving growth
Valuation The auto-components sector trades at PE of 11.4x FY12e and 9x FY13e earnings (compared with 11.4x FY12e and 10.2x FY13e EPS for the automobile sector, distorted mainly by Tata Motor’ cheap valuations). We expect revenue CAGR of 21.5% over FY11-13e, and a higher profit CAGR of 28.4% for our coverage universe. .
Valuations of companies in our coverage universe are still at a discount to their past averages. We expect the discount to reduce and surpass past averages as the auto-components sector sustains a high-growth phase over FY11-13e despite external factors.
Company valuations
Motherson Sumi (Buy; TP: `221): We have a Buy rating on MSS, with a target of `221 (18x target PE, on par with its past six-year average). At the current price, the stock trades at a PE of 15.1x FY12e EPS.
Bharat Forge (Buy; TP: `396): We value the stock at 20x FY12e PE. Our target price is `396. At present valuations, BFL trades at 16.1x FY12e EPS. We believe that current valuations do not reflect the significant upside that would accrue from FY13 from the joint ventures with NTPC, Areva, etc., commencing full-scale operations.
Exide Industries (Hold; TP: `149): We value the standalone business at one-year forward PE of 16x. We value Exide’s stake in ING Vysya Life Insurance at `12. Our target price is `149 (from `128). We retain our Hold.
Amtek Auto (Buy; TP: `225): We cut our target price from `254 to `225 (10x FY12e EPS, and `29 as value of 38% stake in Amtek India). We value Amtek Auto at 10x FY12e earnings, a 50% discount to the target PE multiple for Bharat Forge. Our current EPS estimate excludes Amtek India, and on considering the recent dilution and change in estimates. At the current market price, the stock trades at attractive valuations of 6x FY12e EPS.
Amara Raja Batteries (Buy; TP: `210): We value ARB at 10x FY12e EPS (a 40% discount to the target multiple for market leader Exide Industries). At the ruling market price, the stock trades at 9.5x FY11e and 7.8x FY12e earnings.
22 February 2011 India Auto Components – Overseas sales – Paving growth
Anand Rathi Research 6
Balkrishna Industries (Hold; TP: `144): We value the stock at `144 (8.25x FY12e standalone EPS of `16.5 and `8 as value of its paper business). At the CMP, the upside is not too compelling. We initiate coverage with a Hold.
Mahindra Forgings (Buy; TP: `137): We value MFL at `137 (25x FY12e EPS of `5.5). Future re-rating is likely on: i) proven ability to sustain consolidated profitability and ii) likely restructuring of MFL as part of Mahindra Systech. We initiate coverage with a Buy.
NRB Bearings (Buy, TP `68): At our target price of `68, the stock would trade at 11x 12-month-forward earnings. NRB’s one-year-forward PBV in the past five years has ranged between 0.7x and 3.8x. At `46, NRB trades at PE of 8.9x and 7.3x FY11e and FY12e earnings, respectively, and EV/EBITDA of 4.8x and 4x.
Setco Auto (Buy, TP `182): At our target price, the stock would trade at 9x 12-month forward earnings and EV/EBITDA of 5.1x. The target PE is in line with the three-year average.
Banco Products (Buy, TP `103): We value the stock at `103, based on 9x FY12e EPS of `11.5. It trades at an attractive 6.2x FY12e standalone PE. After a disappointing FY11, we expect the PE multiple to be re-rated, given stable growth ahead. We initiate with a Buy.
Gabriel (Buy, TP `62): At our target price, the stock would trade at 11x FY12e earnings and an EV/EBITDA of 4.8x. The target multiple is at a slight discount to the stock’s five-year average.
Phillips Carbon Black (Buy, TP `246): At our revised target of `246, the stock trades at FY12e PE of 5.6x and EV/EBITDA of 4x. We value PCB at FY12e P/BV of 1.25x.
Risks
Rising commodity costs may squeeze margins, particularly in domestic operations.
Increasing fuel prices and interest rates may arrest auto demand due to higher costs of acquisition and ownership.
Slower-than-expected recovery in Europe and US auto demand would delay the growth trajectory for export-oriented companies.
Fig 4 – Auto component sector: Valuation matrix Amara Raja Amtek
Auto* Banco
Products Balkrishna
IndsBharat Forge*
Exide Inds
Gabriel India
Mahindra Forgings*
Motherson Sumi*
NRB Bearings*
Phillips Carbon
Setco Auto*
Rating Buy Buy Buy Hold Buy Hold Buy Buy Buy Buy Buy Buy
Source: Anand Rathi Research; Note: Ratios are based upon FY12e earnings, * consolidated Prices as on 18 February 2011
22 February 2011 India Auto Components – Overseas sales – Paving growth
Anand Rathi Research 7
Overseas sales to strengthen Despite the few short-term growth catalysts in Europe and the US and withdrawal of incentive schemes, we expect increased optimism among OEMs/suppliers regarding long-term growth prospects. This, along with market share gains, would drive overseas revenue for most Indian auto-parts companies. We expect our auto-parts universe to see a 28.1% standalone exports CAGR over FY10-13e vs. 19.7% CAGR for domestic sales.
Increased optimism among OEMS and suppliers
After a decent demand trend in ’10, export growth for auto components would be further underpinned by a cyclical recovery in the US in the next two years and continued optimism among European OEMs/suppliers.
In Jan ’11, CSM, a widely followed auto-production forecaster, raised its CY11 European production expectations for vehicles to 19m (Dec ’10: 18.6m, May ’10: 17.3m) and for CY12 to 19.7m (Dec ’10: 19.5m May ’10: 18.4m), suggesting a 10% and 7% increase in estimates respectively since May and a 2% and 1% increase respectively since December. For North America, mainly the US, CSM expects vehicle production for CY11 to increase to 12.9m (May’10: 12.7m) and for CY12 to 13.9m (May’10: 13.5m), implying a 2% and 4% increase in estimates respectively since May ’10.
Although we do not see significant short-term growth catalysts in Europe, given the withdrawal of scrappage/incentive schemes by the UK, France, Germany and Italy, we continue to believe that CSM’s estimates are conservative. The revision of CSM’s estimates reiterates our view that European and US auto volumes are expected to be better in CY11 and CY12, demonstrating CAGRs of more than 5% for Europe and ~13% for North America over FY09-12e.
Direct exports constitute 22.9% of the sector’s standalone revenue; total overseas revenue drives this share to nearly 50% for some big auto-component players (like Bharat Forge, Motherson Sumi and Amtek Auto and Mahindra Forgings). We are upbeat on auto-component exports and overseas revenues, due to the upswing in auto demand, as well as the on-going inventory restocking by European and US OEMs.
Fig 5 – CSM global light vehicle production summary by Region (‘000s) CY10 CY11e CY12e CY13e CY14e CY15e CY16e CY17e CAGR
22 February 2011 India Auto Components – Overseas sales – Paving growth
Anand Rathi Research 8
Fig 6: Direction of India’s exports
Asia22%
Europe39%
North America21%
Oceania0%
Australia1%South America
3%Middle East
7%Africa
7%
Source : ACMA
Auto components – Upbeat outlook In the base-case scenario for Western-Europe car demand, anecdotal evidence suggests that there are ~200m cars in the region. Of this, an average 6% is scrapped annually, leading to replacement demand of ~12m vehicles. This includes fleet rental car demand. This generates certain cyclical demand of ~12m vehicles annually.
The European population is expected to increase by 10m in the next 10 years. On average, one car per two individuals would create demand of ~5m cars, translating to structural demand of 0.5m cars a year. Apart from certain sovereign-debt concerns, European GDP growth is now showing a positive trend, and unemployment, after peaking in ’09, is on the decline.
The above structural growth along with eased macro concerns would prove an important demand catalyst, implying that West European car demand would see further green shoots. Western Europe has a substantial positive impact as the region constitutes ~70% of the total European car-demand pie.
A steady revival in auto-component exports and overseas revenue improvement from end-FY10, despite overseas demand (excluding incentive schemes) not significantly improving has been a notable feature of FY11. Ahead, we expect the nascent recovery in export demand to gather steam as auto demand in the US/EU picks up, after having hit bottom through CY08 to CY10.
We expect the recovery to benefit dually – firstly by driving exports and secondly by improving growth in overseas subsidiaries. We expect our auto-parts universe to see a 28.1% standalone exports CAGR over FY11-13e vs. 19.7% CAGR for domestic sales.
Fig 7 – Eurostat GDP growth estimates Eurostat estimates for real GDP growth CY08 CY09 CY10 CY11e CY12eEuropean Union (27 countries) 0.5 -4.2 1.8 1.7 2.0Euro area (16 countries) 0.4 -4.1 1.7 1.5 1.8United States 0.0 -2.6 2.7 2.1 2.5
Source: Eurostat Data
Strong pipeline of some European manufacturers could add to demand European OEMs such as Peugeot (20% of product pipeline up for renewal in CY11), BMW (three new models) and Volkswagen have a healthy
In Europe, people still need a car. Prospects for auto component
manufacturers look upbeat
22 February 2011 India Auto Components – Overseas sales – Paving growth
Anand Rathi Research 9
pipeline. We expect the India auto-components segment to benefit as a result, winning new long-term contracts to supply components for some of these platforms. Indian auto component companies could also benefit by supplying to foreign manufacturers Faurecia, Delphi and Magna, which in turn supply components to these new platforms.
India still a considerably attractive low-cost base India is one of the hottest three destinations for automobile-component manufacturing, on parameters such as lower wage rates, access to cheaper raw materials, availability of engineers and design capabilities, than other low-cost locations. This gives auto-ancillary manufacturers an edge in costs while competing with rivals, who supply to European manufacturers. This helps protect margins. The key cons now are the higher costs of electricity (which has come down over time) and the high transit time to other auto hubs (a location disadvantage). India’s advantages lead to a minimum 20% lower cost, versus the US and other developed nations.
Quality no longer an issue Indian auto-ancillary product offerings are now benchmarked to stringent global standards. This transformation is partly due to technology tie-ups with global automotive manufacturers, leading to transfer of sophisticated technology, in turn helping produce high-end products, meeting requirements of tier-I manufacturers Daimler, BMW, VW and Volvo.
A JD Power survey shows that problems per 1,000 products supplied by Indian manufacturers have reduced 50% from 1997 levels. Auto component companies maintained high standards even while handling huge orders.
As a result global auto-component manufacturers Delphi, Bosch and Visteon have operations in India. Ford, Toyota and General Motors have also set up their international purchasing offices in India.
Fig 8 – Labour costs sustain Rank Country Index 1 Indonesia 14.0 2 Philippines 17.2 3 India 18.7 4 Thailand 20.2 5 Mexico 23.2 6 China 29.2 7 Romania 33.8 8 Argentina 35.9 9 Malaysia 38.3 10 Slovakia 50.3 11 Russia 53.3 12 Hungary 54.8 13 Poland 56.1 14 Hong Kong 59.8 15 Turkey 64.9 16 Brazil 65.8 17 Czech 70.5 18 South Africa 74.6 19 Taiwan 76.3 20 Singapore 80.4 21 Slovenia 86.2 22 South Korea 100.0
Note: Hourly wage cost in major agglomerations, Index hourly wage cost, South Korea = 100 Source: Global Production, Mar ’08
22 February 2011 India Auto Components – Overseas sales – Paving growth
Anand Rathi Research 10
Fig 9 – Automotive specialization: Global Rank Country Index 1 Argentina 4.51 2 Mexico 3.71 3 Slovakia 3.62 4 Czech 3.23 5 Poland 3.12 6 Hungary 3.08 7 Brazil 2.88 8 Turkey 2.85 9 Slovenia 2.61 10 South Africa 2.51 11 South Korea 1.95 12 Thailand 1.25 13 Romania 0.97 14 Russia 0.68 15 India 0.49 16 Indonesia 0.38 17 Taiwan 0.22 18 Philippines 0.21 19 China 0.14 20 Malaysia 0.07 21 Singapore 0.05 22 Israel 0.05 23 Saudi Arabia 0.04 24 Hong Kong 0.01 25 Pakistan 0.01
Note: Measures the country's specialization in exporting automotive products on a scale of 0 to 5 Source: Global Production, Mar ’08
22 February 2011 India Auto Components – Overseas sales – Paving growth
Anand Rathi Research 11
Steady domestic growth After two years of swift growth, the Indian auto sector has now entered a steady growth phase. We expect an industry volume CAGR of 13.7% over FY11-13e, which would strengthen the sector base.
Resilient domestic auto demand... India’s auto demand has proved resilient despite the challenging FY08-10 environment. This was mainly owing to:
continuance of the stimulus package through FY10 and its success;
lower interest rates; and
release of pent-up demand.
The likely key growth drivers for the auto segment are:
1. Sustained two-wheeler demand: We expect two-wheeler demand in India to continue, while penetration and expansion into new areas globally would boost export growth. In the two-wheeler sector, we expect a 13.7% volume CAGR over FY11-13e.
2. Turning into a global small-car hub: India has emerged as a small car manufacturing hub as global giants General Motors (plant of 225,000-unit capacity annually set up at Talegaon near Pune), Volkswagen (plant at Pune), Nissan (plant at Chennai) and Renault (in partnership with Nissan) have joined the existing India old-hands Suzuki and Hyundai. These companies would not only cater to domestic demand but also use India as an export base in the long run. We expect a 13.7% CAGR over FY11-13e in India’s passenger vehicle sales.
3. Replacement demand: would continue to fuel non-cyclical demand for auto-component companies, especially for batteries and tyres. The replacement demand trajectory would follow an increasing trend due to the robust 14% CAGR in India’s auto sales over FY02-11, particularly in batteries and tyres, continue to fuel non-cyclical demand for auto-component companies. Direct replacement demand would occur from upgradation of mode of transport, new entrants and additional vehicle purchases.
Fig 10 – Auto OEM demand
0.0
5.0
10.0
15.0
20.0
25.0
30.0
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
e
FY12
e
FY13
e
FY14
e
-5.0
0.0
5.0
10.0
15.0
20.0
25.0
30.0
Total Auto volumes yoy change (%)
(m units) (%)
Source: SIAM, Anand Rathi Research
Fig 11 – FY11-13e auto sales growth CAGR
10%
11%
12%
13%
14%
15%
16%
PV LCV M&HCV 2wh 3wh Total Autovolumes
Source: SIAM, Anand Rathi Research
22 February 2011 India Auto Components – Overseas sales – Paving growth
Anand Rathi Research 12
4. CV demand in mid-cycle: M&HCV sales have reached mid-cycle, with good demand growth expected on infrastructure development, GDP growth, and the healthy domestic economy.
Replacement demand to be an important growth driver . . .
The automobile sector has seen robust growth in the past few years, with a volume CAGR of 14% over FY02-11. The healthier growth rate portrays durability in India’s auto demand over the long-term, even after factoring in cyclical slumps. This high built-up base of automobiles would translate into replacement demand for tyres, batteries, etc., every 3-4 years, thereby bolstering demand for tyres.
Replacement demand constitutes almost two-thirds of tyre and battery sales annually. These are non-cyclical segments that would contribute towards steady company revenue, both in an economic downturn and during a high-growth phase.
Fig 12 – Volume CAGR: (FY02-11)
10.0
12.0
14.0
16.0
18.0
20.0
22.0
24.0
PV LCV M&HCV 2wh 3wh Total
(%)
Source: Company
. . . but speed-breakers ahead
While demand growth is likely to be sustained, it would not be entirely smooth sailing as speed-breakers are now visible.
Key factors that may constrain growth are:
Rise in interest rates – would raise the cost of ownership for vehicles, thereby potentially constraining demand growth.
Rise in commodity costs – would necessitate further increase in vehicle prices, thereby increasing the cost of acquisition.
Regulatory changes – Increase in excise duty rates to pre-stimulus levels (0% to 2% up) would result in passing on of this cost increase to end-users.
22 February 2011 India Auto Components – Overseas sales – Paving growth
Anand Rathi Research 13
Improved efficiencies Auto-parts companies are benefiting from efforts to conserve cash, reduce costs and improve productivity. Also, de-risking via entry into the non-auto segment and prudent investments would lead to 21.5% sales CAGR in FY11-13e vs. 15% for the auto industry.
Steps taken in tough times would now help Lower demand in 2HFY09 and spiraling raw material costs just prior to this period led companies to rapidly adopt measures to conserve cash, reduce costs and improve productivity. Even as these steps helped them survive the downturn, they augur well for enhanced profitability ahead.
Another step that gained traction during this period was the need to diversify/de-risk business models to account for cyclical trends. Bharat Forge and MSS had already taken such steps; we expect this to be even more widespread.
We believe that ‘diversified’ companies would be better performers. Diversifying into non-automobile segments, upgrading to non-commoditized products and a broad product range are some of the characteristics of companies that would emerge stronger despite the slowdown.
Operating performance to sustain A pick-up in demand and lower channel inventories have led to greater capacity utilization and short-term capacity constraints in certain segments. While higher commodity costs would lower EBITDA margins from the peak, we expect them to sustain at FY11 levels.
Hence, we expect a 21.5% sales CAGR in FY11-13e vs. 15% for the auto industry. Similarly, the profit CAGR at 28.4% would be higher than that for the auto industry (17.6%).
Fig 13 – EBITDA margin trend (FY09-13e)
12
13
14
15
16
17
FY09
FY10
FY11
e
FY12
e
FY13
e
Auto components universe
(%)
Source: Company, Anand Rathi Research
22 February 2011 India Auto Components – Overseas sales – Paving growth
22 February 2011 India Auto Components – Overseas sales – Paving growth
Anand Rathi Research 16
Company Profiles
Anand Rathi Financial Services, its affiliates and subsidiaries, do and seek to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Disclosures and analyst certifications are located in Appendix 1. Anand Rathi Research India Equities
India I Equities
Auto Components
Update
22 February 20011
Motherson Sumi Systems
Good performance to continue; Buy
Motherson Sumi Systems is expected to continue on its steady growth path, boosted by robust domestic demand and new order implementation at Samvardhana Motherson Reflectec in FY12 and subsequent operating leverage from FY13. We re-iterate our Buy on the stock, with a target price of `221.
Benefits of good domestic car growth. Motherson Sumi has benefited from revved-up growth in domestic passenger cars. Domestic car volumes have risen at a healthy ~31.3%, ytd FY11, and are expected to register a 13% CAGR over FY11e-13e. With a 65% share, MSS dominates the market in passenger-car-wiring harnesses. Further, as it is well-established with upcoming models being launched in India, MSS would register higher-than-industry growth.
Steady at SMR. Samvardhana Motherson Reflectec, the rearview-mirror business, has turned around faster than expected after its acquisition by MSS. In ytd FY11, an appreciating rupee capped revenue growth at SMR, but the outlook is robust on new order implementation commencing in FY12 and subsequent operating leverage from FY13.
Valuation and risks. We have a Buy rating on MSS, with a target of `221 (18x target PE, on par with its past six-year average). At the current price, the stock trades at a PE of 15.1x FY12e EPS. Risks: slowdown in European demand or delay in new model launches there, currency risk, and the complicated company structure.
22 February 2011 Motherson Sumi Systems – Good performance to continue; Buy
Anand Rathi Research 19
Investment Argument and Valuation Motherson Sumi Systems is expected to continue on its steady growth path, boosted by robust domestic demand and new order implementation at SMR in FY12, and subsequent operating leverage from FY13. We re-iterate our Buy on the stock, with a target price of `221.
Benefits of good domestic car growth
MSS is a key vendor to almost all passenger-car and two-wheeler OEMs and caters to a wide spectrum of the vehicular industry. It has benefited from revved-up growth in domestic passenger cars.
Domestic car volumes have risen at a healthy ~31.3% in ytd FY11, and are expected to register a 13% CAGR over FY11e-13e. With a 65% share, MSS dominates the market in passenger-car-wiring harnesses. Further, as it is well-established with upcoming models being launched in India, MSS would register higher-than-industry growth.
Steady at SMR
On acquiring Samvardhana Motherson Reflectec, the rearview-mirror business, MSS is one of the largest manufacturers of automobile rearview mirrors in the world, with a market share of ~22%. SMR has raised MSS’s ability to supply high-level assemblies. Post-acquisition, the latter has been able to turn around operations at Samvardhana faster than expected, and the rapid pace of improvement in operations is expected to be sustained.
In ytd FY11, an appreciating rupee capped revenue growth at SMR, but the outlook is robust regarding new order implementation commencing in FY12 and the subsequent operating leverage from FY13.
Valuation and risks
We have a Buy rating with a target price of `221 (18x target PE, on par with its past six-year average). At the current price, the stock trades at a PE of 15.1x FY12e EPS. The company is securely entrenched in its product segments, with a well-charted five-year plan. In the past, the stock has traded at a premium to the rest of the sector.
Risks
Currency fluctuations: As a considerable proportion of its revenue arises from overseas ventures, MSS is highly exposed to risks posed by currency fluctuations.
Complicated structure: Its numerous subsidiaries and joint ventures make for a complex company structure.
Commodity pressure: With commodity prices on an upward trend, any delay in passing on these costs could affect the short-term operating performance.
Slowdown in demand from Europe: Any slowdown in demand growth from Europe or delay in launching new models would cloud prospects for MSS’ overseas businesses.
22 February 2011 Motherson Sumi Systems – Good performance to continue; Buy
Anand Rathi Research 20
Benefits of good domestic car growth Motherson Sumi Systems has benefited from revved-up growth in domestic passenger cars. Domestic car volumes have risen at a healthy ~31.3% in ytd FY11, and are expected to register a 13% CAGR over FY11e-13e. With a 65% share, MSS dominates the market in passenger-car-wiring harnesses. Further, as it is well-established, with models being launched in India, MSS would register higher-than-industry growth.
Leader in the wiring-harness sub-segment
India’s leading passenger-car-wiring harness manufacturer, MSS has a domestic market share of over 65%. It is a key vendor to almost all passenger-car and two-wheeler OEMs and sells to a wide spectrum of the vehicular industry. (It also operates in the non-automobile segment, with customers in earth-moving and material-handling sub-segments; and supplies material-handing markets in Europe.) It has more than 25 manufacturing facilities in India, Sharjah, Ireland and the UK to ensure timely supplies to OEMs in India as well as in Europe.
The company provides complete in-house design services, which results in quicker development. It benefits from having carried out backward integration for critical inputs for wiring harnesses such as wires, connectors, terminals, fuses and fuse-boxes.
It has a technology partnership with Sumitomo of Japan, a leader in wiring harnesses worldwide. It has also tied up with Kyungshin Industrial of South Korea, the wiring-harness supplier to Hyundai Motors in Korea.
The wiring-harness business is the second most important business segment for MSS, till FY08 bringing in 73% of its revenue (standalone; and 66% consolidated). However, on acquiring Visiocorp’s rearview-mirror business, the share of the wiring-harness revenues diminished significantly from FY10. Revenue from its consolidated-wiring-harness sub-segment has seen a robust 27.5% CAGR over FY04-10.
Revenue growth has arisen from revved-up growth domestically in passenger cars, its strong presence in Europe’s two-wheeler and material-handling-equipment markets, faster growth in exports and capacity expansion by key customers Hyundai and Nissan.
Fig 7 – MSS’ wiring harness business growth (FY04-FY10)
0
4,000
8,000
12,000
16,000
20,000
FY04
FY05
FY06
FY07
FY08
FY09
FY10
Standalone Consolidated
(`m)
Source: Company
22 February 2011 Motherson Sumi Systems – Good performance to continue; Buy
Anand Rathi Research 21
Outlook
Even though auto volumes in 2HFY09 slowed considerably, MSS retained its market share in wiring harnesses. Subsequently, as volume growth strongly recovered in India, good revenue growth followed. New model launches from Ford and Nissan would continue to drive MSS’ revenue growth. Domestic car volumes in India have risen at a healthy 31.3% ytd in FY11. Over FY11e-13e, they are expected to touch a 13% CAGR. As the company is well established with upcoming models being launched in India it would register higher-than-industry growth.
A recovery in auto demand, globally, in CY10/11 would significantly boost MSS’ overseas revenue. Moving up the value chain to manufacture progressively more complex products and modules, and capitalising on SMR’s overseas relationships to supply more content per car in the medium term would further enhance volumes and realizations for MSS’s wiring-harness division.
Other business segments
Apart from the wiring harness and mirror sub-segments, MSS’ other business segments are plastic and polymer components, and rubber components. After acquiring SMR, these divisions now constitute a smaller share of MSS’ revenue.
Fig 8 – MSS’ revenue mix (%)
Mirrors & modules, 53
Polymer tooling, 9
Wiring harness, 28
Others, 4
IT, design, & manufacturing
support, 1
Metal working, 1
Elastomer processing, 2
Source: Company
Fig 9 – MSS’ polymer business growth (FY04-FY10)
0
1,000
2,000
3,000
4,000
5,000
6,000
FY04
FY05
FY06
FY07
FY08
FY09
FY10
Standalone Consolidated
(`m)
Source: Company
22 February 2011 Motherson Sumi Systems – Good performance to continue; Buy
Anand Rathi Research 22
Fig 10 – MSS: Growth, rubber components and other products (FY04-10)
0
500
1,000
1,500
2,000
2,500
FY04
FY05
FY06
FY07
FY08
FY09
FY10
Standalone Consolidated
(`m)
Source: Company
Tie-ups with global leaders hold the technological edge
MSS has technology tie-ups/joint ventures with globally leading companies Magna, Sumitomo, Kyungshin Industrial, Continental, Calsonic. Its JVs/tie-ups served the multiple purposes of securing technology, penetrating overseas markets and venturing into new product categories in India. At present, MSS has 24 joint ventures with various partners.
Its recent joint venture with Calsonic Kansei has commenced operations, currently supplying to Ritz, Micra. The JV supplies HVAC systems as complete assemblies. (This includes other components such as audio systems, etc., in addition to ACs.)
22 February 2011 Motherson Sumi Systems – Good performance to continue; Buy
Anand Rathi Research 23
Steady at SMR Samvardhana Motherson Reflectec, the rearview-mirror business, has turned around faster than expected after its acquisition by MSS. In YTD FY11, an appreciating rupee capped revenue growth at SMR, but the outlook is robust for new order implementation commencing in FY12 and subsequent operating leverage in FY13.
Samvardhana Motherson Reflectec, the rearview-mirror business, is one of the largest manufacturers of passenger car rearview mirrors in the world, with a ~22% market share globally, and ~53% in India. Samvardhana has enhanced MSS’ ability to supply high-level assemblies. After the acquisition, MSS has been able to turn around operations at Samvardhana faster than initially expected.
In ytd FY11, an appreciating rupee capped revenue growth at SMR, but the outlook is robust for new order implementation commencing in FY12 and subsequent operating leverage in FY13.
Benefits of the acquisition
With the SMR acquisition, the MSS Group is now one of the largest manufacturers of automobile rearview mirrors in the world. Also, SMR has raised to a higher level MSS’ ability to supply high-level assemblies. Some of the key benefits to MSS from this acquisition are:
The MSS Group is now the largest manufacturer of passenger car mirrors in India.
SMR supplies products to nearly every OEM, nearly 400 individual products. It is a technology leader with 300 patents and a history of innovation.
SMR is a market leader in exterior rearview mirror systems and brings with it cutting-edge technology, covering the complete range of mirrors from low-end entry segments to high-end luxury segments.
The acquisition was made at favourable valuations. Therefore, substantial value-unlocking potential exists under normal conditions in the near future.
Since MSS had been in the business in India for over 13 years in partnership with the erstwhile Visiocorp, it built up certain competencies.
The acquisition brings with it synergies. “Mirrors” is a synergistic product and brings re-sourcing value into the already existing lines of wiring harness (€28m annual buying), polymer processing and elastomers.
The acquisition has opened up new markets such as China, Mexico, the USA, Japan, Spain, France and Hungary.
Since SMR is an established tier-I supplier globally, the acquisition has propelled MSS into the worldwide tier-I league.
There is good potential for MSS to supply more components to SMR’s customers, thereby increasing the content supplied per car.
22 February 2011 Motherson Sumi Systems – Good performance to continue; Buy
Anand Rathi Research 24
SMR: 3Q performance
SMR’s performance continued to steadily improve. Full recovery, however, was affected by the unfavorable exchange rate. In 3Q, revenue was flat yoy, but was up 8% qoq. Sales in India grew 74.1% yoy, while sales outside India fell 2.7% yoy, the effect of the exchange rate. EBITDA margin was 6% (-50bps, both yoy and qoq). Net profit attributable to MSS was `134m (+47.7% yoy and 95.9% qoq).
22 February 2011 Motherson Sumi Systems – Good performance to continue; Buy
Anand Rathi Research 25
Fig 13 – Impact of currency on revenue
120
140
160
180
200
2QFY
10
3QFY
10
2QFY
11
3QFY
11
9,000
9,750
10,500
11,250
12,000
Revenues - Euros Revenues - Rupees (RHS)
(€m) (`m)
Source: Company
In CY11, MSS will commission four plants in India and one each in South Africa and Hungary. By end-CY12, SMR will commission a plant each in Brazil and Thailand. Total capex involved would be ~`5bn, half of which would be in India, the balance overseas. Business prospects are upbeat on nearing of new-order execution and good demand.
Fig 14 – SMR, a significant revenue driver
SMR’s and MSS’s revenue trends
0
20,000
40,000
60,000
80,000
100,000
120,000
140,000
FY10
FY11
e
FY12
e
FY13
e
SMR MSSL
(`m)
SMR’s and MSS’s profit trends
0
1,000
2,000
3,000
4,000
5,000
6,000
FY10
FY11
e
FY12
e
FY13
e
SMR MSSL
(`m)
Source: Company, Anand Rathi Research
22 February 2011 Motherson Sumi Systems – Good performance to continue; Buy
Anand Rathi Research 26
3QFY11 performance was impressive MSS registered a good 3QFY11, driven by robust standalone performance and sustained traction at SMR.
Standalone quarterly performance impressive
MSS reported robust sales growth of 72.1% yoy (+15.2% qoq) to `7.5bn, driven by domestic revenue growth of 76.8% yoy (+15.2% qoq) and exports growth of 37.9% yoy (up 14.6% qoq). Standalone exports saw a healthy increase in sales and continued sequential growth. Other operating income increased ~15.9% yoy to `185m.
The EBITDA margin (adjusted for forex) was 16.6%. It fell 100bps yoy to 16.6%, though qoq it was up 200bps. The yoy decline stemmed from higher raw-material-to-sales (by 200bps yoy), partially offset by 70bps lower staff-expenses-to-sales and 50bps lower other-expenditure-to-sales. In absolute terms, EBITDA was up 60.6% yoy and 31.4% qoq. Boosted by healthy revenue growth and higher other income, adjusted profit grew 85.1% yoy to `759m.
Total extraordinary income 237 112 24 (89.9) (78.6)
Interest 68 81 100 46.8 23.4
Gross Profit 995 1,109 1,324 33.1 19.5
Less: Depreciation 172 199 211 23.1 5.9
PBT 824 909 1,113 35.1 22.5
Tax 224 250 337 50.8 34.7
Effective Tax Rate (%) 27.1 27.5 30.3
Rep. PAT 600 659 776 29.3 17.8
Adj. PAT 410 580 759 85.1 30.9
Source: Company
While MSS’ 3QY11 EBITDA margin was healthy, the rise in copper prices and general commodity cost hikes could impact the EBITDA margin in the next six months, particularly in the standalone operations.
22 February 2011 Motherson Sumi Systems – Good performance to continue; Buy
Anand Rathi Research 27
Consolidated 3QFY11 performance
Net sales in 3Q were up 16.9% yoy (+8.7% qoq) at `20.8bn. Domestic revenue grew 62% yoy, while overseas revenue fell 2.3% yoy.
EBITDA margin improved 110bps yoy and 60bp qoq to 10.4%, while EBITDA grew 31.5% yoy to `2.2bn. The better EBITDA margin and lower tax rate drove MSS’ consolidated profitability 65.6% higher yoy (+27.9% qoq) to `953m.
Total extraordinary income 217 164 158 (27.0) (3.7)
Interest 139 152 171 23.5 12.6
Gross Profit 1,812 1,961 2,231 23.1 13.8
Less: Depreciation 642 610 601 (6.5) (1.5)
PBT 1,170 1,352 1,630 39.4 20.6
Tax 389 471 430 10.7 (8.7)
Effective Tax Rate (%) 33.3 34.9 26.4
Rep. PAT bef MI & ASP 781 880 1,200 53.7 36.3
Minority interest 30 21 137 362.9 562.9
Sh of Profit of Associates -2 0 0 (109.1) -
Rep. PAT after MI & ASP 749 860 1,064 42.0 23.7
Adj. PAT 575 745 953 65.6 27.9
Source: Company
Fig 16– Trend in standalone EBITDA margin
14.814.2 14.4
17.9
14.1
17.5 17.6
19.4
14.6
16.6
14.4
300
500
700
900
1,100
1,300
1,500
1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q
FY09 FY10 FY11
13.0
14.0
15.0
16.0
17.0
18.0
19.0
20.0
EBITDA EBITDA Margin (RHS)
(`m) (%)
Source: Company
Fig 17– Trend in standalone raw material-to-sales
58.3
60.0
58.9
58.5
60.4
57.0
58.6
61.1
60.659.9
57.2
1,500
2,200
2,900
3,600
4,300
5,000
1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q
FY09 FY10 FY11
56.5
57.5
58.5
59.5
60.5
61.5(`m) (%)
Source: Company
22 February 2011 Motherson Sumi Systems – Good performance to continue; Buy
Anand Rathi Research 28
Financials We expect a 21.4% CAGR in MSS’ revenue from FY11 to FY13, with its EBITDA margin improving from 10.2% in FY11e to 10.8% two years later. The EBITDA CAGR would hence be 24.9%, while the adjusted net profit CAGR would come in at 32.8%.
Motherson Sumi Systems supplies wiring harnesses and plastic modules to almost all car manufacturers in India. With its acquisition of SMR it has seen rapid growth (a 64.9% CAGR in net sales from FY07 to FY10) as it has been transformed into a one-stop shop for a wide range of critical components.
We expect a 20.7% CAGR over FY11-13 in MSS’ (standalone) revenue, backed by a stable EBITDA margin of 15.3%, and a 23.8% CAGR in (standalone) adj. net profit.
We expect a 21.4% CAGR over FY11-13 in MSS’ (consolidated) revenue. The EBIDA margin would be 60bps higher as operating leverage on the increased capacities would be seen in FY13. Quicker recovery in global automobile markets would boost growth and lead to upsides to our consolidated earnings estimates. We expect a 32.8% CAGR over FY11-13 in the (consolidated) adj. net profit.
Fig 19 – MSS’ EBITDA margin trend (FY05-FY13e)
7
9
11
13
15
17
19
FY05
FY06
FY07
FY08
FY09
FY10
FY11
e
FY12
e
FY13
e
Standalone Consolidated
(%)
Source: Company, Anand Rathi Research
22 February 2011 Motherson Sumi Systems – Good performance to continue; Buy
Anand Rathi Financial Services Limited does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Disclosures and analyst certifications are located in Appendix 1 Anand Rathi Research India Equities
India I Equities
Key financials
Year end 31 March FY09 FY10 FY11e FY12e FY13e
Sales (`m) 47,740 33,276 48,203 59,882 72,168
Net profit (`m) 1,518 153 3,070 4,844 6,827
Diluted EPS (`) 6.2 0.6 12.5 19.8 27.9
Growth (%) -47.1 -89.9 1,906.5 57.8 40.9
PE (x) 51.4 509.8 25.4 16.1 11.4
PBV (x) 4.3 4.9 3.7 3.1 2.4
RoE (%) 2.5 -5.2 15.0 20.0 22.4
RoCE (%) 9.1 3.7 16.0 20.5 24.2
Dividend yield (%) 0.3 0.3 0.5 0.5 0.6
Net gearing (%) 54.4 55.1 45.1 40.5 34.4
Source: Company, Anand Rathi Research Prices as on 18 February 2011
Auto Components
Update
22 February 2011
Bharat Forge
Ph-1 complete, ph-2 of re-rating on the anvil; Buy
We expect Bharat Forge, with its diversified business model and domestic market leadership, to register 49.1% consolidated profit CAGR over FY11-13e, given our view that the CV industry would see steady growth over FY11-13e and good overseas demand. We re-iterate our Buy with a target price of `396 (from `317).
To benefit from steady demand. Domestic auto demand is expected to follow a steady growth trend, while overseas markets too are showing signs of improvement. Given that BFL is the domestic market leader and earns ~60% revenue from overseas, we expect it to largely benefit from this growth.
JVs, non-auto demand add to revenue. We expect BFL’s four non-auto JVs to be operational by end-FY13. The JVs, to cater to power sector requirements, have strong revenue growth and profitability potential.
Introducing FY13 estimates. We introduce FY13 estimates and expect sales of `72.2bn, EBITDA margin of 20.7% and EPS of `27.9 (40.9% yoy growth) by FY13.
Valuation and risks. We value the stock at 20x FY12e PE. We believe that commencement of operations of JVs would trigger a re-rating of the stock. Our target price is `396. At present valuations, BFL trades at 16.1x FY12e EPS. Risks: slowdown in execution, delayed overseas recovery.
Rating: Buy Target Price: `396 Share Price: `319
Key data BHFC IN/BRFG.BO
52-week high/low `413/`232Sensex/Nifty 18212 / 54593-m average volume US$4.1m Market cap `48.97bn/US$1.65bn
22 February 2011 Bharat Forge – Ph-1 complete, ph-2 of re-rating on the anvil; Buy
Anand Rathi Research 33
Investment Argument and Valuation We expect Bharat Forge, with its diversified business model and domestic market leadership, to register 49.1% consolidated profit CAGR over FY11-13e, given our view that the CV industry would see steady growth over FY11-13e and good overseas demand. We re-iterate our Buy with a target price of `396 (from `317).
Beneficiary of demand improvement
Domestic auto demand is expected to follow a steady growth trend, while overseas markets, too, are showing signs of improvement. Given that Bharat Forge is a market leader in India and that it earns around ~60% of revenue from overseas, we expect it to be a major beneficiary of the industry’s growth ahead.
For example, in 3QFY11, the recovery in CV demand and good PV demand has resulted in BFL’s revenue growing 50.2% yoy and 11.2% qoq. Production tonnage has improved – from a low 18,246 in 4QFY09 to ~35,000 in 3QFY10 and now to ~48,000 tons.
JVs, non-auto demand add to revenues
We expect Bharat Forge’s four non-auto JVs to be operational by around FY13-end. These JVs to cater to the power sector requirements have good revenue growth and profitability potential. These would add significantly to BFL’s revenues and profitability in the long run.
Continued robust operating performance
Bharat Forge has seen a consistent increase in sales for the past seven quarters, driven by strong growth in exports (driven by new products and customers in US and Europe), higher revenues from the non-automotive business, improved market share and programme ramp-up (in both non-automotive and automotive). These, along with the company’s efforts to lower its breakeven point, sustained efforts to reduce costs, better capacity utilization and improved performance of subsidiaries, have helped it regain its past normalised EBITDA margin of ~24% for its standalone operations and ~18% for its consolidated operations.
Valuations
In the past, Bharat Forge has commanded a premium to other forgings companies due to its pioneering dual-shore model, diversified nature and healthy EBITDA margin.
At present, to work out our target price, the JVs have not been taken into account, as they are likely to commence only by FY13-end. They would, however, be significant value-drivers once they begin operations.
We value the stock at 20x FY12e. Our target price is `396. At current valuations, Bharat Forge trades at 16.1x FY12e EPS.
Overseas demand recovery and non-auto demand would be the next big
growth drivers
22 February 2011 Bharat Forge – Ph-1 complete, ph-2 of re-rating on the anvil; Buy
Anand Rathi Research 34
Risks
Currency fluctuations: The rising proportion of exports (both to the US and Europe) in total revenue would raise currency fluctuation risks. The movement of the rupee against the US dollar and the euro would play an important role.
Execution risk: Given the nature of new greenfield projects involved, there remains an execution risk.
Inability to turn around subsidiaries: Most of BFL’s acquisitions were bankrupt companies. Therefore, there is an inherent risk that it may not be able to turn them around or sustain the operations at improved levels
22 February 2011 Bharat Forge – Ph-1 complete, ph-2 of re-rating on the anvil; Buy
Anand Rathi Research 35
Beneficiary of demand improvement Domestic auto demand is expected to follow a steady growth trend, while overseas markets, too, are showing signs of improvement. Given that Bharat Forge is a market leader in India and that it earns around ~60% of revenue from overseas, we expect it to be a major beneficiary of the industry’s growth ahead, both domestically and internationally.
The recovery in CV demand and good PV demand has resulted in BFL’s consolidated revenue growing 50.2% yoy and 11.2% qoq in 3QFY11. Production tonnage has improved – from a low 18,246 in 4QFY09 to ~35,000 in 3QFY10 and now to ~48,000 tons.
BFL’s FY11 performance reflects the steady recovery in the global auto industry and strong performance in the domestic M&H CV sector. The move towards greater non-auto share in production is also paying good dividends for Bharat Forge.
Fig 8 – M&HCV sales and impact on Bharat Forge’s EBITDA margin
20,000
30,000
40,000
50,000
60,000
70,000
80,000
90,000
1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q
FY09 FY10 FY11
15
17
19
21
23
25
27
29
M&HCV sales EBITDA margin (RHS)
(units) (%)
Source: Company, SIAM
Exports contribute ~40% of BFL’s revenue (standalone), with overseas sales (including those of overseas subsidiaries) bringing in around ~60% of its (consolidated) revenue. The overseas subsidiaries have borne the brunt of the global slump in automobile demand, with their sales falling
22 February 2011 Bharat Forge – Ph-1 complete, ph-2 of re-rating on the anvil; Buy
Anand Rathi Research 36
45-75% in FY10. The steady improvement in demand overseas has benefited Bharat Forge’s overseas revenues as well, with the growth expected to be sustained ahead.
Fig 9 – Decline and recovery in Bharat Forge’s standalone exports
1,000
1,500
2,000
2,500
3,000
3,500
4,000
1QFY
09
2QFY
09
3QFY
09
4QFY
09
1QFY
10
2QFY
10
3QFY
10
4QFY
10
1QFY
11
2QFY
11
3QFY
11
(`m)
Source: Company
In FY09, Bharat Forge’s exports to the US were `4,359m, dropping from `4,855m the year prior. As a result, Europe overtook the US as the major importer of the company’s products. However, with US demand expected to recover strongly on the back of the oldest fleet of trucks in recent history, demand recovery there is expected to be extremely robust.
22 February 2011 Bharat Forge – Ph-1 complete, ph-2 of re-rating on the anvil; Buy
Anand Rathi Research 37
We expect the domestic CV sector to sustain good growth ahead, at a CAGR of 13.1% over FY11-13e. The global automobile market recovery ahead, after bottoming out in 2009-2010, is an added positive. As a significant proportion of its revenue derives from overseas and because of its leading position in India, Bharat Forge would be the prime beneficiary of an FY12 recovery.
Fig 12 – Bharat Forge: Rise in revenue (FY06-FY12e)
-40
-20
0
20
40
60
80
FY06
FY07
FY08
FY09
FY10
FY11
e
FY12
e
Standalone Domestic Standalone Exports Total Standalone Consolidated
(%)
Source: Company, Anand Rathi Research
CV demand in the US and Europe to be robust
Recent data released by FTR Associates (a leading North American transportation forecaster) on truck sales, indicates that Class 8 (heavy commercial vehicle) truck orders for major North American OEMs have shown consistent high percentage-point increases in the last five months. January Class 8 truck net orders were 27,009 units for major North American OEMs, a modest 1% mom increase but 324% yoy. These order levels were also the highest since May ’06.
Fig 13 – North America Class 8 and 4-7 production (‘000)
Source: FTR Associates
Ahead, FTR expects orders to show a normal seasonal increase to a level of between 22,000-25,000 units a month. Since the orders for class 8 trucks are showing exceedingly high growth rates, we expect the positive spillover effect to impact M&HCV (class 4-7 trucks) segment as well. All these point to the fact that truckers are willing to start ordering equipment, indicating a recovery for the truck-equipment market in North America. We think that most of these orders would come from leasing companies
22 February 2011 Bharat Forge – Ph-1 complete, ph-2 of re-rating on the anvil; Buy
Anand Rathi Research 38
and large fleets; small and medium-sized companies would also participate in this recovery.
Fig 14 – U.S. truck freight-ton miles
2.782.85
2.89 2.90
2.74
2.42
2.54
2.65
2.78
2.1
2.2
2.3
2.4
2.5
2.6
2.7
2.8
2.9
3
CY0
4
CY0
5
CY0
6
CY0
7
CY0
8
CY0
9
CY1
0
CY1
1
CY1
2
(Trillions)
Source: FTR Associates
As per ACEA (European Automobile Manufacturers Association) data, the European CV market is also in a recovery phase. In Dec ’10, demand for new commercial vehicles continued to soar (+12.5% yoy) in all sub-segments, except buses and coaches (-1.4% yoy). In CY10, EU markets for vans and trucks expanded while registrations of buses and coaches fell, leading to an overall 8% growth in Europe. As a result, European truck manufacturers have substantially increased production levels, indicating restocking by vendors on improved demand.
Fig 15 – Western Europe medium and heavy truck production GVW>6t (000)
478535 545
196
472380
303
422 442
0
100
200
300
400
500
600
CY0
4
CY0
5
CY0
6
CY0
7
CY0
8
CY0
9
CY1
0
CY1
1
CY1
2
('000)
Source: JD Power and Associates
22 February 2011 Bharat Forge – Ph-1 complete, ph-2 of re-rating on the anvil; Buy
Anand Rathi Research 39
JVs, non-auto demand add to revenues We expect Bharat Forge’s four non-auto JVs to be operational by around FY13-end. These address power sector requirements, have good revenue growth and profitability potential and would add significantly to BFL’s revenues and profitability in the long run.
Non-automotive segment – a growth driver
The non-automotive business, which comes from the industrial and oil & gas industries, currently accounts for 19% of BFL’s consolidated and ~38% of its standalone sales. Due to the ongoing capex in the Indian economy and large-scale global oil & gas exploration, BFL’s expects strong growth in this segment. Forgings have varied industrial applications – in turbines for power plants, in parts of aircraft, in machined parts for the steel and cement industries, and in rigs for oil exploration.
The greater share of revenue from the non-auto segment would increasingly de-risk BFL’s business model, and result in a diversified product range. The sharper focus on the non-automotive business would see the higher proportion of CVs in the global revenue mix declining a little. The non-automotive business remains a lucrative segment for BFL.
Fig 16 – Bharat Forge’s non-automotive capacity Plant Capacity Baramati An 80-metre counterblow hammer for production of heavy forgings for large diesel engines
and aerospace applications, and a machining line for heavy-duty and medium-duty crankshafts. Commenced operations in Mar ’09.
Baramati Completed installation of a ring-rolling mill capable of rolling rings up to 4.5 metres in diameter and 50mm in height, along with its blanking press. Operational in Jun ’09. Secured orders from wind-turbine and large gearbox manufacturers from global OEMs.
Mundhwa A 4,000-ton open-die forgings press, commissioned in Aug ’08 and now fully operational. Source: Company
Fig 17 – Bharat Forge: Growth in share of non-automotive revenue (FY05-12e)
0
5
10
15
20
25
30
35
40
FY05
FY06
FY07
FY08
FY09
FY10
FY11
e
FY12
e
(%)
Source: Company, Anand Rathi research
Entry into the non-automotive space would further de-risk BFL’s business model and this segment is expected to contribute up to 40% of global revenues by FY12 (17% in FY07, and 20% in FY10e).
22 February 2011 Bharat Forge – Ph-1 complete, ph-2 of re-rating on the anvil; Buy
Anand Rathi Research 40
JVs
Through its joint ventures with Alstom and NTPC, Bharat Forge would be tapping growth in segments where demand is high and supply is constrained.
Fig 18 – Details of Bharat Forge’s new JVs JVs Description
BF-NTPC Energy Systems (BFL 51%) - aimed at the power sector, in the balance-of-plant space. High-pressure piping, pumps, valves, related forgings and castings. A business plan would be developed on the appointment of a consultant. To manufacture sub-critical and super-critical turbines and generators at a port in India. Aims at further exploring possibilities for manufacturing turbines and generators for gas and nuclear power plants.
BF-Alstom
Plants of these companies are expected to be ready by 2012. BF-Alstom 1 (BF 49%)
To manufacture 5000 MW of turbines and generators of 300-800 MW+ range annually for coal-based power plants.
BF-Alstom 1 (BF 51%)
To manufacture sub-critical and super-critical turbines and generators at a port-based location in India. To manufacture a range of heat exchangers, condensers, de-aerators, and other auxiliaries for these power plants. To build a plant for heavy forgings in India. Would meet requirements of the indigenous power-generation sector.
BF - Areva Exploring locations, JV would have a state-of-the-art 14,000-ton open-die forgings press with associated equipment and an integrated steel-making facility.
Source: Company
22 February 2011 Bharat Forge – Ph-1 complete, ph-2 of re-rating on the anvil; Buy
Anand Rathi Research 41
Continued robust operating performance Successive sales increases, strong growth in exports, higher non- automotive revenues, capacity increases, efforts to lower breakeven point and sustained efforts to reduce costs have helped Bharat Forge regain its past normalised EBITDA margin of ~24% for standalone operations and ~18% for consolidated operations.
Bharat Forge has seen a consistent increase in sales for the past seven quarters, driven by strong growth in exports (driven by new products and customers in US and Europe), higher revenues from the non-automotive business, improved market share and program ramp-up (in both non-automotive and automotive). These, along with the company’s efforts to lower its breakeven point, sustained efforts to reduce costs, better capacity utilization and improved performance of subsidiaries, have helped it regain its past normalised EBITDA margin of ~24% for its standalone operations and ~18% for its consolidated operations.
The recovery in CV demand and good PV demand has resulted in BFL’s consolidated revenue growing 50.2% yoy and 11.2% qoq in 3QFY11. Production tonnage has improved – from a low 18,246 in 4QFY09 to ~35,000 in 3QFY10 and now to ~48,000 tons. In 3QFY11 volumes were up 4.3% qoq due to strong growth in exports and continued ramp-up of non-automotive capacities.
The 3QFY11 standalone EBITDA margin improved 90bps yoy and 10bps qoq to 24.3%, while EBITDA increased 58% yoy and 8% qoq. The yoy improvement in the EBITDA margin came mainly from the lower staff cost-to-sales ratio (60bps lower yoy and 10bps qoq), lower manufacturing cost-to-sales ratio (80bps lower yoy but qoq 40bps higher) and lower ‘other expenditure’ to sales (60bps qoq lower but 10 bps higher yoy). The 3QFY11 standalone adjusted PAT increased more than 2x yoy.
The share of the non-automotive business to sales increased to 37%, from 26% in 3QFY10, due to the ramp-up of new programmes at the new dedicated facilities, as well as to increase in market share with existing clients.
Consolidated performance
BFL’s 3QFY11 combined performance (India + overseas operations excl. China) marked the continuing qoq improvement as subsidiaries did well, driven by strong international operations due to a recovery in the European CV market. Revenue growth was 11.2% qoq and 50.2% yoy; the adjusted PAT increased 29.9% qoq to `787m.
There was an exceptional expense of `81m for a one-time cost incurred regarding concessions on labour union negotiations in Bharat Forge America as well as on business transfer expenses from Bharat Forge Scottish Stampings. The company said that the non-auto growth stemmed from new customer additions, higher value-addition of critical components and expanded product range. In CYFY11, it expects a better performance from subsidiaries post-restructuring, better capacity utilization and cost control.
22 February 2011 Bharat Forge – Ph-1 complete, ph-2 of re-rating on the anvil; Buy
Anand Rathi Research 42
Financials We expect a 22.4% CAGR in Bharat Forge’s consolidated revenues from FY11 to FY13e, with the EBITDA margin improving from 10.2% to 20.7% and an adjusted net profit CAGR of 49.1%.
We expect a 24.2% CAGR in Bharat Forge’s (standalone) revenue from FY11 to FY13e, but a 220bps EBITDA margin decline, and a 26% CAGR in the standalone adj. net profit.
We expect a 22.4% CAGR in (consolidated) revenue from FY11 to FY13e, backed by robust EBITDA margin improvement. The margin improvement in subsidiaries would be driven by higher capacity utilization, following mounting demand in the global auto market. We expect a 49.1% CAGR in the consolidated adj. net profit from FY11 to FY13e.
Fig 19 – Bharat Forge: Improvement in net profit (FY05-FY12e)
0
800
1,600
2,400
3,200
4,000
4,800
FY05
FY06
FY07
FY08
FY09
FY10
FY11
e
FY12
e
S/a PAT Cons PAT
(`m)
Source: Company, Anand Rathi Research
Fig 20 – Bharat Forge: Improvement in EBITDA (FY05-FY12e)
Anand Rathi Financial Services Limited does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Disclosures and analyst certifications are located in Appendix 1 Anand Rathi Research India Equities
India I Equities
Key financials
Year end 31 March FY09 FY10 FY11e FY12e FY13e
Sales (`m) 33,929 37,940 44,974 58,739 69,706
Net profit (`m) 3,207 5,229 6,006 7,270 8,580
Diluted EPS (`) 3.8 6.2 7.1 8.6 10.1
Growth (%) 39.0 63.0 14.9 21.0 18.0
PE (x) 34.6 21.2 18.5 15.3 12.9
PBV (x) 8.3 5.0 4.0 3.3 2.7
RoE (%) 25.7 23.6 21.8 21.7 21.1
RoCE (%) 33.4 33.9 29.1 30.1 30.5
Dividend yield (%) 0.5 0.8 1.0 1.1 1.3
Net gearing (%) 33.9 20.8 17.7 18.7 11.5
Source: Company, Anand Rathi Research Prices as on 18 February 2011
Auto Components
Update
22 February 2011
Exide Industries
Industrial slowdown impact; maintain Hold
Its industry dominance and backward integration measures are long-running positives for Exide. However, slowdown in industrial demand and hence lower pricing power, short-term capacity constraints and fair valuations lead us to re-iterate our Hold rating.
4Q to be subdued. Capacity commissioning for Exide’s auto segment in Apr ’11 would help it address replacement demand, which is now inadequately serviced. However in 4Q, weaker demand from the industrial segment and continuing capacity constraints in the auto segment are likely to temper Exide’s sales growth and profitability.
Industrial segment slowdown. The slowdown in user segments, power, telecoms and railways, led to sluggish demand. Poor demand has lowered Exide’s pricing power in the industrial-battery segment, where it had been able to pass on price increases.
Change in estimates. We reduce our FY12e EBITDA margin for Exide, by 3%, partially set off by higher other income, thereby lowering our FY12e standalone EPS, by 3.8%.
Valuation and risks. We value the standalone business at one-year forward PE of 16x. We value Exide’s stake in ING Vysya Life Insurance at `12. Our target price is `149 (from `128). We retain our Hold. Risks: Upside: recovery in industrial demand, lower lead prices. Downside: auto demand slowdown, delayed capex, industrial demand and pricing power being further lowered.
22 February 2011 Exide Industries – Industrial slowdown impact; maintain Hold
Anand Rathi Research 48
Investment Argument and Valuation Its industry dominance and backward integration measures are long-running positives for Exide Industries. However, the slowdown in industrial demand and hence lower pricing power, short-term capacity constraints and fair valuations lead us to re-iterate our Hold rating.
4QFY11 to be subdued
Exide is expected to temper the rise in lead prices by increased in-house sourcing of the raw material from its lead smelters. The commissioning of its automobile-battery capacities, in Apr ’11, would help it address replacement demand, which is now inadequately serviced. However, in 4Q, weaker demand for industrial batteries and continuing capacity constraints in its automobile-battery division are likely to temper Exide’s sales growth and profitability.
Moreover, delayed recovery in industrial demand would lead to further lowering of our FY12 estimates.
Industrial-batteries division slowdown
The industrials segment, encompassing power, telecoms, railways, is seeing sluggish demand due to a slowdown in user segments. Additionally, poor demand has lessened Exide’s pricing power in a segment where, in the past, it had been able to pass on price increases.
The slowdown, which commenced in telecoms, has been more widespread in 3Q, as it affected demand for power inverters.
Replacement demand, key trigger in the automobile-battery division
The automobile OEM sector would register lower growth ahead, but the good 14% CAGR in auto volumes from FY02 to FY11 has generated high potential for replacement demand. Moreover, the high-volume Nano is a potential trigger when production accelerates. The completion of Exide’s capex in 1QFY12 would address replacement demand, which is now inadequately serviced due to higher demand from OEMs.
Valuations
We value Exide’s standalone business at one-year forward standalone PE of 16x (average of the past two years’ one-year-forward PE; the past six years average is 15x). We value Exide’s stake in ING Vysya Life Insurance at `12. Our new target price is `149 (from `128). We retain our Hold rating.
Upside risks
A faster-than-anticipated recovery in demand in Exide’s industrial-battery division.
Lower lead prices.
Downside risks
A lower economic interest in the insurance business would lower Exide’s target price to that extent.
Imports are a significant threat to Indian battery manufacturers. Exide has strong brand equity and products at various prices. Hence, its OEM-segment share is unlikely to be hit. However, imports could
22 February 2011 Exide Industries – Industrial slowdown impact; maintain Hold
Anand Rathi Research 49
impact its replacement-market sales.
Delayed capex.
Industrial demand and pricing power being further lowered.
22 February 2011 Exide Industries – Industrial slowdown impact; maintain Hold
Anand Rathi Research 50
4QFY11 to be subdued In 4Q, weaker demand in Exide’s industrial-battery division and continuing capacity constraints in its automobile-battery division are likely to temper its sales growth and profitability. Moreover, recovery in industrial demand, if delayed, would lead to a lowering of FY12 estimates.
3Q performance reflected industrial slowdown and lower replacement demand
Exide’s 3QFY11 sales rose only 15% yoy to `10.5bn, due to capacity constraints in its automobile-battery division and weaker performance in its industrial-battery division. Its EBITDA margin slid 800bps yoy to 14.7%. The company says this was chiefly due to: i) more OEM sales, diverting capacity from the replacement segment; ii) lack of buoyancy in the industrials segment; iii) high commodity prices – lead prices rose 18.4% qoq and 4% yoy; and iv) cautiousness in passing on costs in the replacement market.
Exide’s adjusted profit declined 1.5% yoy to `1.2bn; this was lower than its EBITDA decline owing to considerably low interest costs and significantly higher other income.
Demand not being serviced
OE demand is buoyant and Exide is a strong player with OE relationships built over the years; this could also have a reverse effect. In 3QFY11, Exide looked to supply more to OEMs in order to maintain this relationship.
Hence, the OE to replacement (& trade) ratio has been adverse in 3QFY11. For the past four or five years, the replacement-OE ratio was 1.4:1 or 1.45:1. In the downturn, when OE sales crashed, the ratio went to 1.6:1. In FY10, it was 1.61:1; the FY11 target was 1.65:1. In 1QFY11, this went to 1.32:1, while in 3QFY11, this was further lower at 1.17:1. Although the ratio has grown increasingly adverse, the two-year target is 1.75:1.
Exide is expected to temper the rise in lead prices by increased in-house sourcing of the raw material from its lead smelters. Its commissioning of capacities in its automobile-battery division, in Apr ’11, would help it address replacement demand, which is now inadequately serviced. However, in 4Q, weaker demand for industrial batteries and continuing capacity constraints in its automobile-battery division are likely to temper its sales growth and profitability. Moreover, recovery in industrial demand, if delayed, would lead to a lowering of FY12 estimates.
22 February 2011 Exide Industries – Industrial slowdown impact; maintain Hold
Anand Rathi Research 51
Fig 7 – Exide: EBITDA margin trend
14.7
21.7
22.420.8
22.725.823.1
18.5
16.817.417.5
1,000
1,400
1,800
2,200
2,600
3,000
1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q
FY09 FY10 FY11
13
16
19
22
25
28
EBITDA As a % of Sales (RHS)
(`m) (%)
Source: Company
22 February 2011 Exide Industries – Industrial slowdown impact; maintain Hold
Anand Rathi Research 52
Industrial segment slowdown The industrials segment, encompassing power, telecoms, railways, is seeing sluggish demand due to a slowdown in user segments. Additionally, poor demand has lessened Exide’s pricing power in a segment where, in the past, it had been able to pass on price increases.
Exide is strongly represented in industrial batteries, with a 55% market share. This division (batteries for industry) brings in about 35-40% of its revenue.
The industrial division, manufacturing batteries for power equipment, telecoms, the railways, etc., has seen lower demand due to sluggish telecom demand, higher power generation leading to lower requirement of inverters, and lower pricing power due to the lower demand.
Unlike in the OEM battery segment, Exide has higher pricing power in the industrial-battery segment. It would frequently hike prices of batteries for the industrial segment, particularly for inverters and UPS. Its pricing power in this segment helped it sustain profitability even when other auto-parts companies started feeling their profitability pinch. In the present context, though, this is no longer true. Hence, the scope for greater profitability stands substantially reduced.
Commodity price risk escalates
The cost of lead comprises 70% of raw material cost for batteries. Lead prices corrected off their peak of US$3,800 a ton in 3QFY08 to less than half that, at US$1,500 in 1QFY10. Subsequently, it has steadily risen to ~US$2,500 a ton. Weak industrial demand raises concerns since Exide would not be able to pass on lead price increases.
Fig 8 – Lead prices (Apr ’06-Feb ’11)
800
1,300
1,800
2,300
2,800
3,300
3,800
Apr-0
6
Jul-0
6
Oct
-06
Jan-
07
Apr-0
7
Jul-0
7
Oct
-07
Jan-
08
Apr-0
8
Jul-0
8
Oct
-08
Jan-
09
Apr-0
9
Jul-0
9
Oct
-09
Jan-
10
Apr-1
0
Jul-1
0
Oct
-10
Jan-
11
LME cash
($/tonne)
Source: LME
22 February 2011 Exide Industries – Industrial slowdown impact; maintain Hold
Anand Rathi Research 53
Fig 9 – Exide: Raw material costs-to-sales trend
65.5
60.1
58.0
55.1
58.3
61.6
63.7
65.667.4
60.0 59.4
4,000
4,600
5,200
5,800
6,400
7,000
7,600
8,200
1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q
FY09 FY10 FY11
54
56
58
60
62
64
66
68
Raw-material As a % of Sales (RHS)
(`m) (%)
Source: Company, Anand Rathi Research
22 February 2011 Exide Industries – Industrial slowdown impact; maintain Hold
Anand Rathi Research 54
Replacement-demand recovery, the key The good 14% CAGR in automobile volumes from FY02 to FY11 has generated high potential for replacement demand. Completion of Exide’s capex in 1QFY12 would help it address replacement demand, which is now inadequately serviced due to higher supply pressure from OEMs.
Exide dominates the car-battery market, with a ~50% share, and is the leader in the organised sector for replacement batteries. Being a market leader, it is ensured steady volume growth, offsetting lower margins in OEM sales through greater economies of scale. Further, its well-established connection with OEMs helps brand-building and goodwill, boosting replacement-market sales and offering greater pricing power than the competition. Implementation of the more stringent norms pertaining to recycling of used batteries is another positive trigger. This would reduce the number of unorganised players in the replacement market.
The auto OEM segment would register relatively lower growth ahead, but the good 14% CAGR in auto volumes from FY02 to FY11 has generated great potential in replacement demand. Moreover, the high-volume Nano is a potential trigger ahead when production accelerates. Completion of Exide’s capex in 1QFY12 would help it address the replacement demand, which is now inadequately serviced due to higher supply pressure from OEMs.
Further, Exide would benefit from the 13.7% CAGR expected in auto OEM sales growth over FY11-13e.
Fig 10 – Auto OEM growth expected
-
5,000
10,000
15,000
20,000
25,000
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
e
FY12
e
FY13
e
-5
0
5
10
15
20
25
30
Total Auto volumes yoy change (RHS)
(000' Nos.) (%)
Source: SIAM, Anand Rathi Research
22 February 2011 Exide Industries – Industrial slowdown impact; maintain Hold
Anand Rathi Research 55
Financials We expect a 24.5% CAGR in Exide’s revenue from FY11 to FY13e, with a steady EBITDA margin of 18.6% and a 19.5% CAGR in adjusted net profit.
We expect a 24.5% CAGR in Exide’s revenue, based on assumptions of timely completion of capex and better industrial demand in the next 2-3 years (than in 2HFY11).
However, we lower our estimates to factor in more pressure from a further rise in the price of lead, short-term reduced supply to the auto replacement segment and lower demand and pricing power in the industrial-battery division.
We also factor in higher other income on the back of an increase in dividend from subsidiaries (Leadage Alloys and Chloride Metals). Our revised EBITDA margin expectation is 18% for FY12e (3% lower). The net impact on our FY12e standalone EPS estimate is 3.8% lower.
The expected volatility in commodity prices would only be partially neutralized by Exide’s backward integration step of purchasing lead smelters. We expect a 19.5% CAGR in adjusted net profit (standalone) from FY11 to FY13e.
Fig 15 – Cash flow statement Y/E MARCH FY09 FY10 FY11e FY12e FY13eOP/(Loss) before Tax 5,311 7,903 7,560 9,649 11,935Depreciation & Amortisation 679 807 818 937 1,025Direct Taxes Paid -1,577 -2,557 -2,583 -3,228 -4,226(Inc)/Dec in Working Capital 808 -945 -821 -2,351 -1,382Other Items -123 5,123 0 0 0CF from Oper. Activity 5,098 10,330 4,975 5,007 7,352Extra-ordinary Items -543 221 576 0 0CF after EO Items 4,555 10,551 5,551 5,007 7,352(Inc)/Dec in FA+CWIP -1,515 -1,098 -3,750 -2,500 -1,000(Pur)/Sale of Invest. -1,499 -6,672 -1,000 -2,500 -2,500CF from Inv. Activity -3,014 -7,770 -4,750 -5,000 -3,500Issue of Shares 0 50 0 0 0Inc/(Dec) in Debt -326 -2,272 0 0 0Interest Rec./(Paid) -414 -18 838 849 871Dividends Paid -480 -850 -1,063 -1,275 -1,488CF from Fin. Activity -1,221 -3,089 -224 -426 -617Inc/(Dec) in Cash 320 -308 577 -419 3,235Add: Beginning Balance 17 337 29 605 186Closing Balance 337 29 605 186 3,421
Source: Company, Anand Rathi Research
Anand Rathi Financial Services Limited does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Disclosures and analyst certifications are located in Appendix 1 Anand Rathi Research India Equities
India I Equities
Key financials Year end 31 March FY09 FY10 FY11e FY12e FY13e
Sales (`m) 33,211 35,429 45,187 55,972 66,722
Net profit (`m) 1,238 2,480 3,719 4,604 5,686
Diluted EPS (`) 5.3 10.5 15.8 19.6 24.2
Growth (%) -66.1 100.4 50.0 23.8 23.5
PE (x) 22.3 11.1 7.4 6.0 4.9
PBV (x) 0.5 0.5 0.5 0.4 0.4
RoE (%) 3.8 5.4 7.4 8.3 9.2
RoCE (%) 5.1 7.0 9.6 11.1 12.7
Dividend yield (%) 0.5 1.0 0.8 0.9 1.1
Net gearing (%) 48.5 38.9 36.7 34.3 32.4
Source: Company, Anand Rathi Research Prices as on 18 February 2011
Auto Components
Update
22 February 2011
Amtek Auto
Better times ahead; maintain Buy
We expect Amtek Auto to benefit from sustained auto demand locally and the nascent global recovery, along with market-share gains overseas. Its completed organizational restructuring and near completion of its non-auto capex are added positives. We trim our target price from `254 to `225, while maintaining a Buy.
Improvement in demand. Domestic auto demand has entered a steady growth mode, which would continue to provide a firm base for Amtek’s future operations. As demand in overseas auto markets recovers, Amtek’s sales volumes would further improve due to new orders, raising its market-share. Better operating leverage in its overseas subsidiaries would boost its profitability.
Non-auto capex nearing completion. Amtek Auto’s non-auto capex is nearing completion, thereby significantly raising its revenue potential. Further, on the successful completion of the open offer, Amtek India is now close to being a subsidiary. This has led to all forgings and castings units being brought under the ‘Amtek Auto’ umbrella. We expect this to result in better integrated operations, clearer efficiencies in sourcing and negotiations, and greater transparency in operations.
Valuation and risks. We cut our target price from `254 to `225 (10x FY12e EPS, and `29 as value of 38% stake in Amtek India). Risks: slower-than-expected demand ramp-up in Europe, unfavourable currency fluctuations and commodity-cost increases.
Rating: Buy Target Price: `225 Share Price: `117
Key data AMTK IN/AMTK.BO
52-week high/low `201/`106Sensex/Nifty 18211 / 54593-m average volume US$4.7m Market cap `25.4bn/US$0.56bn
22 February 2011 Amtek Auto – Better times ahead; maintain Buy
Anand Rathi Research 60
Investment Argument and Valuation We expect Amtek Auto to benefit from sustained auto demand locally and the nascent global recovery, along with market-share gains overseas. It’s completed organizational restructuring and near completion of its non-auto capex are added positives. We trim our target price to `225 and re-iterate our Buy on the stock.
Improvement in demand
Amtek is the only Indian company, and one of the select few globally, to have integrated component-manufacturing facilities in forgings, iron castings, aluminium castings, machining and sub-assemblies of auto and non-auto components. Domestic demand for automobiles has entered a secular growth mode, which would continue to provide a firm base for Amtek’s operations. In the next 2-3 years, as demand in overseas auto markets recovers, Amtek’s sales volumes would further improve due to its market-share gains.
Operating leverage at overseas subsidiaries
Amtek’s overseas subsidiaries are now recovering, benefiting from improved auto demand in Europe, new orders from OEMs there and ‘job work’ to boost revenues, especially in the German subsidiary. Improved operating leverage in its overseas subsidiaries would further boost Amtek’s profitability and help counter raw material cost increases. Non-auto capex, restructuring nearing completion
Amtek’s non-auto capex is nearly complete, thereby significantly increasing its revenue potential. This would enable it to compete for wagon demand (from Oct ’11), expected to be strong in India. Additional avenues being targeted are demand from Defence, aerospace, specialty vehicles, etc.
Further, on the successful completion of the open offer, Amtek India is now close to becoming a subsidiary. This has resulted in bringing all the forgings and castings units of all group companies under the ‘Amtek Auto’ umbrella. We expect this to lead to better integration of operations, clearer efficiencies in sourcing and negotiations, and greater transparency in operations.
Valuation
We cut our target price from `254 to `225 (10x FY12e EPS, and `29 as the value of 38% stake in Amtek India). We value Amtek Auto at 10x FY12e earnings, a 50% discount to the target PE multiple for Bharat Forge. Our current EPS estimate excludes Amtek India and takes into account the recent dilution and change in estimates. At the current market price, the stock trades at attractive valuations of 6x FY12e EPS.
Mounting demand would raise capacity utilization and prove the
key to Amtek’s operating performance improvement
22 February 2011 Amtek Auto – Better times ahead; maintain Buy
Anand Rathi Research 61
Risks
Slower-than-expected demand ramp-up in Europe and unfavourable currency fluctuations
Commodity cost increases
Corporate governance issues in the past.
22 February 2011 Amtek Auto – Better times ahead; maintain Buy
Anand Rathi Research 62
Improvement in demand Domestic auto demand has entered a secular growth mode, which would continue to provide a firm base for operations. In the next 2-3 years, as demand in overseas auto markets recovers, Amtek’s sales volumes would further improve due to its market-share gains
Amtek Auto is the only Indian company, and among a select few globally, to have integrated component-manufacturing facilities in forgings, iron castings, aluminium castings, machining and sub-assemblies of auto and non-auto components. Given its wide reach, at home and overseas, Amtek would benefit from economic growth in India as well as from the global recovery.
Steady growth ahead
The domestic automobile industry is on a good growth trajectory. The global auto-components market is seeing qoq improvement after bottoming out in CY09-10. Exports, which used to bring in a significant 22% of Amtek’s standalone revenue, had dipped to a low of just 3-4% in 2HFY09. The steady recovery overseas has seen this increase to ~8% of revenue now (on the higher base of robust domestic demand).
Fig 7 – Trend in Amtek Auto’s standalone exports
0100
200300
400
500
600
700
800
900
Q1F
Y09
Q2F
Y09
Q3F
Y09
Q4F
Y09
Q1F
Y10
Q2F
Y10
Q3F
Y10
Q4F
Y10
Q1F
Y11
Q2F
Y11
0
5
10
15
20
25
30
Standalone exports % of net sales (RHS)
(`m) (%)
Source : Company
Amtek would strongly benefit from this demand improvement, given its wide geographical reach. We expect a robust 37.9% CAGR (excl. the impact of the merger) in its (consolidated) profit over FY10-13. Similarly, its revenue growth would also be at a solid 23.5% CAGR over FY10-13e.
22 February 2011 Amtek Auto – Better times ahead; maintain Buy
Anand Rathi Research 63
Fig 8 – Net sales trend (FY06-12e)
24.027.5
6.7
-26.1
23.831.0
52.5
10,000
20,000
30,000
40,000
50,000
60,000
FY06
FY07
FY08
FY09
FY10
FY11
e
FY12
e
-40.0
-20.0
0.0
20.0
40.0
60.0
Net Sales yoy change (RHS)
(`m) (%)
Source: Company, Anand Rathi Research
Revenue breakup, region-wise
Europe: Amtek markets its products in Europe, exporting from the Indian parent and group companies, and through European subsidiaries. Products for Europe span the entire Amtek Auto and Amtek India range. Major customers are Jaguar, Land Rover, Ford, Audi, Mercedes, BMW, PSA and Renault.
US: Sales to the US used to be through a US subsidiary. The product range was relatively smaller: flexplates and ring-gear assemblies. To lower costs, production plants in the US were moved to India and now the entire product range is being manufactured in India.
India: The entire range of Amtek Auto and Amtek India products are marketed in India through the parent company and other group entities. Major customers are Maruti, M&M, Tata Motors, Chrysler and GM.
Fig 9 – Revenue breakup FY08 (segment-wise)
Passenger cars71% Commercial
Vehicles10%
2/3 wheelers8%
Tractors7%
Others4%
FY10 (segment-wise)
Passenger cars62%
Others11%
Tractors7%
2/3 wheelers9%
Commercial Vehicles
11%
FY09 (region-wise) US2%
Europe35%
India63%
FY10 (region-wise) US1% Europe
20%
India79%
Source: Company
22 February 2011 Amtek Auto – Better times ahead; maintain Buy
Anand Rathi Research 64
Fig 10 – Global customer base Segment Customer Base
Railways Indian Railways, Diesel Locomotive Works, Diesel Loco Modernisation Works, GE Transportation.
Other non-auto Briggs & Stratton, JCB, Ingersoll Rand, Kawasaki, the Knorr-Bremse Group, LG, Tecumseh.
Source : Company
With its integrated facilities across India, Europe and North America, Amtek Auto is poised to benefit from improving demand. It has 43 manufacturing locations (38 domestic, five overseas).
Amtek has made the most of low-cost manufacturing sites, giving it an edge over its global peers. Further, its JVs with international manufacturers offer opportunities for accelerated growth, not just in terms of a broader product range, but also rising internal demand (as would be seen in its joint venture with American Railcar, Inc.).
Amtek’s growth potential is highlighted by the following projections:
Two-year growth CAGR (FY11-13) in India: PVs 13% and two-wheelers 13.7%. FY02-11 PV growth CAGR was 16.8%; two-wheelers, 13%.2.
Indian auto-components sub-segment expected to increase to US$29.1bn in FY13 from US$21.1bn in FY10 (11% growth CAGR). FY05-10 growth CAGR was 21.1%.
Indian auto-components exports sub-segment expected to increase to US$8.6bn in FY13 from US$4.7bn in FY10 (22.8% growth CAGR). FY05-10 growth CAGR was 23.7%.
No customer accounts for more than 15% of revenues
22 February 2011 Amtek Auto – Better times ahead; maintain Buy
Anand Rathi Research 65
Overseas’ operating leverage Improved operating leverage in its overseas subsidiaries would further boost Amtek’s profitability and help offset raw material cost increases. Its average capacity utilization has risen through FY10 to 2QFY11.
Amtek’s overseas subsidiaries are now recovering, benefiting from rising automobile demand in Europe, fresh orders from OEMs there and taking up job work to boost revenues, especially in its German subsidiary, Amtek Deutschland. Improved operating leverage in its overseas subsidiaries would further boost profitability and help offset raw material cost increases.
Improved operating leverage
Its UK operations are showing the biggest sign of improvement as a result of increased volumes from Amtek’s largest customers. The robust increase in sales in the UK is being driven by the above-market performance of Amtek’s customers. Moreover, the restructuring of overseas operations has been completed and Amtek would benefit from sustained higher margins in these markets.
The European market lagged that of the UK; also, currency movements in Europe were unfavourable. Overall, the European operations have secured fresh orders in 1Q and are expected to see higher capacity utilisation in FY12.
Its US order book has been transferred to India, from where products are being exported to Amtek’s North American distribution centres, resulting in a significant increase in profitability.
22 February 2011 Amtek Auto – Better times ahead; maintain Buy
Anand Rathi Research 66
Non-auto capex, restructuring nearing completion Amtek’s non-auto capex is nearly complete, thereby significantly increasing its revenue potential. Further, the open offer for Amtek India has been successfully completed. We expect this to lead to better integration of operations, clearer efficiencies in sourcing and negotiations, and greater transparency in operations.
Non-auto capex Amtek’s non-auto capex is nearing completion, thereby significantly increasing its revenue potential. This would enable it to compete for wagon demand, which is expected to be strong in India. Additional avenues being targeted are Defence, aerospace, specialty vehicles, etc.
Amtek is sharpening its focus on the non-auto segment, the share of which is targeted to be raised from 18% to 25% in the current upswing.
Amtek’s non-auto strategy includes:
Increase in Defence-related sales, focused on Defence markets in India and South Africa. (~US$30bn has been earmarked to upgrade the Indian army). Opportunities abound in ammunition shell forgings, armoured vehicles, and upgrading military tanks.
Railcars to significantly contribute, with increase in sales revenue. Wagon manufacturing would contribute US$400m to sales in the JV over four years (Amtek’s share is 50%). American Railcar would provide technical expertise. Targeting the Indian Railways and the Middle East markets.
Railcar-components business to grow significantly in the next four years.
New ventures of specialty vehicles to address increasing demand.
Aerospace to be developed in future.
Restructuring The open offer for Amtek India has been successfully completed. After the last stage of restructuring, Amtek India is likely to be made a subsidiary of Amtek Auto, by Mar ’11. This has resulted in bringing all the forgings and castings units under the ‘Amtek Auto’ umbrella. We expect this to lead to better integration of operations, clearer efficiencies in sourcing and negotiations, and greater transparency in operations.
Rationale for the Amtek India open offer:
Simplifying the group structure,
Achieving greater economies of scale,
Improving fund allocation across business units, and
Strengthening the balance sheet.
22 February 2011 Amtek Auto – Better times ahead; maintain Buy
Anand Rathi Research 67
Financials We expect a 23.5% CAGR in Amtek’s revenues over FY10-13 (with the EBITDA margin improving from 21.8% to 23.1%) and a 31.9% CAGR in adjusted net profit.
We expect a 23.5% CAGR in Amtek’s revenue over FY10-13e, following a 130bps better EBITDA margin owing to lower raw material costs, a more favourable product mix (towards machined products), greater capacity utilization and a larger share of non-automotive products. We expect a 31.9% CAGR in adjusted net profit over FY10-13.
Its robust financial performance leads us to expect Amtek’s RoCE would improve, from a low 7% in FY10 to 12.7% three years later.
Fig 12 – AAL: standalone and consolidated EBITDA margins (FY04-12e)
22 February 2011 Amtek Auto – Better times ahead; maintain Buy
Anand Rathi Research 68
Change in estimates We raise our estimates to factor in a faster-than-expected recovery in Amtek’s overseas business, reflected in better operating leverage, benefits of cost restructuring and new orders overseas. We raise our EBITDA margin estimate for FY12, by 290bps, and factor in higher depreciation, interest expense and minority interest. The net effect on our FY12 profit estimate is to raise it by 2.8%.
Fig 21 – Associate performance trend: Amtek India Income Statement
Year end Jun (`m) FY08 FY09 FY10 1QFY11 2QFY11
Net Sales 10,673 8,094 9,814 10,362 11,097
Change (%) 16.5 -24.2 21.2 32.1 27.9
Operating Other Income 0 0 0 0 0
Total Income 10,673 8,094 9,814 10,362 11,097
Expenditure 8,030 6,332 7,459 7,921 8,537
EBITDA 2,643 1,762 2,355 2,442 2,560
Change (%) 21.1 -33.3 33.6 62.0 43.1
% of Net Sales 24.8 21.8 24.0 23.6 23.1
Depreciation 540 706 962 825 810
EBIT 2,103 1,056 1,393 1,617 1,750
Deferred Revenue Exp. 0 0 0 0 0
Interest & Finance Charges 306 442 830 546 648
Other Income 361 216 551 366 387
Non-recurring Expense 66 0 0 0 0
Non-recurring Income 2,220 0 0 0 0
PBT 4,312 830 1,113 1,437 1,489
Tax 783 248 326 395 421
Effective Rate (%) 18.2 29.9 29.3 27.5 28.3
Rep. PAT 3,529 582 787 1,041 1,067
Change (%) 173.8 -83.5 35.2 125.4 63.7
Adj. PAT 1,374 582 787 NA NA
Change (%) 6.7 (57.6) 35.2 NA NA
Adj. PAT (After MI) 1,374 582 787 917 932
Change (%) 6.7 (57.6) 35.2 126.3 59.8
Source: Company, Anand Rathi Research
Anand Rathi Financial Services Limited does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Disclosures and analyst certifications are located in Appendix 1 Anand Rathi Research India Equities
India I Equities
Key financials Year end 31 Mar FY09 FY10 FY11e FY12e FY13e
Sales (`m) 13,177 14,652 17,388 20,596 24,184
Net profit (`m) 947 1,590 1,470 1,793 2,213
Diluted EPS (`) 11.1 18.6 17.2 21.0 25.9
Growth (%) -33.1 67.8 -7.5 22.0 23.4
PE (x) 14.8 8.8 9.5 7.8 6.3
PBV (x) 3.5 2.6 2.1 1.7 1.4
RoE (%) 19.8 30.7 22.6 22.3 22.3
RoCE (%) 22.8 38.0 27.6 29.0 30.3
Dividend yield (%) 0.5 1.8 2.4 2.2 2.4
Net gearing (%) 40.8 23.7 23.6 24.4 18.0
Source: Company, Anand Rathi Research Prices as on 18 February 2011
We expect the structural soundness of Amara Raja Batteries’ business to play out over the long term and, hence, help it out-perform its peers. Even though short-term concerns persist regarding the rise in commodity prices and lower industrial demand, we yet maintain our Buy recommendation.
Branding is key. Amara Raja is India’s second-largest battery maker in the regulated sector and has made its mark via branding, strong retail network and entry into the two-wheeler segment.
Healthy automotive demand. ARB operates in the auto replacement market and caters to some OEMs as well. With the strong automotive demand expected, a 13.7% CAGR over FY11-13e, we expect good growth in ARB’s automotive battery sales.
Industrials, a key segment. Notwithstanding the present industrial slowdown, we expect the segment to recover from the current lows in the medium to long term and drive demand in the long term. Being a significant revenue contributor for ARB, industrial demand recovery in FY12 would be a major positive.
Valuation and risks. We value ARB at 10x FY12e EPS (a 40% discount to the target multiple for market leader Exide Industries). At the ruling market price, the stock trades at 9.5x FY11e and 7.8x FY12e earnings. Risks: Delayed industrial demand recovery, further increase in the price of lead.
Rating: Buy Target Price: `210 Share Price: `165
Key data AMRJ IN/AMAR.BO
52-week high/low `228/`140Sensex/Nifty 18212 / 54593-m average volume US$0.7m Market cap `14.04bn/US$313m
22 February 2011 Amara Raja Batteries – Short-term concerns, positive potential; maintain Buy
Anand Rathi Research 76
Investment Argument and Valuation Even though short-term concerns regarding higher commodity prices and lower industrial demand persist, we expect the structural soundness of Amara Raja Batteries’ business to play out in the long term and result in it outperforming its peers. We maintain our Buy recommendation.
Branding, the key Amara Raja Batteries is India’s second-largest battery manufacturer in the regulated sector. It has made its mark through branding, a strong retail network and entry into the two-wheeler segment.
It has been steadily expanding its “after-sales” retail network, which now comprises more than 200 franchisees and over 18,000 active retailers. A wider retail network would assist in further penetration in the replacement market.
Good automotive demand Amara Raja largely operates in the auto-replacement market and caters to some OEMs. With good automotive demand expected (a 13% CAGR over FY10-13e), we expect good growth in ARB’s battery sales.
Further, the strong 9.3% CAGR in auto volumes over FY02-09 could generate high replacement demand. This would continue to fuel replacement demand.
Industrials, a key segment Notwithstanding the current industrial slowdown, we expect the segment to recover in the medium to long term and thereby drive demand over this period. Being a significant revenue contributor for ARB, industrial demand recovery in FY12 would be a major positive.
The segment is crucial as it accounts for 40% of sales, by value, of the Indian storage-battery market. This segment registered a 25% CAGR in the past four years. VRLA (valve-regulated lead-acid) batteries constitute 60% of the industrial storage-battery market in India. The medium-VRLA segment accounts for the biggest sub-segment, growing 30% historically. Highly fragmented, the industrial battery segment's biggest consumers consist of telecoms, IT and ITeS, BFSI and companies/organizations.
Valuation We value Amara Raja Batteries at 10x FY12e EPS (a 40% discount to the target multiple for market leader Exide Industries). At the ruling market price, the stock trades at 9.5x FY11e and 7.8x FY12e earnings.
Risks
The battery-replacement market in India has not yet matured to a situation where batteries are picked up off the shelf. Hence, the retail focus of ARB may see hurdles to growth.
A slower-than-anticipated growth in OEM production and lukewarm demand for the Nano would lessen demand potential from the automobile segment.
ARB has focussed on branding and retail network expansion
22 February 2011 Amara Raja Batteries – Short-term concerns, positive potential; maintain Buy
Anand Rathi Research 77
Imports constitute a significant threat to Indian battery manufacturers. Imports could whittle down sales in the replacement market.
Continuing lower demand from the industrial segment would be an added concern.
Higher lead prices even from current levels would threaten profitability.
Fig 7 – Lead prices (Apr ’06-Feb ’11)
800
1,300
1,800
2,300
2,800
3,300
3,800
Apr-0
6
Jul-0
6
Oct
-06
Jan-
07
Apr-0
7
Jul-0
7
Oct
-07
Jan-
08
Apr-0
8
Jul-0
8
Oct
-08
Jan-
09
Apr-0
9
Jul-0
9
Oct
-09
Jan-
10
Apr-1
0
Jul-1
0
Oct
-10
Jan-
11
LME cash
($/tonne)
Source: LME
22 February 2011 Amara Raja Batteries – Short-term concerns, positive potential; maintain Buy
Anand Rathi Research 78
Expanding retail network Amara Raja Batteries is India’s second-largest battery manufacturer in the organised sector. It has made its mark through branding, a strong retail network and entry in the two-wheeler segment. A wider retail network would assist in further penetration into the replacement market.
ARB has been steadily expanding its “after-sales” retail network, which now comprises more than 200 franchisees and over 18,000 active retailers. A wider retail network would assist in deeper penetration into the replacement market.
To boost volumes and improve market share in the higher-margin replacement market, the company has conceptualized retail outlets called ‘PowerZones’, to be set up in rural and semi-urban areas.
Key initiatives by ARB in this respect
1. A network of 18,000 active retailers has given ARB a touch point in urban India at almost every 5km.
2. ARB has also pioneered the concept of Amaron Pitstop and PowerZone, of which it has ~150 and 700 outlets, respectively, to provide a unique shopping experience in urban and rural regions.
3. Another of its innovations is the introduction of unconventional distribution channels – small shopkeepers, telephone-booth operators, auto-mechanics and lube sellers.
4. ARB has widened its reach through the ‘70 Aqua’ distribution network, which caters to replacement demand in industrial batteries.
5. ARB’s batteries are now used by more than 10m consumers. There are 175,000 live battery banks, providing uninterrupted backup power for various critical applications.
Fig 8 – Installed capacity
0
2
3
5
6
8
9
11
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
(m nos)
Source: Company
Fig 9 – EBITDA and sales volume growth
0
500
1,000
1,500
2,000
2,500
3,000
3,500
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
0
20
40
60
80
EBITDA Sales Volume Growth (RHS)
(`m) (%)
Source: Company
22 February 2011 Amara Raja Batteries – Short-term concerns, positive potential; maintain Buy
Anand Rathi Research 79
High auto-replacement potential ARB operates in the auto replacement market and caters to some OEMs. With good automotive demand expected (a 13.7% CAGR over FY11-13e), we anticipate good growth in ARB’s battery sales.
Further, the strong 14% CAGR in auto volumes over FY02-11 would generate high replacement demand. This would further fuel replacement demand.
Fig 10 – Auto OEM growth expected
0
5,000,000
10,000,000
15,000,000
20,000,000
25,000,000
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
e
FY12
e
FY13
e
-5.0
0.0
5.0
10.0
15.0
20.0
25.0
30.0
Total Auto volumes yoy change (RHS)
(Nos.) (%)
Source: SIAM, Anand Rathi Research
Although ARB’s OE market share is relatively lower, anticipated growth in this segment is a positive for it from the point of view of greater demand and increased replacement-demand potential.
Entry into the two-wheeler sub-segment
In May ’08, ARB launched VLRA batteries in the two-wheeler sub-segment. VLRA technology is normally used in luxury cars. The entry into the two-wheeler segment with a good product and adequate installed capacity could help penetration there. ARB manufactures VLRA batteries with technology from its JV partner Johnson Controls, Inc.
In addition to the traditional segments, the regulated replacement-battery market growth is fueled by the greater popularity of the high-end two-wheelers and new users of non-gear scooters from urban and semi-urban women. The increasing shift from kick-start to self-start bikes also increases the importance of battery technology.
22 February 2011 Amara Raja Batteries – Short-term concerns, positive potential; maintain Buy
Anand Rathi Research 80
Industrials, a key segment Notwithstanding the current industrial slowdown, we expect the segment to recover from the lows in the medium to long term and drive demand over this period. Being a significant revenue contributor for ARB, industrial demand recovery over FY12 would be a major positive.
The high exposure of ARB to the telecom batteries segment (~30% of revenues) and ~17-18% from the inverter segment make it vulnerable to the current slowdown in demand there. However, we expect the segment to recover from the recent lows and to grow at a good clip ahead. Fundamental factors would continue to drive growth in the industrials segment.
The segment is crucial as it accounts for 40% of sales, by value, of the Indian storage-battery market. This segment registered a 25% CAGR in the past four years. VRLA batteries constitutes 60% of the industrial storage-battery market in India. The medium VRLA segment accounts for the biggest sub-segment, growing 30% annually, historically. Highly fragmented, the industrial battery segment's biggest consumers comprise telecoms, IT and ITeS, BFSI and companies/organizations.
The key growth recovery factors are :
1. Replacement demand from telecoms-tower batteries
2. Entry of new players and introduction of new services (3G) in the telecoms sector
3. Increasing computerisation, especially among government agencies
4. Demand from IT, ITeS, and BFSI sectors
5. Rising automation across business enterprises
6. Power deficit, enhancing the need for back-up batteries in critical equipment and processes
7. Part of the telecoms capacity to be utilized to support the UPS business
ARB’s strength in the segment is that it is the preferred vendor among domestic utilities, government agencies, multi-nationals and domestic telecoms service providers. The company plans to strengthen its presence in high-growth sectors and create products for specific user segments.
22 February 2011 Amara Raja Batteries – Short-term concerns, positive potential; maintain Buy
Anand Rathi Research 81
Financials We expect a 17.9% CAGR in Amara Raja’s revenue over FY11-13–with the EBITDA margin improving from 14.8% to 15.6%–and a 22.7% CAGR in adjusted net profit.
From FY11 to FY13 we expect a 17.9% CAGR in ARB’s revenue, with the EBITDA margin improving from a low 14.8% to 15.6%. The expected volatility in commodity prices would be countered by ARB’s increasing presence in the industrials segment and greater “replacement”-market share. The volatility in lead price can impact ARB’s EBITDA margin either way, since it does not have the fall-back of backward integration like Exide Industries. We expect a 22.7% CAGR in adjusted net profit from FY11 to FY13e.
To support growth, ARB would aggressively expand its capacity: four-wheeler batteries from 4.2m to 6m, and two-wheeler batteries from 1.8m to 5m.
Fig 11 – Amara Raja’s sales and net profit growth (FY04-12)
0
5,000
10,000
15,000
20,000
25,000
FY04
FY05
FY06
FY07
FY08
FY09
FY10
e
FY11
e
FY12
e0
400
800
1,200
1,600
2,000
Sales PAT (RHS)
(`m) (`m)
Source: Company, Anand Rathi Research
Despite the ongoing capex and the decline in profitability in FY11, ARB has maintained healthy return ratios of over 20%.
Fig 12 – Amara Raja’s RoE, RoCE and asset turnover (FY04-12e)
0
5
10
15
20
25
30
35
40
FY04
FY05
FY06
FY07
FY08
FY09
FY10
e
FY11
e
FY12
e
0.5
1.0
1.5
2.0
2.5
RoE RoCE Asset Turnover (RHS)
(%) (x)
Source: Company, Anand Rathi Research
22 February 2011 Amara Raja Batteries – Short-term concerns, positive potential; maintain Buy
Anand Rathi Research 82
Change in estimates We lower our estimates to factor in the short-term concerns regarding commodity price increases and lower demand for industrial batteries. We trim our EBITDA margin estimate for FY12, by 300bps, and factor in higher raw material and employee costs. We also cut our FY12 profit estimates, by 12.9%.
The cost of lead works out to 70% of raw material cost of batteries. The price of lead has corrected off its peak of US$3,850 a ton in 4QFY08 to less than half that, at US$1,500 in 1QFY10. Subsequently, though, it has bounced back to US$2,500 now, thereby eating into margins in FY11.
Fig 14 – EBITDA margin
7.7
14.213.0
18.0
23.422.5
19.6
16.113.9 14.5
15.6
200
300
400
500
600
700
800
1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q
FY09 FY10 FY11
6
10
14
18
22
26
EBITDA As a % of Sales (RHS)
(`m) (%)
Source: Company
Fig 15 – Raw material costs
72.8
68.166.5
61.0
56.458.0
60.0
64.2
66.6
63.8 64.5
1,000
1,500
2,000
2,500
3,000
1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q
FY09 FY10 FY11
54
58
62
66
70
74
Raw-material cost As a % of Sales (RHS)
(`m) (%)
Source: Company
22 February 2011 Amara Raja Batteries – Short-term concerns, positive potential; maintain Buy
Anand Rathi Research 83
Fig 16 – Income Statement Year end 31 Mar (`m) FY09 FY10 FY11e FY12e FY13e
Net Sales 13,177 14,652 17,388 20,596 24,184
Change (%) 21.6 11.2 18.7 18.5 17.4
Expenditure 11,291 11,779 14,807 17,488 20,413
EBITDA 1,886 2,873 2,581 3,109 3,771
Change (%) 19.6 52.3 -10.2 20.4 21.3
EBITDA Margin (%) 14.3 19.6 14.8 15.1 15.6
Depreciation 346 429 422 471 511
EBIT 1,541 2,444 2,159 2,637 3,260
Interest & Finance Charges 182 68 19 18 14
Other Income 81 50 50 50 50
Non-recurring Expense 212 0 2 0 0
Non-recurring Income 0 121 27 0 0
PBT 1,227 2,546 2,214 2,669 3,295
Tax 422 876 728 876 1,082
Effective Rate (%) 34.4 34.4 32.9 32.8 32.9
Rep. PAT 805 1,670 1,486 1,793 2,213
Change (%) -14.7 107.5 -11.0 20.7 23.4
Adj. PAT 947 1,590 1,470 1,793 2,213
Change (%) 0.4 67.8 -7.5 22.0 23.4
Source: Company, Anand Rathi Research
Fig 17 – Balance Sheet Year end 31 Mar (`m) FY09 FY10 FY11e FY12e FY13e
Sources of Funds
Share Capital 171 171 171 171 171
Reserves 3,885 5,266 6,398 7,874 9,742
Net Worth 4,056 5,436 6,569 8,045 9,913
Loans 2,859 912 1,012 812 612
Deferred Tax Liability 183 216 414 414 414
Capital Employed 7,097 6,565 7,995 9,271 10,939
Application of Funds
Gross Fixed Assets 4,271 4,911 5,638 6,138 6,638
Less: Depreciation 1,458 1,854 2,276 2,747 3,258
Net Fixed Assets 2,813 3,057 3,362 3,391 3,380
Capital WIP 396 227 0 0 0
Investments 471 161 461 761 1,061
Curr.Assets, L & Adv. 5,260 6,311 7,169 8,379 10,053
Inventory 1,608 2,176 2,573 3,386 3,975
Sundry Debtors 2,078 2,423 2,875 3,668 4,307
Cash & Bank Balances 703 625 634 238 684
Loans & Advances 870 1,087 1,087 1,087 1,087
Other Current Assets 0 0 0 0 0
Current Liab. & Prov. 1,843 3,191 2,997 3,260 3,555
Sundry Creditors 937 1,376 1,429 1,693 1,988
Other Liabilities 201 281 281 281 281
Provisions 705 1,534 1,287 1,287 1,287
Net Current Assets 3,417 3,120 4,172 5,119 6,498
Application of Funds 7,097 6,565 7,995 9,271 10,939
Source: Company, Anand Rathi Research
22 February 2011 Amara Raja Batteries – Short-term concerns, positive potential; maintain Buy
Anand Rathi Research 84
Fig 18 – Ratios @`165 Year end 31 Mar FY09 FY10 FY11e FY12e FY13e
Basic (`)
EPS 11.1 18.6 17.2 21.0 25.9
EPS Fully Diluted 11.1 18.6 17.2 21.0 25.9
Cash EPS 13.5 24.6 22.3 26.5 31.9
EPS Growth (%) -33.1 67.8 -7.5 22.0 23.4
Book Value per Share 47.5 63.7 76.9 94.2 116.1
DPS 0.8 2.9 4.0 3.5 3.9
Payout (Incl. Div. Tax) % 0.1 0.2 0.2 0.2 0.1
Valuation (x)
P/E 14.8 8.8 9.5 7.8 6.3
Cash P/E 12.2 6.7 7.3 6.2 5.1
EV/EBITDA 8.3 4.9 5.4 4.4 3.4
EV/Sales 1.2 1.0 0.8 0.7 0.5
Price to Book Value 3.5 2.6 2.1 1.7 1.4
Dividend Yield (%) 0.5 1.8 2.4 2.2 2.4
Profitability Ratios (%)
RoE 19.8 30.7 22.6 22.3 22.3
RoCE 22.8 38.0 27.6 29.0 30.3
Turnover Ratios
Asset Turnover (x) 1.9 2.2 2.2 2.2 2.2
Leverage Ratio
Debt/Equity (x) 0.7 0.2 0.2 0.1 0.1
Source: Company, Anand Rathi Research
Fig 19 – Cash flow statement Year end 31 Mar (`m) FY09 FY10 FY11e FY12e FY13e
OP/(Loss) before Tax 1,541 2,444 2,159 2,637 3,260
Interest/Dividends Received
Depreciation & Amortisation 346 429 422 471 511
Direct Taxes Paid -409 -842 -530 -876 -1,082
(Inc)/Dec in Working Capital 730 171 -1,059 -1,342 -934
Other Items -69 6 1 -15 -15
CF from Oper. Activity 2,138 2,208 993 876 1,740
Extra-ordinary Items -212 121 25 0 0
Other Items
CF after EO Items 1,926 2,328 1,017 876 1,740
(Inc)/Dec in FA+CWIP -1,009 -504 -500 -500 -500
(Pur)/Sale of Invest. -309 310 -300 -300 -300
CF from Inv. Activity -1,318 -194 -800 -800 -800
Issue of Shares 57 0 0 0 0
Inc/(Dec) in Debt -304 -1,947 100 -200 -200
Interest Rec./(Paid) -102 -18 30 31 35
Dividends Paid -68 -248 -338 -302 -330
CF from Fin. Activity -417 -2,213 -208 -471 -494
Inc/(Dec) in Cash 191 -78 9 -395 445
Add: Beginning Balance 511 703 625 634 238
Closing Balance 703 625 634 238 684
Source: Company, Anand Rathi Research
Anand Rathi Financial Services Limited does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Disclosures and analyst certifications are located in Appendix 1 Anand Rathi Research India Equities
India I Equities
Key financials
Year end 31 March FY09 FY10 FY11e FY12e FY13e
Sales (`m) 12,523 13,870 19,435 23,015 27,171
Net profit (`m) 700 2,069 1,798 1,601 2,116
EPS (`) 7.2 21.3 18.5 16.5 21.8
Growth (%) -32.9 195.5 -13.1 -10.9 32.1
PE (x) 17.6 6.0 6.9 7.7 5.8
PBV (x) 2.6 1.9 1.5 1.3 1.1
RoE (%) 15.0 31.3 21.7 16.4 18.0
RoCE (%) 14.6 28.0 20.0 15.0 16.2
Dividend yield (%) 0.9 1.1 1.0 0.9 1.1
Net gearing (%) 54.6 47.4 47.2 52.4 52.5
Source: Company, Anand Rathi Research Prices as on 18 February 2011
Auto Components
Initiating Coverage
22 February 2011
Balkrishna Industries
Good business model, rubber concerns; initiate with Hold
Balkrishna Industries focuses on agricultural tyres and the off-road sub-segment overseas. It typically enjoys higher margins than domestic peers. However, short-term capacity constraints and rising rubber prices have dampened its short- to medium-term outlook. We initiate coverage on BIL with a Hold recommendation.
Robust business model. Balkrishna mainly caters to the higher-margin segments–off-road vehicles and agricultural tyres. As it supplies heavier tyres mainly for export, it enjoys higher-than-industry margins.
Rubber is a concern. The escalating price of rubber is a concern for the entire tyre industry. While Balkrishna’s forward contracts at lower prices insure it from higher rubber prices in FY11, the impact cannot be avoided in FY12.
Peaking capacity. While demand for tyres is robust, BIL’s peaking capacity utilisation indicates that its revenue growth would be constrained in FY12.
Valuations and risks. We value the stock at `144 (8.25x FY12e standalone EPS of `16.5 and `8 as value of its paper business). At the CMP, the upside is not too compelling. We initiate coverage with a Hold. Upside risks: decline in rubber prices, faster-than-expected ramp-up in new capacities, and more-than-expected price increases. Downside risk: unfavourable currency movement.
22 February 2011 Balkrishna Industries – Good business model, rubber concerns; initiate with Hold
Anand Rathi Research 87
Investment Argument and Valuation Focussed on the agricultural-tyre and off-road sub-segments in the overseas market, Balkrishna Industries typically enjoys margins higher than its peers. However, short-term capacity constraints and rising rubber prices have dampened its short- to medium-term outlook. We initiate coverage on BIL with a Hold recommendation.
Robust business model
Balkrishna Industries mainly addresses the higher-margin tyre segments – off-road vehicles and agricultural tyres. As it supplies heavier tyres mainly for export, it enjoys higher-than-industry margins.
Fig 7 – Comparative EBITDA margins of tyre companies
0
5
10
15
20
25
30
FY05
FY06
FY07
FY08
FY09
FY10
FY11
e
BIL Apollo Tyres Ceat MRF
(%)
Source: Company, Anand Rathi Research.
Rubber is a concern
The escalating price of rubber is a concern for the entire tyre industry, Balkrishna included. While its forward contracts at lower prices insure it against higher rubber prices in FY11, the impact cannot be avoided in FY12.
High rubber prices are a function of a rise in international prices of rubber (due to abnormal weather conditions), a surge in demand backed by robust auto demand, an increase in the price of crude oil, and plateauing production at plantations.
Peaking capacity
While demand for tyres is robust, BIL’s peaking capacity utilisation indicates that its revenue growth would be constrained in FY12. For immediate additional capacity, it is undertaking de-bottlenecking. By Oct ’11, de-bottlenecking of 10,000 tons, at `2bn, would be complete. Of this, `600m-700m has already been incurred. By Mar ’11, an additional `200m-300m would have been incurred.
This de-bottlenecking involves adding equipment, increasing radial capacity, mixing capacity at Waluj, building a raw-material and finished-goods warehouse, and adding a press. The greenfield complex being set up at Bhuj would be completed only by 4QFY13.
Focus on exports; supply to the off-road & agricultural-tyre sub-
segments and successful hedging policy have helped Balkrishna register better-than-industry EBITDA
margins
22 February 2011 Balkrishna Industries – Good business model, rubber concerns; initiate with Hold
Anand Rathi Research 88
Valuations not too compelling
We value the stock at `144 (8.25x FY12e standalone EPS of `16.5 and `8 as the value of the paper business). Our target PE multiple is at a 15% discount to the five-year average PE multiple of 9.75x. We attribute this discount to escalating rubber prices. At the current market price, the upside is not too compelling. We initiate coverage on the stock, with a Hold rating.
Fig 8 – BIL EV/EBITDA Band
0
4
8
12
16
20
Apr-0
5
Nov
-05
Jun-
06
Jan-
07
Aug-
07
Mar
-08
Oct
-08
May
-09
Dec
-09
Jul-1
0
Feb-
11
Source: Company
Risks
Upside: Decline in rubber prices, faster-than-expected ramp-up in fresh capacities, and more-than-expected price increases.
Downside: Currency fluctuations.
22 February 2011 Balkrishna Industries – Good business model, rubber concerns; initiate with Hold
Anand Rathi Research 89
Robust business model Balkrishna Industries mainly addresses the higher-margin tyre segments—off-road vehicles and agricultural tyres. As it supplies heavier tyres mainly for export, it enjoys margins higher-than-industry peers.
Off-road, exports, key sub-segments
Balkrishna Industries is a leading manufacturer of a broad range of ‘off-road’ tyres in agriculture, construction, industrials, earthmovers and ATVs (all-terrain vehicles). It has three manufacturing plants and one die/tooling unit in Rajasthan and Maharashtra.
Products for which tyres are supplied vary from tractors, trailers and other farm equipment in agriculture to heavy earthmovers, compactors, graders, underground mining and backhoes in non-agriculture.
Demand drivers
Large farms in Europe have a high degree of mechanisation. Hence, agricultural-tyre requirement is higher, both from OEMs and in the replacement market.
Growth in the agricultural and mining sector in the Americas, coupled with the fast-growing South American economies.
Trend towards large farm equipment in America.
Growth in agriculture and infrastructure in Asia-Pacific and movement from traditional to larger equipment.
Growth in the off-road segment in India would be an additional demand driver. While India’s share of Balkrishna’s turnover is just 11%, on completion of its greenfield plant, Balkrishna would be in a position to further its penetration in India. To this end, it is tying up with new OEMs and establishing a distribution network.
Fig 9 – Revenue break-up by region
0
1,500
3,000
4,500
6,000
7,500
Euro
pe
Amer
ica
Asia
Indi
a
RoW
FY06 FY10
(`m)
Source: Company
Balkrishna has benefited from this demand
With a wide product range of 1,900 stock-keeping units (SKUs), Balkrishna is India’s leading exporter of off-highway tyres, and addresses markets in more than 120 countries in Europe, America, Asia-Pacific, the Middle East, etc. To cater to more markets, it has taken aggressive steps in
22 February 2011 Balkrishna Industries – Good business model, rubber concerns; initiate with Hold
Anand Rathi Research 90
the past five years:
Increasing achievable production capacity by ~2.5x from 48,750 tons to 120,000 tons, and setting up a third plant.
The markets being serviced increased from 75 to 120.
The number of distributors was increased from 120 to over 200.
The company has a range of over 1,800 types of tyres, from 5kg to 1,500kg. Thus, its product-mix is more versatile, but entails a longer turnaround time between products. Further, BIL’s product profile has 1,900 SKUs; daily, 1,200 SKUs are active. Also, typically, a mould is changed every three days; but this could go up to 30 days per mould. All sizes are manufactured at all plants.
User segments for BIL’s off-highway tyres:
Agriculture: Constituting ~70% of revenues, these include tyres for tractors, trailers, forestry, farm equipment, and specifically designed as per farm requirement. The agriculture segment also has more pricing power.
OTR: Constituting ~26% of revenues, these include industrial, construction, and earthmover tyres, for dump trucks, loaders, underground mines, and port applications.
Others: Constituting ~4% of revenues, these include tyres for sports and utility vehicles such as golf carts, lawn & garden tyres, and all-terrain-vehicle tyres.
Fig 10 – Sales breakup
Distributors75%
OEM15%
Off-take10%
Source: Company
Competitors
Global leaders like Bridgestone and Michelin manufacture off-highway tyres; off-road tyres comprise less than 5% of their revenues. However, their off-road tyre volumes are higher than BIL’s.
The Chinese are largely absent in the agri-segment, which has low volumes and great variety; hence, is not a volumes game. This is a positive for BIL.
BIL’s line of business is differentiated from other tyre manufacturers and is tough to replicate. BIL is the only Indian manufacturer that supplies off-road radials abroad.
In India, off-road tyre suppliers are local players such as Apollo Tyres. BIL does not supply extensively in the home market, but prefers to export. Capacity constraints do not allow it to tap the domestic market in the near term.
22 February 2011 Balkrishna Industries – Good business model, rubber concerns; initiate with Hold
Anand Rathi Research 91
Rubber is a concern The escalating price of rubber is a concern for the entire tyre industry, Balkrishna included. While, its forward contracts at lower prices insure it against higher rubber prices in FY11, the impact cannot be avoided in FY12.
RM prices scaling a new peak
Natural rubber, a key input, has been scaling new peaks. This, in turn, has translated into higher raw material costs for most tyre companies.
High rubber prices are a function of a rise in international prices of rubber (due to abnormal weather conditions), a surge in demand (backed by robust auto demand), an increase in the price of crude and plateauing production at plantations.
Fig 11 – Trend in rubber prices
5,500
8,500
11,500
14,500
17,500
20,500
23,500
Apr-0
5
Nov
-05
Jun-
06
Jan-
07
Aug-
07
Mar
-08
Oct
-08
May
-09
Dec
-09
Jul-1
0
Feb-
11
Domestic Rubber price
(`/quintal)
Source: Rubber Board of India
BIL, a short-term exception to higher rubber prices
Balkrishna booked natural rubber (NR) contracts at US$3,400/ton and synthetic rubber (SR) contracts at US$2,700/ton. These contracts would run till Mar ’11. Spot prices of NR are US$5,200 in India and US$6,200 internationally. Approximately 60% of BIL’s operating costs are raw material costs. If NR increases 10%, the company would need to raise prices 1-1.5%.
Fig 12 – Key raw-material composition, by volume (%)
Natural rubber32%
Carbon black27%
Synthetic rubber16%
Chemicals16%
Fabric6%
Bead wire3%
Source: Company
22 February 2011 Balkrishna Industries – Good business model, rubber concerns; initiate with Hold
Anand Rathi Research 92
In the past, imported rubber has been cheaper, by `20/kg, due to lower import duties. Recent trends in rubber prices, however, have been against the grain. The advance-license scheme availed of by BIL implies even lower costs. Advance licenses are given on export quantities; since 90% of BIL’s production is exported, the company benefits.
Transportation too constitutes a huge cost. Freight costs work out to 9-10% of revenue. Hence, the company has three-month contracts with shipping companies. In a month, it exports 900-1,000 containers. Imports comprise 40% of exports.
Benefits of the DEPB (duty-exempt passbook) scheme are received after exports; advance licenses are given before exporting. Though the net benefit in a stable raw-material price context is similar, in a fluctuating raw-material price context, the advance license proves beneficial.
A rubber plant takes seven years before it begins to produce rubber. In FY05-06, plantations saw an increase in the number of rubber saplings planted. The life of a rubber plant is 25 years. Supply constraints in natural rubber are expected to ease only by end-CY12.
Fig 13 – Comparative RM/sales and rubber price trend
5,040
9,040
13,040
17,040
21,040
25,040
1QFY
08
2QFY
08
3QFY
08
4QFY
08
1QFY
09
2QFY
09
3QFY
09
4QFY
09
1QFY
10
2QFY
10
3QFY
10
4QFY
10
1QFY
11
2QFY
11
3QFY
11
4QFY
11e
40
45
50
55
60
65
Rubber price RM/Sales (RHS)
(`/quintal) (%)
Source: Company, Anand Rathi Research
Fig 14 – Ratio of BIL's average rubber price to spot price
0.7
0.8
0.9
1
1.1
FY06
FY07
FY08
FY09
FY10
FY11
e
(x)
Source: Company, Anand Rathi Research
On average, BIL’s contracting policies have been very astute
22 February 2011 Balkrishna Industries – Good business model, rubber concerns; initiate with Hold
Anand Rathi Research 93
Peaking capacity While demand for tyres is robust, BIL’s peaking capacity utilisation indicates that its revenue growth would be constrained in FY12.
Greenfield capacity two years away
In the short term, Balkrishna would be faced with capacity constraints. Moreover, since various SKUs are involved in the production mix, 100% capacity utilisation is not possible.
While demand for tyres is robust, BIL’s peaking capacity utilisation indicates that its revenue growth would be constrained in FY12.
To gain some immediate additional capacity, the company is undertaking de-bottlenecking. By Oct ’11, de-bottlenecking of 10,000 tons, at `2bn, would be complete. Of this, `600m-700m has been incurred. By Mar ’11 an additional `200m-300m would have been incurred. The de-bottlenecking would improve achievable production capacity by 10,000 tons to 130,000 tons.
This de-bottlenecking involves adding equipment, increasing radial capacity, mixing capacity at Waluj, building a raw-material and finished-goods warehouse, and adding a press. Balkrishna is also setting up a greenfield complex at Bhuj, Gujarat. This would be ready only by 4QFY13, taking 16 months to ramp up to full capacity. It would have installed capacity of 120,000 tons and achievable capacity of 90,000 tons.
Fig 15 – Trend in BIL’s installed capacity
0
50,000
100,000
150,000
200,000
250,000
300,000
FY06
FY10
FY12
e
FY14
e
Installed capacity Achievable capacity
(MT
Source: Company
22 February 2011 Balkrishna Industries – Good business model, rubber concerns; initiate with Hold
Anand Rathi Research 94
Financials We expect BIL to register an 8.5% profit CAGR over FY11-13. We expect an 18.2% revenue CAGR (driven mainly by price hikes) and an EBITDA margin decline of 150bps.
Three major factors restricting Balkrishna’s revenue and profit expansion would be the surge in input costs, capacity constraints and the greenfield project at Bhuj, which would raise interest costs.
The de-bottlenecking is being carried out with internal accruals, while the greenfield project would be financed by external debt.
Balkrishna’s working capital cycle is 90 days. Its exports are on vanilla terms only. Debt drawal is in Jan ’11, but unlinked to project progress. The facility is available for six years, with a moratorium of three years. The rate would be LIBOR+3%. Considering the planned capex, the company does not plan to significantly increase dividend from the 10-15% current payout.
Under these assumptions, we expect BIL to register an 8.5% profit CAGR over FY11-13e. We expect an18.2% revenue CAGR (driven mainly by price hikes) and an EBITDA margin decline of 150bps.
Fig 16 – Revenue and profit trend – standalone
0
5,000
10,000
15,000
20,000
25,000
30,000
FY05
FY06
FY07
FY08
FY09
FY10
FY11
e
FY12
e
FY13
e
500
800
1,100
1,400
1,700
2,000
2,300
Revenue Profit (RHS)
(`m (`m)
Source: Company, Anand Rathi Research
22 February 2011 Balkrishna Industries – Good business model, rubber concerns; initiate with Hold
22 February 2011 Balkrishna Industries – Good business model, rubber concerns; initiate with Hold
Anand Rathi Research 97
Company Background & Management Balkrishna Industries is a leading manufacturer of a broad range of ‘off road’ tyres for agriculture, construction, industrials, earthmovers and ATVs (all-terrain vehicles). It has three manufacturing plants and one die/tooling unit in Rajasthan and Maharashtra.
Founded in 1988 to manufacture two- and three-wheeler tyres, Balkrishna shifted to the off-road tyre segment in 1993-94.
It focuses on producing off-highway tires for agriculture, industry, materials-handling, forestry, lawns and gardens, construction and earth-movers. It has a worldwide distribution network, ensuring extensive reach and penetration.
Balkrishna’s plants:
Aurangabad: bias at 85-88 tpd;
Bhiwadi: 80% radial and 20% bias; can go to 50-50 mix; 125 tpd;
Chopankhi: 115 tpd. 30 OTR radial, balance bias;
Dombivali: manufacturing own moulds;
The upcoming Bhuj plant.
Management
Aurag Poddar is VC & MD.
Rajeev Poddar is executive director.
B K Bansal is CFO.
Anand Rathi Financial Services Limited does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Disclosures and analyst certifications are located in Appendix 1 Anand Rathi Research India Equities
India I Equities
Key financials - Consolidated
Year end 31 March FY09 FY10 FY11e FY12e FY13e
Sales (`m) 22,434 13,278 18,980 24,316 29,334
Net profit (`m) -771 -1,492 76 506 878
EPS (`) -8.4 -16.2 0.8 5.5 9.5
Growth (%) -290.6 93.6 -105.1 565.2 73.4
PE (x) - - 78.4 11.8 6.8
PBV (x) 0.6 0.7 0.8 0.7 0.6
RoE (%) - - 1.0 6.0 9.4
RoCE (%) 0.1 - 4.0 8.5 11.9
Dividend yield (%) 0.0 0.0 0.0 0.0 0.0
Net gearing (%) 55.6 46.7 45.1 44.0 40.8
Source: Company, Anand Rathi Research Prices as on 18 February 2011
Auto Components
Initiating Coverage
22 February 2011
Mahindra Forgings
Steady improvement; initiate with Buy
Mahindra Forgings is one of the leading forgings companies globally and is set to gain from the steady recovery in European auto demand. This would, in turn, drive a sustainable and profitable performance ahead. We initiate coverage on MFL with a Buy and a target price of `137.
Sound domestic demand. Domestic demand is good, especially in MFL’s key segments, PVs and tractors, thereby benefiting its India operations. The transfer of dies from Europe in FY11, while resulting in short-term pain, would help improve production standards and capture additional demand ahead.
Improved operations. Increased share of machined components at its India operations and greater operating leverage would lead to improved margins.
Overseas performance to see steady improvement. Given the scale of its European operations, ~80% of MFL’s revenue arises from outside India. Demand in the European auto market is expected to continue boosting steady recovery, which would benefit it both in terms of higher revenue and operating leverage.
Valuation and risks. We value MFL at `137 (25x FY12e EPS of `5.5). Future re-rating is likely on: i) proven ability to sustain consolidated profitability and ii) likely restructuring of MFL as part of Mahindra Systech. We initiate coverage with a Buy. Risks: decline in domestic or overseas auto sales; currency fluctuations.
22 February 2011 Mahindra Forgings - Steady improvement; initiate with Buy
Anand Rathi Research 100
Investment Argument and Valuation One of the leading forgings companies globally, MFL would benefit from the steady recovery in European auto demand. This would, in turn, drive a sustainable and profitable performance. We initiate coverage on MFL with a Buy recommendation and a target price of `137.
Sound domestic demand
Domestic demand is sound, particularly in MFL’s key segments of PVs and tractors. We expect the auto industry in India to see a 13.7% volume CAGR over FY11-13e. Auto volume growth in FY11 has been robust at 25.1% yoy, while the FY02-11 CAGR was 14%. Hence, MFL’s domestic operations would benefit from the secular growth expected in PVs and tractors.
Transfer of dies from Europe in FY11, while leading to short-term pain, would help improve production standards and capture additional demand ahead.
Improved efficiencies
Higher operating leverage, benefits of cost-reduction measures, completion of business restructuring and a greater proportion of machined forgings would drive MFL’s EBITDA margin higher from FY12.
Moreover, measures at its overseas operations to conserve cash, reduce costs and improve productivity, while helping in surviving the downturn, would also augur well for enhanced profitability ahead.
Direct exports comprise a negligible proportion of MFL’s consolidated revenue, but the scale of the European operations means that ~80% of revenue arises from outside India. Demand in the European auto market is expected to steadily recover from FY11, after bottoming out over CY08-10, thereby benefiting MFL.
Turnaround
With a host of global majors setting up car manufacturing plants in India, adequate capacity is a prime requisite for business growth. New machining and forgings lines being set up would help address this growing demand.
We expect MFL to turn around its operations and register a profit CAGR of 239.6% over FY11-13e (from a very low base), together with a revenue CAGR of 24.3% and an EBITDA margin improvement of 200bps.
Valuation
Since listing, MFL’s price performance has been hampered by organizational restructuring, operational restructuring and the impact of the demand downturn. Hence, past valuations are not too meaningful.
Future re-rating is likely on two counts: proven ability to sustain profitability and benefits of re-organization with Mahindra Systech. We value MFL at `137 (25x FY12e EPS of `5.5). We initiate coverage on MFL with a Buy rating.
22 February 2011 Mahindra Forgings - Steady improvement; initiate with Buy
Anand Rathi Research 101
Risks
Decline in auto demand
Double-dip recession in Europe
Currency fluctuations
Delay in ramp-up in India machining capacity.
22 February 2011 Mahindra Forgings - Steady improvement; initiate with Buy
Anand Rathi Research 102
Sound domestic growth Domestic demand is sound, particularly in MFL’s key segments of PVs and tractors. Domestic operations would benefit from the secular growth expected in these segments.
In India, the key sources of revenues for MFL are the PV (both cars and UVs) and tractor segments. Other segments constitute a much smaller share of MFL’s annual revenue.
Domestically, MFL derives 41.5% of its revenue from passenger cars, 23.4% from MUVs, 12.8% from tractors, 9.5% from LCVs, 2.8% from HCVs and 9.9% from the non-auto segment. Non-M&M business accounts for more than 70% of MFL’s sales.
India turning into a small car manufacturing hub, new capacities from global OEMs being set up in India, ramp-up in capacity of the Nano and increasing preference for UVs as a lifestyle product would lead to PVs seeing 13% volume CAGR over FY11-13e.
On the other hand, the tractor segment would be more volatile, with seasonal vagaries of weather having a glaring influence on annual demand.
PVs and tractors to continue doing well
After two years of breakneck growth, the Indian auto sector has entered the secular growth phase in the current cycle. We expect an industry volume CAGR of 13.7% over FY11-13e, providing firm support to the sector.
PVs – India has emerged as a small car manufacturing hub as global giants General Motors (plant of 225,000-unit capacity annually set up at Talegaon near Pune), Volkswagen (plant at Pune), Nissan (upcoming plant at Chennai), and Renault (in partnership with Nissan) have joined the existing India old hands such as Suzuki and Hyundai. These companies not only cater to domestic demand but would also use India as an export base in the medium term.
Tractors – The tractor segment would benefit from the agri-friendly policies of the government and increased penetration in non-traditional tractor markets. An additional factor would be the increase in usage in non-traditional areas such as transportation and infrastructure. Tractor demand growth is expected to see a 9% CAGR over FY11-13e, subject to monsoon cycles.
22 February 2011 Mahindra Forgings - Steady improvement; initiate with Buy
Anand Rathi Research 103
Fig 8 – Industry: Volume growth expectation for PCs
0
500,000
1,000,000
1,500,000
2,000,000
2,500,000
3,000,000
3,500,000
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
e
FY12
e
FY13
e
7
11
15
19
23
27
31
35
PC yoy change (RHS)
(Nos.) (%)
Source: SIAM, Anand Rathi Research
Fig 9 – Industry: Volume growth expectation for UVs
0
50,000
100,000
150,000
200,000
250,000
300,000
350,000
400,000
450,000
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
e
FY12
e
FY13
e
-15
-10
-5
0
5
10
15
20
25
30
UV yoy change (RHS)
(Nos.) (%)
Source: SIAM, Anand Rathi Research
22 February 2011 Mahindra Forgings - Steady improvement; initiate with Buy
Anand Rathi Research 104
Improved operations Increased share of machined components and greater operating leverage would lead to improved margins for MFL.
Higher operating leverage, benefits of cost reduction activities, completion of business restructuring and an increased proportion of machined forgings would drive MFL’s EBITDA margin higher, from FY12 onwards.
Moreover, measures at its overseas operations to conserve cash, reduce costs and improve productivity, while helping survive the downturn, would augur well for enhanced profitability ahead.
Operating efficiencies at India operations
Over FY09-10, MFL’s India operations were impacted by a combination of factors – adverse forex movement, breakdown of press, and auto demand slowdown.
Ahead, we expect Mahindra Forgings India (MFI) to put behind this phase, and register sustainable improvement in its EBITDA margin, owing to:
1. Increase in share of machined forgings in MFI’s product mix – MFI is setting up additional machining capacity. This would in turn do away with the need for MFI to outsource machining, or for OEMs to carry out machining in-house. As machining is a more value-added and hence profitable activity, an incremental share would drive up MFI’s profitability.
Fig 10 – Mahindra Forgings India: Increase in share of machined forgings
0%
25%
50%
75%
100%
FY09
FY10
e
FY11
e
FY12
e
FY13
e
Machined Forgings Non-machined forgings Source: Company, Anand Rathi Research
2. Operating leverage – As production activity picks up, MFI would benefit increasingly from higher operating leverage. Current capacity utilization is ~60% (of actual usable capacity), which is expected to be scaled up to >80% by FY13e.
22 February 2011 Mahindra Forgings - Steady improvement; initiate with Buy
Anand Rathi Research 105
Fig 11 – Mahindra Forgings India: Trend in capacity utilization
20%
30%
40%
50%
60%
70%
80%
90%
FY06
FY07
FY08
FY09
FY10
FY11
e
FY12
e
FY13
e
on rated capacity on usable capacity Source: Company, Anand Rathi Research
3. Productivity and efficiency gains – MFI has been able to improve its operational productivity by ~20% from FY09 levels. Among other steps to improve profitability, improvement in yield is expected to contribute ~4% savings on its raw-material costs. Lastly, focus on reduction in rejections would help save costs significantly. Current level of rejections is ~5%, which is lower than that in FY09 (~8%). Even a reduction to the level at which Bharat Forge operates (~4%) would result in considerable savings. The target for MFI is 2% rejections, which would bring it on par with its European operations.
4. Transfer of dies from Europe carried out in FY11, while leading to short-term pain, would help improve production standards and capture additional demand.
Fig 12 – Mahindra Forgings India: Trend in EBITDA margin
0
2
4
6
8
10
12
14
16
FY06
FY07
FY08
FY09
FY10
FY11
e
FY12
e
FY13
e
(%)
Source: Company, Anand Rathi Research
Steps taken to improve MFE profitability
With a significant downturn in the European CV market, Mahindra Forgings Europe (MFE) has trimmed expenditure and turned around its performance, owing to stringent steps including:
1. Reduction of personnel expenses – by 34% in FY10 vis-à-vis FY09. This included measures such as reduction of head count by 31% and up to 100% short-time-working.
2. Stock reduction – MFE has reduced WIP and finished goods worth €12m, while reducing raw-material inventory, by €8m, since Aug ’08.
22 February 2011 Mahindra Forgings - Steady improvement; initiate with Buy
Anand Rathi Research 106
Hence, due to exhaustion of channel inventories, a pick-up in demand would lead to greater capacity utilization.
3. Cost reduction – MFE has been successful in reducing its fixed costs by ~40%. To ensure that costs do not significantly spiral up, further capacity expansion has been kept at an absolute minimum, with the focus being on cash-flow generation. Closure of the Walsall, UK, plant is also a step in this direction.
Key for European operations is that except for the 3-5% annual maintenance capex, no further investments are required to accommodate future growth. The company’s co-development approach adopted with OEMs would continue to help forge long-term business relationships. Strong technological capabilities and an innovation culture would serve as a tool to garner incremental share of new business.
22 February 2011 Mahindra Forgings - Steady improvement; initiate with Buy
Anand Rathi Research 107
Turnaround in financials We expect MFL to record a turnaround in its operations and register a profit CAGR of 239.6% over FY11-13e. We expect a revenue CAGR of 24.3% and an EBITDA margin improvement of 200bps.
Direct exports comprise a negligible proportion of MFL’s consolidated revenue, but the scale of European operations means that ~80% of revenue arises from outside India. Demand in the European auto market is expected to steadily recover from FY11, after bottoming out over CY08-10, thereby benefiting MFL.
Anecdotal evidence suggests that European CV demand has slid ~60% in FY10 from FY09. We expect a 24.9% revenue CAGR over FY11-13e for MFE. This is after a compounded annual 36.4% decline in revenue over FY08-10. Ahead, growth would be driven by improvement in demand as well as commencement of supply for new orders. Increase in low-cost sourcing from India and diversification into non-autos and marines would open long-term growth avenues for MFL.
With a host of global majors setting up car manufacturing plants in India, adequate capacity is a prime requisite for business growth. New machining and forgings lines being set up would help address this growing demand.
We expect MFL to record a turnaround in its operations and register a profit CAGR of 239.6% over FY11-13e. We expect a revenue CAGR of 24.3% and an EBITDA margin improvement of 200bps.
Fig 14 - Trend in MFL standalone revenues and profitability
2,000
2,500
3,000
3,500
4,000
4,500
5,000
5,500
FY08
FY09
FY10
e
FY11
e
FY12
e
FY13
e
-450
-330
-210
-90
30
150
270
390
Total Income Adj. PAT (RHS)
(`m) (`m)
Source: Company, Anand Rathi Research
22 February 2011 Mahindra Forgings - Steady improvement; initiate with Buy
Anand Rathi Research 108
Fig 15 - Trend in MFL’s consolidated revenues and profitability
10,000
14,000
18,000
22,000
26,000
30,000
FY08
FY09
FY10
FY11
e
FY12
e
FY13
e
-1,600
-1,100
-600
-100
400
900
Total Income Adj. PAT (RHS)
(`m) (`m)
Source: Company, Anand Rathi Research
We expect 22.5% CAGR in MFL’s (standalone) revenue over FY11-13e, backed by EBITDA margin improvement to 14% in FY13e from 10% in FY11e. The margin improvement is expected to be facilitated by a better product mix favoring machined products, higher capacity utilization and operational efficiencies. We expect a movement to adjusted profit from a loss in FY11e.
We expect a 24.3% CAGR in (consolidated) revenue over FY11-13e, backed by an EBITDA margin improvement to 10.8% in FY13e from 8.8% in FY11e. In the past, MFL’s overseas subsidiaries have had a higher EBITDA margin than the standalone operations. We expect the trend to change in favor of India operations (MFI) from FY10. Margin improvement in subsidiaries would be driven by higher capacity utilization and cost restructuring & reduction. We expect a 239.6% CAGR in the (consolidated) adjusted net profit over FY11-13e.
Trend in India operations’ production tonnage
Production tonnage growth CAGR in India operations is expected to be high for MFL due to:
1. Higher visibility of revenue growth since 78.1% of revenue is from the fast-growing PV and tractor segments; and
2. Increased machining potential.
Reduction in debt
MFL would steadily lower its debt over a period of time. The debt-equity ratio would be reduced to 0.5x in FY12e from 0.8x in FY10 and 1.2x in FY09. This would gradually lower the interest expense for MFL.
22 February 2011 Mahindra Forgings - Steady improvement; initiate with Buy
22 February 2011 Mahindra Forgings - Steady improvement; initiate with Buy
Anand Rathi Research 111
Company Background & Management MFL is part of Mahindra Systech, which is the ‘Art to Part’ business arm of the M&M Group. MFL focuses on forgings, with operations in India and Europe. The company has a diversified revenue stream, with ~70% of European revenues arising from the truck segment; India operations focus more on PVs and tractors.
MFL is part of the Systech business of the Mahindra Group. Systech comprises various businesses, offering customers full services, from designing to delivery.
The Systech division is made up of three segments:
1. Contract sourcing – for sourcing of components at competitive prices;
2. Mahindra Engineering Services – for design solutions (revenue of US$34m); and
3. Auto-components business unit (ACBU) – the manufacturing and main revenue generating arm, which consists of plants manufacturing forgings, castings, stampings, gears, steel and composites.
Annualized revenue of the Systech division in FY09 stood at ~US$850m. Among all segments of the ACBU, the forgings segment is the biggest, with revenue of ~US$400m.
Fig 20 – Current Mahindra Systech: organisational chart
Mahindra & Mahindra & Mahindra
Mahindra Forgings Limited(Chakan)
Mahindra Forgings Limited(Chakan)
MahindraForgings Europe
MahindraForgings Europe
MahindraCastings
(Urse)
MahindraCastings
(Urse)
Mahindra Gears* (Rajkot )
Mahindra Gears* (Rajkot )
PE1PE1 PE2PE2
MetalCastelloMetalCastello
53%
47%51%65%35%
India
Europe
53%
Mahindra & Mahindra & Mahindra
Mahindra Forgings Limited(Chakan)
Mahindra Forgings Limited(Chakan)
MahindraForgings Europe
MahindraForgings Europe
MahindraCastings
(Urse)
MahindraCastings
(Urse)
Mahindra Gears* (Rajkot )
Mahindra Gears* (Rajkot )
PE1PE1 PE2PE2
MetalCastelloMetalCastello
53%
47%51%65%35%
India
Europe
53%47%
Source: Company
Fig 21 – Mahindra Systech businesses
Key Businesses
Forgings
Mahindra Forgings (Listed)
One of the leading forgings company in the world*
Castings
Mahindra Hinoday(with PE partner)
HPDC, Induction Melting, Auto Pour, Computerized Sand Mixing
Gears
Mahindra Gears and Transmission Pvt. Ltd.
Metalcastello S.r.l.(with PE partner)
150,000 gears every month
Stampings & Steel
MUSCO (Listed)
Alloy steel and critical stamping parts required for auto & non-auto
22 February 2011 Mahindra Forgings - Steady improvement; initiate with Buy
Anand Rathi Research 112
Creation of a global forgings capacity
Mahindra Forgings is a leading manufacturer of forgings, with plants in three countries, India, Germany and the UK. Its product portfolio includes a range of forged components for cars, tractors, trucks as well as the non-auto segment.
In FY06-07, several acquisitions were made by M&M and group companies in the forgings business, to build its manufacturing capacity, product portfolio, technological abilities and add clients. Some acquisitions are:
1. Apr ’05 – 100% stake in Amforge, Chakan unit, India, subsequently renamed Mahindra Forgings
2. Jan ’06 – 99.5% stake in Stokes, UK
3. Nov ’06 – 67.9% stake in Jeco Holdings, Germany
4. Dec ’06 – 90.47% stake in Schoeneweiss, Germany
Consequent on these acquisitions, the European companies became subsidiaries of MFL during the subsequent restructuring. Post consolidation and restructuring, MFL is one of the biggest forgings companies globally, with forgings capacity comparable with that of Sumitomo and Hirschvogel.
Key management personnel:
Mr. Anand Mahindra - Chairman
Mr. Hemant Luthra: President - Systech Sector
Mr. Sanjay Joglekar: CFO - Systech Sector
Mr. Deepak Dheer – MD – Mahindra Forgings
Anand Rathi Financial Services Limited does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Disclosures and analyst certifications are located in Appendix 1 Anand Rathi Research India Equities
India I Equities
Key financials
Year end Mar FY09 FY10 FY11e FY12e FY13e
Sales (`m) 2,968 3,568 4,797 6,135 7,900
Adj. Net profit (`m) 26 217 497 602 831
EPS (`) 0.3 2.2 5.1 6.2 8.6
Growth (%) -92.2 727.6 128.8 21.1 38.2
PE (x) 168.4 20.4 8.9 7.3 5.3
P/BV (x) 2.5 2.3 1.9 1.6 1.3
RoE (%) 1.4 11.8 23.4 23.4 26.8
RoCE (%) 6.2 15.0 27.3 27.6 32.2
Dividend yield (%) 1.8 2.2 2.6 3.2 3.8
Net gearing (%) 76.8 47.0 42.8 41.1 29.6
Source: Company, Anand Rathi Research Prices as on 18 February 2011
Auto Components
Initiating Coverage
22 February 2011
NRB Bearings
The leader in needle roller bearings; initiate at Buy
We initiate coverage on NRB, the leading manufacturer of needle bearings in India, with a Buy rating and a target of `68. The huge rise in number of vehicles in India, NRB’s sharper focus on exports and the replacement market, and its expansion are likely to lead to a 29% earnings CAGR over FY11-13e.
Market leader in needle bearings, with a ~10% share in the organised bearings sector. The bearings sector is split equally between organised and unorganised companies. NRB has a ~10% market share in the organised sector; in needle bearings it has a commanding 70% market share.
Sharper focus on exports and replacement market. As exports and replacement markets command higher margins, the company is increasing its focus on these markets. In the next three years exports would rise to 20% of sales.
Adding capacities to satisfy stable auto demand. As most of NRB’s revenue comes from the auto segment, robust demand for automobiles would benefit it. To cater to this roaring demand, NRB is investing `0.6bn to double its needle bearings capacity by Jul ’11.
Valuations and risks. At our target of `68, the stock would trade at 11x 12-month-forward earnings and an EV/EBITDA of 5.7x. Risks: fragmentation in the sector, spurious products in after-sales market, threat of cheap imports from China, increase in prices of raw materials.
Rating: Buy Target Price: `68 Share Price: `46
Key data NRBBR IN / NBEA.BO
52-week high/low `65/`29Sensex/Nifty 18212 / 5459
3-m average volume US$0.1m Market cap `4.4bn/US$96mShares outstanding 97m
Free float 26.2%
Promoters 73.8%
Foreign Institutions 8.0%
Domestic Institutions 4.5%
Public 13.7%
Relative price performance
NRBBR
Sensex
20
30
40
50
60
70
Feb-
10
Apr-1
0
Jun-
10
Aug-
10
Oct
-10
Dec
-10
Feb-
11
Source: Bloomberg
22 February 2011 NRB Bearings – The leader in needle roller bearings; initiate at Buy
Anand Rathi Research 114
Quick Glance – Financials and Valuations Fig 1 – Income statement (`m)
22 February 2011 NRB Bearings – The leader in needle roller bearings; initiate at Buy
Anand Rathi Research 115
Investment Argument and Valuation We initiate coverage on NRB, a leader in needle roller bearings, with a Buy rating and a target price of `68. Its dominance in needle roller bearings, the vast rise in vehicle volumes, the sharper focus on exports and replacements, and its expansion are likely to lead to a 29% earnings CAGR over FY11-13e.
Market leader in needle bearings, with a ~10% overall share in the organised bearings sector
The bearings sector is split equally between organised and unorganised companies. In the organised space, the company has a ~10% market share; it leads in needle bearings, with a commanding 70% market share. The Indian bearings industry was worth `120bn-130bn in 2010, and has seen a healthy growth rate. The domestic industry satisfies 75% of that demand, the balance 25% is met through imports. A number of global bearings manufacturers have established units in India through joint ventures or 100% ownership.
Fig 7 – Structure of the bearings industry
Organised, 37.50%
Unorganised, 37.50%
Imported, 25%
Source: Company, Anand Rathi Research
Sharper focus on exports and the replacement market
NRB plans to leverage its leading position in needle roller bearings by concentrating on furthering exports. It aims at a consistent 20-25% growth pa in the next five years, largely from mounting exports. We expect the exports share in sales to rise from 8% in FY10 to 20% in FY13e.
Adding capacities, to satisfy stable automobile demand
As a huge 93% of demand for NRB’s bearings in India arises from the automobile segment (both OEM and replacement), stable demand prospects in this segment are a positive for the company. As many of NRB’s products are in the R&D stage, and with new product launches planned for OEMs, we expect healthy volume off-take for NRB.
The fourth largest in the bearings segment, dominated by SKF, FAG and NEC (unlisted), NRB’s market share has stagnated at around 10% since FY04. For growth, NRB has chalked out a capacity expansion plan, at its present plant at Waluj where it has sufficient land. It has already ordered machinery. It is doubling its needle roller bearings capacity by Jul ’11 (the benefits would show from 2HFY12). When this expansion goes on stream, its market share would improve to ~13-14%.
22 February 2011 NRB Bearings – The leader in needle roller bearings; initiate at Buy
Anand Rathi Research 116
Outlook and Valuation
We expect the domestic automobile industry to grow 13.7% over FY11-13e, boosting demand for bearings. Hence the domestic bearings sector would see a 15-20% CAGR over FY11-13e. NRB would benefit from this emerging domestic demand and increased export opportunity.
On all valuation parameters—P/E, P/BV, MCap/sales—NRB is available at a discount to FAG and SKF. Also, both SKF India and FAG Bearings have trading revenues; NRB’s revenues arise only from its products.
The industry is characterized by high-end technology and the amount of capital required (raising entry barriers to others). Hence, organised domestic bearings companies, mainly global players, have a dominant share through their tie-ups. SKF India has a 37% market share, FAG 19%, NRB Bearings ~10%.
NRB’s enhanced capacity would help satisfy the booming demand and boost sales volumes. Its profitability would rise owing to its operating leverage, rising exports and after-sales share. Given the better long-term growth prospects for bearings, we expect healthy return ratios for NRB.
At our target price of `68, the stock would trade at 11x 12-month-forward earnings. NRB’s one-year-forward PBV in the past five years has ranged between 0.7x and 3.8x. At `46, NRB trades at PE of 8.9x and 7.3x FY11e and FY12e earnings, respectively, and EV/EBITDA of 4.8x and 4x.
Fig 8 – 12-month-forward P/BV – Mean and standard deviations
Mean
+1SD
+2SD
-1SD
-2SD
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
Apr-0
5
Sep-
05
Feb-
06
Jul-0
6
Dec
-06
May
-07
Oct
-07
Mar
-08
Aug-
08
Jan-
09
Jun-
09
Nov
-09
Apr-1
0
Sep-
10
Feb-
11
Source: Bloomberg, Anand Rathi Research
Risks to our valuation
Increase in prices of raw materials. Steel, constituting almost 35% of net sales, has a significant impact on margins. Any increase in steel prices would result in pricing and margin pressures if NRB is not able to pass on the higher costs.
Spurious products. Spurious products are a significant part of the Indian bearings market, mainly in the price-sensitive replacement market. This market uses inferior materials, which are relatively unsafe and unreliable.
Threats from imports. Customs duty on imported bearings was reduced from 30% in FY03 to nil. This has attracted more imports, catering mainly to the replacement market. Major imports of ball bearings are from China and have been rising.
We value NRB at 11x 12-month-forward earnings; target price: `68
22 February 2011 NRB Bearings – The leader in needle roller bearings; initiate at Buy
Anand Rathi Research 117
Leading in needle roller bearings NRB Bearings manufactures almost all types of bearings: needle roller bearings, spherical roller bearings, cylindrical roller bearings, tapered roller bearings, ball bearings, crank pins and wide inner-ring bearings. It is a leader in the domestic needle roller bearings markets, with a commanding 70% market share. Its strength lies in customising bearings to meet the needs of its clients.
NRB has well-established relationships with some major OEMs. Its top-five customers are Tata Motors, Hero Honda, Ashok Leyland, Mahindra & Mahindra, and Bajaj Auto, bringing in 35-40% of its revenues. But no single customer accounts for >10%, resulting in a suitably diversified client portfolio. Its global clientele isare Daimler, Volvo and Volkswagen. Its non-automobile clients are TAFE, Siemens, ABB, Lucas and LMW.
Fig 9 – NRB's client-wise percentage sales break-up (FY09 and FY10) Company FY09 FY10
Tata Motors 7.8 9.9
Hero Honda 7.1 6.5
Ashok Leyland 4.2 5
M&M 4.6 5.5
Bajaj 5 5
HMSI 2.1 2
Maruti 2 1.5
Source: Company
The roaring prospects in the automobile sector augur well for demand for bearings, and we expect all segments of the automobile industry to report robust growth in coming years. We expect the bearings sector to continue seeing good times, riding on the auto sector boom and export growth.
However, we expect NRB, the market leader in needle roller bearings to report a better performance in the next two years, as demand growth in key user industries is expected to rise sharply. The automobile industry, which is the primary client of NRB Bearings (93% of its sales go to auto companies) grew 25% yoy in FY10 and registered 28% yoy growth till Jan ’11.
The Indian bearings industry is estimated at `120bn-130bn. Domestic manufacturers address almost 75% of that demand. Imports cater to the rest of that demand (25%), essentially for industrial applications and special purpose.
Fig 10 – Bearings industry structure Bearing Industry(~ 120bn-130bn)`
Organised~37.5%
Unorganised~37.5%
Imported~25%
OEM(Auto, Rail & Industrial)
Replacement Special Purpose Bearing
Source: Company, Anand Rathi Research
22 February 2011 NRB Bearings – The leader in needle roller bearings; initiate at Buy
Anand Rathi Research 118
Demand for bearings is derived from demand in two key user segments, automobiles and industrial sector growth. The automobile industry is the largest growth driver as it accounts for almost 47% of the bearings market. The industrial sector makes up the rest.
Since the bearings industry is technology-intensive, most Indian manufacturers have collaborated as joint-venture partners with other more established global players. The largest user segments of bearings in India are the auto industry, the industrial OEM segment, and the replacement market. Leaders in this market are SKF in ball bearings (with a 41% market share), FAG in spherical roller bearings (60%), NBC in tapered roller bearings (23%) and NRB in needle roller bearings (70%).
Fig 11 – User-segment demand for bearings
Auto47%Industrial
53%
Source: Company, Anand Rathi Research
22 February 2011 NRB Bearings – The leader in needle roller bearings; initiate at Buy
Anand Rathi Research 119
Capacity expansion, a growth driver In order to cater to mounting demand in the auto segment, NRB has chalked out an expansion programme. This would help it raise its market share.
On account of slowdown in the auto industry in FY09, NRB had not increased its capacity for ball and roller bearings in FY09, but its utilization levels fell considerably, from 76% in FY08 to 60% in FY09. In FY10, on the revival in the automobile industry, NRB’s production improved 40%, utilization levels improved to 76% on 10% higher capacities. At present, NRB’s average utilization levels are 80-85%. In order to grow at more than 20%, it has been undertaking regular capacity expansions at its main plants at Waluj and Jalna, by 20-25% in course of time. A further ramp-up in capacity would take place as and when demand from its customers increases.
Demand from the automobile sector makes up 47% of demand for bearings. Over FY05-10, bearings have seen an 8-10% CAGR. If the industry has to grow at 20% pa, with greater preference for branded products, there is need for capacity ramp-ups and product development to meet the new-age user requirements.
In order to grow, NRB has chalked out a capacity expansion plan. It is doubling its needle roller bearings capacity by Jul ’11, and such benefits would be reflected from 2HFY12. Its market share has stagnated at around 10% since FY04, and when this expansion goes on stream its market share would rise to 13-14%. The expansion would take place at its present plant at Waluj, where it has enough land. It has already ordered machinery. The rationale behind establishing this plant (involving capital outlay of `0.6bn) is to cater to the swelling demand from auto companies and from exports.
The Thailand subsidiary formed at an investment of `200m would cater to the ASEAN and SAARC markets, 70% would be exported and 30% sold in the Thai market. Manufacturing at this subsidiary is likely to go on stream from Q4FY11. It would have capacity to produce 32m pieces yearly. According to us, a key trigger for NRB would be the execution of its capacity expansion plans as that would place it in an ideal situation to gain market share.
Expansion in needle bearings in 2QFY12 would drive growth.
The full impact of the enhanced capacity would be seen in FY12
Auto industry to drive demand
22 February 2011 NRB Bearings – The leader in needle roller bearings; initiate at Buy
Anand Rathi Research 120
Focus on exports and replacements NRB plans to leverage its leading position in needle roller bearings by focusing on furthering exports. It aims at a consistent 20-25% growth pa in the next five years, chiefly from rising exports. We expect the exports share in sales to rise from 8% in FY10 to 20% in FY13.
Since exports and the replacement market command higher margins, the company is increasing its focus in these segments. Its exports, which were 8% of its sales, would rise to 20% in the next three years. NRB focuses on non-commoditised bearings, i.e., it customises bearings for important clients. It has come a long way from manufacturing only needle-roller bearings. Today, it has diversified into cylindrical, tapered, roller, spherical and ball bearings, and is making a concentrated effort to boost exports by focusing on its research and development centre. This centre has churned out 1,500 products so far. NRB has old customers in Renault, Volvo and the UK-based ZF Group.
This is a technology-intensive industry and there is a significant difference in the quality of products manufactured by others. This works in India's favour. Dumping by Chinese companies (selling in India under fake brand names) is common. As the Indian auto components industry is doing well, this has a direct effect on demand for bearings of quality. These are certainly good times for many Indian manufacturers. Ahead, there will not be adequate capacity to satisfy the vast and growing demand.
NRB is hence looking at widening its global footprint and proposes to focus on exports. In the next three years, we estimate the share of exports to sales would increase from 8% now to 20%. The company has sensed outsourcing opportunities and has initiated the process to produce a range of bearings to meet the requirements of the parent or of other global customers.
NRB has already entered into talks with some major OEMs. It is also exploring the possibility of tapping replacement markets in Asia and Europe. It plans to develop new products to satisfy the requirements of the international market. Technical collaboration with Nadella, France, would prove significant in achieving export targets.
Fig 12 – Trend in exports over the years
0
200
400
600
800
1,000
1,200
1,400
1,600
FY05
FY06
FY07
FY08
FY09
FY10
FY11
e
FY12
e
FY13
e
5
7
9
11
13
15
17
19
21
Forex earnings on exports % of sales (RHS)
(`m) (%)
Source: Company, Anand Rathi Research
22 February 2011 NRB Bearings – The leader in needle roller bearings; initiate at Buy
Anand Rathi Research 121
Also, the sharper and greater focus on the replacement market would help safeguard NRB in a slowdown, which could lead to lower growth in the OEM segment and higher growth in replacement demand. NRB has been concentrating on improving its share in the replacement market, and is set to garner a higher share there.
In order to deepen its penetration into the replacement market it is focusing on developing the market. It is also widening its dealer network in the lucrative semi-urban and rural markets. This initiative would help it penetrate further into such lucrative areas. Margins in the replacement market being higher would translate into higher overall margins.
22 February 2011 NRB Bearings – The leader in needle roller bearings; initiate at Buy
Anand Rathi Research 122
Financials Roaring demand in the auto sector coupled with NRB’s capacity expansion to satisfy this demand offers assurance of revenue for the next two years. We expect NRB to register CAGRs of 28% in revenue and 29% in net profit over FY11-13e.
A 28% CAGR in revenue expected over FY11-13e
Following expansion in needle bearings capacity on the increase in demand, we expect a robust revenue performance from NRB. Capex planned for FY11-12 is `0.8bn. We expect a 28% CAGR in revenue from FY11 to FY13. We believe the share of exports as well as of the after-sales market would rise in the next two years.
Fig 13 – Revenue and revenue growth
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000FY
09
FY10
FY11
e
FY12
e
FY13
e
-15
-10
-5
0
5
10
15
20
25
30
35
Net sales Sales growth (RHS)
(`m) (%)
Source: Company, Anand Rathi Research
Margins to be stable
We expect the EBITDA margin over FY11-13 to be around 20-21%. This strong EBITDA performance would stem from the healthy growth in export and replacement sales.
Fig 14 – EBITDA and EBITDA margin
0
200
400
600
800
1,000
1,200
1,400
1,600
1,800
FY09
FY10
FY11
e
FY12
e
FY13
e
11
13
15
17
19
21
23
EBIDTA EBITDA margins (RHS)
(`m) (%)
Source: Company, Anand Rathi Research
We expect a 28% CAGR in revenue from FY11 to FY13
We expect the EBITDA margin over FY11-13 to be around
20-21%
22 February 2011 NRB Bearings – The leader in needle roller bearings; initiate at Buy
Anand Rathi Research 123
A 29% CAGR in net profit expected over FY11-13
We expect NRB to post a 29% CAGR in net profit over FY11-13. The growth in net profit would be reflected in expanded return ratios. Over FY11-13, we expect the RoE to rise from 23.4% to 26.8% and the RoCE from 27.3% to 32.2%.
Comfortable balance sheet
The FY10 net debt-equity ratio holds at a manageable 0.5x and falls within the industry range of 0.2x to 2x. We expect it to gradually slip to around 0.3x in FY13. Working capital days are also at manageable levels of around 98 days. Over FY11-13, this is expected to be maintained around FY11 levels.
The company has capex plans for the next two years, of ` 0.8bn, which would be met by internal accruals and debt. Its FY10 debt-equity ratio is 0.5x. This implies that it is in a comfortable position to raise debt, if required.
Fig 17 – Working capital days
0
40
80
120
160
FY09
FY10
FY11
e
FY12
e
FY13
e
(Days)
Source: Company, Anand Rathi Research
Fig 18 – Debt and Net-debt-to-equity ratio
0
200
400
600
800
1,000
1,200
1,400
1,600
FY09
FY10
FY11
e
FY12
e
FY13
e
25
32
39
46
53
60
67
74
81
Debt Net Debt/Equity (RHS)
(`m) (%)
Source: Company, Anand Rathi Research
Fig 15 – Net profit and Net-profit margin
0
100
200
300
400
500
600
700
800
900
FY09
FY10
FY11
e
FY12
e
FY13
e
0
2
4
6
8
10
12
PAT PAT margin (RHS)
(`m) (%)
Source: Company, Anand Rathi Research
Fig 16 – Return ratios
0
5
10
15
20
25
30
35
FY09
FY10
FY11
e
FY12
e
FY13
e
RoE RoCE
(%)
Source: Company, Anand Rathi Research
We expect NRB to post a 29% CAGR in net profit over
FY11-13
22 February 2011 NRB Bearings – The leader in needle roller bearings; initiate at Buy
22 February 2011 NRB Bearings – The leader in needle roller bearings; initiate at Buy
Anand Rathi Research 125
Fig 21 - Cash flow statement (`m) Year end 31 March FY09 FY10 FY11e FY12e FY13e
PAT 26 217 497 602 831
+Depreciation 202 206 240 270 288
+Deferred tax 7 2 2 2 2
Cash profit 235 426 739 873 1,121
-Increase/(Decrease) in WC 200 (291) 428 448 590
Operating cash flow 35 716 310 425 531
-Capex 279 121 386 400 200
Free cash flow (244) 596 (76) 25 331
-Dividend 91 113 136 163 196
+Equity raised - - 0 - -
+Debt raised 325 (473) 200 100 (50)
+Minority interests 3 0 - - -
-Investments - - - - -
-Miscellaneous items 9 - (95) 2 2
Net cash flow (16) 10 83 (40) 83
+Opening cash 62 45 55 138 98
Closing cash 45 55 138 98 181
Source: Company, Anand Rathi Research
Fig 22 - Ratio analysis @ `46 Year end 31 March FY09 FY10 FY11e FY12e FY13e
Basic (`)
EPS Fully Diluted 0.3 2.2 5.1 6.2 8.6
Cash EPS 2.4 4.4 7.6 9.0 11.5
EPS Growth (%) (92.2) 727.6 128.8 21.1 38.2
Book Value per Share 18.4 19.5 24.2 28.8 35.3
DPS 0.8 1.0 1.2 1.4 1.7
Valuation (x)
P/E 168.4 20.4 8.9 7.3 5.3
Cash P/E 19.4 10.4 6.0 5.1 3.9
EV/EBITDA 13.5 8.0 4.8 4.0 3.2
EV/Sales 1.8 1.5 1.1 0.9 0.7
Price to Book Value 2.5 2.3 1.9 1.6 1.3
Dividend Yield (%) 1.8 2.2 2.6 3.2 3.8
Profitability Ratios (%)
RoE 1.4 11.8 23.4 23.4 26.8
RoCE 6.2 15.0 27.3 27.6 32.2
Turnover Ratios
Debtors (Days) 99.1 76.1 67.4 70.1 70.9
Inventory (Days) 112.4 93.2 77.4 78.8 77.8
Creditors (Days) 52.8 45.7 47.9 48.0 47.0
Working Capital (Days) 155.7 124.9 98.1 102.8 103.8
Asset Turnover (x) 1.2 1.0 0.8 0.8 0.7
Leverage Ratio
Debt/Equity (x) 0.8 0.5 0.5 0.4 0.3
Source: Company, Anand Rathi Research
22 February 2011 NRB Bearings – The leader in needle roller bearings; initiate at Buy
Anand Rathi Research 126
Company Background & Management NRB manufactures ball and roller bearings and is the only one in India to make all types of bearings: ball, needle, cylindrical, spherical, tapered, thrust, roller. It is a market leader (70% share) in needle roller bearings, which bring in ~55% of its revenues, and has a notable 16% market share in cylindrical roller bearings. Besides, it has also taken up manufacturing ball and tapered roller bearings. Over FY05-10, NRB had a 9% revenue CAGR.
Brief history and business
Incorporated in 1966, The Needle Roller Bearing Co. a joint venture with Nadella, France, was the first in India to manufacture needle roller bearings. In view of its diversified range and types of bearings, it was renamed NRB Bearings. It manufactures over 600 types of bearings at its plants at Thane, Jalna, Waluj and Pantnagar. It has two subsidiaries, the profitable SNL Bearings in Ranchi (in which it holds a 69% equity stake) and the loss-making 100% subsidiary in Thailand. NRB supplies all types of bearings and is dominant in needle roller bearings. It also supplies light-weight bearings where the load is low, as in automobiles: for gears, clutches and brakes.
Fig 23 – Key management Key Person Designation Background
Trilochan Singh Sahney
Executive Chairman
M.A.; CEO. Executive chairman since 1 Oct ’10; till then, managing director; member, Governing Council, and VP, Indo-French Chamber of Commerce & Industry. Was non-executive director, Punjab Tractors.
P D Ojha
Director B.A (Econ) M.A (Advanced Econ), Ph.D (Economics) 56 years experience; retired as Deputy Governor of The Reserve Bank of India
Kala S Pant
Director B.Sc., M.Sc. (Stats.) for Economics and Industry. Doctoral research work in quantitative methods in banking and transport. 42 years experience in management and research methodologies; research in the problems of transport, ports, infrastructure cost-benefit analysis, both macro and micro
Harshbeena S Zaveri
Managing Director
23 years in industry, in planning, purchase & imports, and marketing. Since January, responsible for entire operations Is also on the Board of SNL Bearings.
Devesh S Sahney
Director 16 years’ experience. B.A. (Business Administration & Economics), Richmond College, London, and MBA (general management), Asian Institute of Management (Philippines)
K M Elavia
Director B.Com (Hons), FCA; 39 years post-qualification experience. Former partner, Kalyaniwalla & Mistry; on the Boards of many listed and unlisted Indian companies
Anand N Desai
Additional Director
LL.B., Bombay University, LLM (International Law), University of Edinburgh, Scotland. Managing partner, DSK Legal. Has extensive experience in banking and financial services law, intellectual property rights, among others
Source: Company
Anand Rathi Financial Services Limited does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Disclosures and analyst certifications are located in Appendix 1 Anand Rathi Research India Equities
We initiate coverage on Setco Automotive, the leader in M&HCV clutches, with a Buy and a target of `182. Setco’s unique business model, expansion and upswing in vehicle volumes would lead to 29% earnings CAGR over FY11-13e.
Domestic leader in M&HCV clutches. While Setco is one of the top-five clutch manufacturers globally, it is the largest in India. It caters to the OEM and replacement markets, meeting ~75% of the M&HCV OEM clutch demand in the country.
Unique business model. Setco is one of the largest clutch suppliers to the after-sales segment via the distribution networks of Tata Motors, Ashok Leyland and Eicher. Its after-market sales saw a 29% CAGR over FY03-10, and growth even during the economic downturn.
Expansion to cater to the growing demand. Setco caters to the strong sustainable demand from the clutch replacement and OEM markets that we believe would continue. The company plans setting up a unit in an SEZ to cater to rising exports; the unit would be completed by FY12-13.
Valuation and risks. At our target price, the stock would trade at 9x 12-month forward earnings and EV/EBITDA of 5.1x. The target PE is in line with the three-year average. Key risks: low volume offtake from OEMs and rising raw material prices.
22 February 2011 Setco Automotive – M&HCV clutch leader; initiate with a Buy
Anand Rathi Research 129
Investment Argument and Valuation We initiate coverage on Setco, the leader in M&HCV clutches, with a Buy recommendation and a target price of `182. The company’s unique business model, expansions to cater to exports and healthy growth in the automobile sector would lead to 29% earnings CAGR over FY11-13e, in our view.
Domestic leader in M&HCV clutches
Setco meets 75% of India’s M&HCV OEM clutch demand and is among the top-five (in volumes) globally. Eaton is #1 internationally (but does not operate in India), followed by Fisher & Facs, a part of the ZF Group. LUK is #3 and is part of the Scaefller Group. Valeo, which caters to the car and LCV clutch segments in India, is #4.
Setco commands a 40% share of the domestic industry and saw 26% revenue CAGR through FY06-10. It expects a similar growth rate in the next five years.
Setco is the largest supplier of M&HCV clutches to Tata Motors, Ashok Leyland, Eicher and Asia Motor Works. Also, it is an approved source for Daimler India. Robust growth in the M&HCV business and the shift to higher value-added new-generation CVs would boost its growth. Its strength in the after-sales market and the recognition of its LIPE brand give it added penetration.
Unique business model
Setco is one of the largest suppliers of clutches to the after-sales market, through the distribution networks of Tata Motors, Ashok Leyland and Eicher Motors. Its after-market sales have seen a 29% CAGR through FY03-10. Even in the severe economic downturn, it saw growth. It has tie-ups with OEMs for their distribution networks to cater to the replacement markets (where Setco supplies ~56% of its products).
Expansion to cater to the growing domestic and export demand
Setco caters to the clutch replacement market (clutches need replacement every 2-2.5 years on average) and to OEMs. The strong demand growth in OEMs and in the replacement market would continue. To cater to rising exports, Setco plans to set up a `0.7bn unit in an SEZ, to be complete by FY13 and to be funded via debt and internal accruals. Access to international CV players through acquisitions in the US and UK has enhanced its customer portfolio. The lower cost of production in India would continue to help it gain international clients. At present, its plants run on two shifts, and can be increased to three if demand increases.
Outlook and valuations
The domestic automobile industry grew a strong 14% through FY02-11. We expect the growth to continue, boosting demand for clutches in the OEM and replacement markets. Consequently, we estimate that domestic clutch volumes would see a 20-25% CAGR over FY10-13e. Setco would benefit from the emerging domestic demand and increased export opportunity.
We believe that the stock would be re-rated owing to Setco’s leading position, strong OEM clients, unique business model and a breakeven in its international business operations. We expect the enhanced capacity to
22 February 2011 Setco Automotive – M&HCV clutch leader; initiate with a Buy
Anand Rathi Research 130
cater to the growing demand and to boost sales volumes. Profitability would improve on account of the operating leverage, rising exports and after-sales contribution.
At the current market price, the stock trades at FY11e and FY12e EPS of 7.8x and 5.8x respectively. At present valuations, it appears inexpensive. We initiate coverage on Setco with a Buy rating and a target price of `182. The stock would trade at 9x 12-month-forward earnings and an EV/EBITDA of 5.1x. The target PE is in line with the three-year average.
Fig 7 – Twelve-month forward PE: Mean and standard deviations
Mean
+1SD
+2SD
-1SD
0
2
4
6
8
10
12
14
16
Aug-
06
Dec
-06
Apr-0
7
Aug-
07
Dec
-07
Apr-0
8
Aug-
08
Dec
-08
Apr-0
9
Aug-
09
Dec
-09
Apr-1
0
Aug-
10
Dec
-10
Source: Bloomberg
Risks
OEM risk. The replacement market comprises 56% of Setco’s sales; OEMs constitute nearly 37%. Low volume growth in OEMs would directly affect the company’s revenue.
Interest-rate risk. Many vehicles are purchased through auto finance. Higher interest rates would raise the cost of auto loans and curb volume growth of auto players, thereby affecting Setco’s growth.
High raw-material prices. Raw material costs, as high as 55% of sales, affect pricing and margins. Steel, aluminium and ceramic buttons are key raw materials. Any rise in prices would erode margins.
Risk of economic slowdown. A slowdown in the economy would affect demand for M&HCVs, curtailing Setco’s revenue.
We value Setco at 9x FY12e earnings, with a target price of `182
22 February 2011 Setco Automotive – M&HCV clutch leader; initiate with a Buy
Anand Rathi Research 131
Domestic leader in M&HCV clutches Setco is leveraging its strong brand, market leadership and marquee clientele to ride on the strong auto demand.
The prevailing macro-economic scenario is benefiting the auto sector and, in turn, the auto clutch segment. Setco manufactures new-technology clutches under the LIPE brand, with over 90% of its sales coming from clutches. It is a market leader in the OEM segment (sales to OEMs constitute ~37% of sales) and one of the largest suppliers of clutches to the after-sales segment (56% of sales).
UK subsidiary 2006 1 Clutch assembly and R&D Clients added to Setco: Daimler, BMC and after-sales market
USA subsidiary 2007 44 Clutch assembly, hydraulics Clients added to Setco: Caterpillar, Terex and after-sales market
Source: Company
The company’s domestic unit at Kalol, Gujarat, manufactures all clutches for original-equipment-manufacturer (OEM) sales. The export-oriented unit (EOU) at Kalol caters to international demand. Setco has set up a new press shop at the Kalol unit, at ~`320m. Commercial production commenced in FY10.
In FY08, Setco set up a new assembly line at Sitarganj, Uttarakhand (for its tax incentives, entailing exponential growth potential), especially for the replacement market, for ~`80m. The Sitarganj unit, which mainly caters to the after-sales market, has the flexibility to meet increasing demand. Setco also has the option to purchase components and assemble them, since it can set up an additional assembly line quickly, without high capital costs.
Setco is a manufacturer of new-technology clutches, which it markets globally under the ‘LIPE’ brand. It is a pioneer in cera-metallic friction technology clutches in India and a tier-I supplier to Tata Motors, its largest customer. MCV clutches supplied to Tata Motors average `4,000 and HCV clutches range from `6,000 to `11,000.
Strong in the OEM market
Healthy growth in CVs and its business strategy have helped Setco establish itself as a strong player. This trend is expected to continue. We expect M&HCV demand to see an 11.5% CAGR through FY11-13e. Setco enjoys a strong clientele, including major OEMs Tata Motors, Ashok Leyland and Eicher Motors in India and others in Europe and the US. Setco meets ~80% of Tata Motors’ M&HCV clutch requirement, 100% of Eicher Motors’ and 65% of Ashok Leyland’s. It has added global clients Caterpillar, General Motors, Daimler-Benz, Chrysler and Hitachi to its elite client list. Also, Setco is the approved vendor for some global OEMs which have entered India; this would help it service such global markets. It boasts of a loyal client base, attributable to timely delivery, robust and simple clutch designs and an effective cost structure.
22 February 2011 Setco Automotive – M&HCV clutch leader; initiate with a Buy
Anand Rathi Research 132
Fig 9 – Domestic business opportunities
M&HCV opportunity5.5bn-6bn p.a.`
OEM1.1bn`
Setco’s 75% share790m`
Replacement~ 4.5bn-4.9bn`
Setco’s 30% share1.3bn`
2m vehicles added inthe last 10 years.
1m clutches replaced every year @ 4,400 each`
Source: Company, Anand Rathi Research
We believe Setco would cater to clutches for new-age trucks. These have higher realizations for their higher value addition. Its R&D facility in the UK is continually improvising clutch designs. Future demand for higher capacity trucks also augurs well for Setco’s growth potential.
Fig 10 – Demand drivers for clutches
Increasing Freight Capacity
Huge replacement
demand
Massive investment in road sector
Ban on Overloading
Source: Company, Anand Rathi Research
Fig 11 – Factors affecting clutch life
Condition of roads
Distance Travelled
Application
Driver
Overloading
Source: Company, Anand Rathi Research
22 February 2011 Setco Automotive – M&HCV clutch leader; initiate with a Buy
Anand Rathi Research 133
Unique business model Setco is one of the largest suppliers of clutches to the after-market sales, through the distribution networks of Tata Motors, Ashok Leyland and Eicher Motors. Its after-market sales has thus seen a 29% revenue CAGR through FY03-10. Hence, the cyclical effect in the automobile sector is mitigated by the strong after- market sales, as even during the severe downturn in the CV cycle, Setco continued to grow.
In the Indian market, Setco supplies to OEMs and original equipment suppliers (OESs), who cater to the M&HCV segment. Others such as Clutch Auto cater to the MCV, LCV and passenger-car segments, marketing products through OEMs, OESs and the after-market sales. Exide India (erstwhile Ceekay Daikin) supplies only to LCVs and passenger cars via OEMs, OESs and the after-sales market. There are two others, LUK Clutch and Amalgamations Valeo Clutch, in the organised space. Amalgamations Valeo competes with Clutch Auto in the segments it operates in, while LUK caters to the farm-equipment segment only.
On account of its customer profile and nature of the segment (M&HCVs) it caters to, Setco would always have a high replacement market. Also, realizations and margins for Setco’s clutches are very high. The company caters to the replacement market mainly via OEMs’ spare-parts divisions (i.e., OES), which contribute ~56% to its turnover. We believe Setco is well placed to cater to the rising demand as it is the largest manufacturer of M&HCV clutches in India, where it enjoys a ~40% market share. Setco’s clutch realization per piece is much higher than that of its peers (Fig 12-13) on account of its thrust into higher value-added products.
With the increasing number of new-generation CVs on Indian roads, the market for branded clutches is rising. Setco deals in OE as well the after-sales market, giving it a hedge in any downturn in the automobile industry and providing a steady sales pipeline. Clutches need frequent replacement owing to wear & tear in M&HCVs. With more advanced and costly M&HCVs nowadays, demand for clutches being used by OEMs has increased in the after-sales market as well.
Fig 12 – Average realization, clutch cover assembly
0
1,000
2,000
3,000
4,000
5,000
FY05
FY06
FY07
FY08
FY09
FY10
Setco Clutch auto Exedy India
(`/unit)
Source: Company
Fig 13 – Average realization, clutch plate/disc
0
500
1,000
1,500
2,000
2,500
FY05
FY06
FY07
FY08
FY09
FY10
Setco Clutch auto Exedy India
(`/unit)
Source: Company
22 February 2011 Setco Automotive – M&HCV clutch leader; initiate with a Buy
Anand Rathi Research 134
In addition to India, Setco caters to the US, Europe, the Middle East, South Asia and African markets. It plans to expand its client base in the after-sales segment in the aforementioned markets, especially West Africa and Iran. The typical validation period for a clutch, with major OEMs, is 2-3 years. Setco follows the cost-plus pricing formula with customers, thereby largely insulating itself from the change in base prices as well as exchange-rate risks.
Growth in after-market sales is expected to translate into a higher profit margin, since margins in this market are higher than those in OE products. We believe that the size of the Indian M&HCV clutch segment is `5.5bn-6bn, where the organized sector caters to OEM demand and the unorganized sector serves the replacement market only.
Wear and tear requires replacement of a clutch every two years or after 200,000km for M&HCVs. The cover assembly needs to be replaced every 4-5 years. Demand in the replacement market is largely catered to by unorganized manufacturers. Owing to quality and technology issues, the trend is slowly reversing. OEM measures to promote genuine products, customer awareness programmes and tie-ups with local mechanics have helped the organised sector. There has been healthy volume growth in OEMs in the past decade, leading to more vehicles on the road, stimulating replacement demand for clutches.
Setco’s cost-efficient business model enables clients (OEMs) to offer quality spares to end-users and create a sustainable source of revenue. Hence, it has clocked growth through FY09, the worst year for the auto sector. Superior new-age trucks are coming into the market, shifting to organised manufacturers offering premium, branded clutches. M&HCVs produced in the past decade use Setco-manufactured, new-technology clutches.
Fig 14 – Sales trend: segment-wise
60 5750
2936
32 35 43
6356
8 8 7 8 8
0
25
50
75
100
FY06
FY07
FY08
FY09
FY10
OEM Aftermarket Export
(%)
Source: Company
At present, there are +6m CVs in India. In the past decade, more than 2m M&HCVs were produced. Higher growth rates are expected in future. The after-sales market for clutches, which command a higher margin, has significant potential. We expect sales during FY11-13e (in terms of replacement demand for clutches) to grow 25-30%. Also, exports, which command a higher margin, contribute 8% to the company’s revenue and are expected to increase to 15% by FY12e.
22 February 2011 Setco Automotive – M&HCV clutch leader; initiate with a Buy
Anand Rathi Research 135
Expansion to meet rising demand In order to meet the increasing demand, Setco has chalked out an expansion strategy, which would help it increase market share. It is also aggressively looking at exports.
Setco caters to the clutch replacement market and OEMs, where demand drivers are strong. Strong demand revival from OEMs and the replacement market would continue. The company has tie-ups with OEMs for their distribution networks to cater to the replacement markets (where Setco supplies ~56% of its products). Its strength in the after-sales market and high LIPE-brand recognition provide high penetration.
Growing demand
Strong demand revival from OEMs and the replacement market would continue through FY12-13. With these markets booming, Setco is set to see further gains. Access to international CV players through acquisitions in the US and UK has enhanced the company’s customer portfolio. The lower cost of production in India would help the company gain international clients. Robust growth in M&HCVs and the shift to higher value-added new generation CVs would boost growth. The company’s strength in the after-sales segment and brand recognition through its LIPE brand provide high penetration.
Expansion plans
Utilization at Setco’s plants is high. To capitalise on expected growth, the company plans to set up capacity at its Kalol SEZ, at `0.7bn, to cater to rising exports. The unit would be complete by FY13 and funded through debt and internal accruals. Setco also plans to set up an SEZ and R&D centre. These expansion projects would support additional demand and assure a strong revenue stream in future.
Ahead, Setco is looking at increasing its global footprint and plans sharpening its focus on exports. In the next two years, we estimate exports’ share in sales to increase, from 8% at present to 15% by FY13. The company has doubled capacity in the past two years, and continues to increase it, to meet the growing demand for clutches.
Product and research capabilities.
Setco has the ability to produce new-generation ceramic clutches. It acquired two companies to add to its abilities and obtain technology, brands and access to the US and European markets. It has dedicated R&D centres, which help improve customization for export markets
In Jan ’06, Setco acquired the LIPE clutch division from Dana Corporation, UK, along with the latter’s manufacturing and R&D centre. The facility is now known as Setco Automotive, UK. The company has an agreement since CY00 to use the LIPE brand and has been paying royalty to Dana Corp. In addition, it acquired the engineering designing capabilities as well as technical competencies and intellectual property of LIPE to develop new products for India and international markets.
In FY07 Setco acquired the manufacturing plants of Haldex in Paris, USA, in an asset-purchase deal. It became the sole owner of the LIPE brand globally. The acquisition aimed to add important OE customers, especially in the US. Setco has already added Caterpillar and Terex in the US for hydraulics sale.
22 February 2011 Setco Automotive – M&HCV clutch leader; initiate with a Buy
Anand Rathi Research 136
Exports
As exports are a high-margin business, we expect Setco to increase them, from 8% of sales at present to 15% by FY13e. Manufacturing costs in India are 25-30% lower than in the West. The expected entry of major global auto companies Navistar, Mann and Daimler into India, to set up low-cost manufacturing bases would open up fresh opportunities. Supplying the Indian arm of global majors would throw up opportunities to tap demand from other areas for auto components.
Other opportunities
The company has the ability to manufacture clutches for LCVs. It proposes to enter the segment early next fiscal. Technological advances such as hydraulics manufacturing being introduced from the US to India would help gain more international clients. Strong products, R&D capital and the ability to provide a low-cost base for international markets are key ingredients in tapping the vast export opportunities.
22 February 2011 Setco Automotive – M&HCV clutch leader; initiate with a Buy
Anand Rathi Research 137
Financials Robust demand in the auto sector coupled with Setco’s capacity expansion to cater to such demand gives assurance of revenue for the next two years. We expect CAGRs of 23% in revenue and 29% in net profit over FY11-13. We believe that the company would see increased volumes along with better margins.
23% revenue CAGR expected over FY11-13e
With increased demand, we expect a robust revenue performance from Setco. We expect a 23% revenue CAGR over FY11-13. We believe the contribution from exports as well as from the after-sales market would rise in the next two years. The company has seen a 19% revenue CAGR in the past three years despite a recession in the auto industry.
Fig 15 – Revenue and revenue growth
0
1,000
2,000
3,000
4,000
5,000
6,000FY
09
FY10
FY11
e
FY12
e
FY13
e
0
6
12
18
24
30
36
Revenue Revenue growth (RHS)
(`m) (%)
Source: Company, Anand Rathi Research
On account of mounting demand, OEM sales (as percent of total sales) increased in FY10. Exports (as percent of sales) decreased, but are expected to rise in future.
We expect a 23% CAGR in revenue during FY11-13
Fig 16 – Revenue breakdown (FY09)
OEM29%
Aftermarket63%
Export8%
Source: Company
Fig 17 – Revenue breakdown (FY10)
OEM37%
Aftermarket57%
Export6%
Source: Company
22 February 2011 Setco Automotive – M&HCV clutch leader; initiate with a Buy
Anand Rathi Research 138
Increase in margins due to operating leverage
We expect Setco’s EBITDA margin to increase to 17.4% in FY13, mainly on account of the healthy margin in the India operations and improvement in the foreign subsidiaries. In the past few quarters, the company has improved its profit margin. PAT margin has improved from 7.9% in 9MFY10 to 10.2% in 9MFY11. The EBIDTA margin rose from 18.6% to 19.4% in the same period.
9MFY11 performance
Revenue stood at `1,925m (34.8% yoy growth); EBITDA was `373m (40.4% yoy growth) and PAT was `19.6m (73.7% yoy growth).
Fig 18 – EBITDA and EBITDA margin
0
180
360
540
720
900
FY09
FY10
FY11
e
FY12
e
FY13
e
13
14
15
16
17
18
EBIDTA EBITDA margins (RHS)
(`m) (%)
Source: Company, Anand Rathi Research
29% CAGR in net profit expected over FY11-13e
We expect Setco to see a 29% CAGR in net profit over FY11-13e. The growth in net profit would be reflected in expanded return ratios. Over FY11-13, we expect the RoE to be 32.6% in FY11e and 30.9% in FY13e, and the RoCE to increase from 23.3.2% to 24.8%.
Fig 19 – Net profit and net-profit margin
0
150
300
450
600
FY09
FY10
FY11
e
FY12
e
FY13
e
5
6
7
8
9
PAT PAT Margin (RHS)
(`m) (%)
Source: Company, Anand Rathi Research
Fig 20 – Return ratios
15
19
23
27
31
35
FY09
FY10
FY11
e
FY12
e
FY13
e
RoE RoCE
(%)
Source: Company, Anand Rathi Research
We expect the EBITDA margin to increase to 17.4% in FY13, from
14.5% in FY10
We expect Setco to post a 29% CAGR in net profit over
FY11-13
22 February 2011 Setco Automotive – M&HCV clutch leader; initiate with a Buy
Anand Rathi Research 139
Balance sheet improving
Setco’s FY10 net debt-equity ratio was 1.65x and would fall to 0.9x in FY13e. Its working capital days would remain in the 120-day range from FY11-13.
Fig 21 – Working capital days
108
110
112
114
116
118
120
122
FY09
FY10
FY11
e
FY12
e
FY13
e
(Days)
Source: Company, Anand Rathi Research
Fig 22 – Debt and Net debt-to-equity ratio
400
600
800
1,000
1,200
1,400
1,600
1,800
FY09
FY10
FY11
e
FY12
e
FY13
e
70
90
110
130
150
170
190
210
Debt Net Debt/ Equity (RHS)
(`m) (%)
Source: Company, Anand Rathi Research
22 February 2011 Setco Automotive – M&HCV clutch leader; initiate with a Buy
22 February 2011 Setco Automotive – M&HCV clutch leader; initiate with a Buy
Anand Rathi Research 141
Fig 25 - Cash flow statement (`m) Year end 31 March FY09 FY10 FY11e FY12e FY13e
PAT 160 143 264 357 442
+Depreciation 44 84 98 123 142
+Deferred tax 12 6 0 0 0
Cash profit 216 233 362 480 584
-Increase/(Decrease) in WC 118 91 220 346 293
Operating cash flow 98 142 143 134 291
-Capex 278 87 100 250 250
Free cash flow (180) 55 43 (116) 41
-Dividend 26 31 37 45 54
+Equity raised - - - - -
+Debt raised 214 14 100 200 150
+Minority interests - - - - -
-Investments (3) 10 - - -
-Miscellaneous items 9 17 - - -
Net cash flow 1 11 106 39 137
+Opening cash 11 12 23 129 169
Closing cash 12 23 129 169 306
Source: Company, Anand Rathi Research
Fig 26 - Ratio analysis @ `117 Year-end 31 Mar FY09 FY10 FY11e FY12e FY13e
Basic (`)
EPS Fully Diluted 9.1 8.1 15.0 20.2 25.0
Cash EPS 11.5 12.9 20.5 27.2 33.1
EPS Growth (%) 17.6 (10.4) 84.4 35.3 23.6
Book Value per Share 33.7 39.4 52.3 70.0 92.0
DPS 1 2 2 2 3
Valuation (x)
P/E 12.9 14.4 7.8 5.8 4.7
Cash P/E 10.1 9.1 5.7 4.3 3.5
EV/EBITDA 7.9 6.5 4.5 3.5 2.9
EV/Sales 1.1 1.0 0.8 0.6 0.5
Price to Book Value 3.5 3.0 2.2 1.7 1.3
Dividend Yield (%) 1.1 1.3 1.5 1.8 2.2
Profitability Ratios (%)
RoE 30.4 22.2 32.6 33.1 30.9
RoCE 18.0 17.2 23.3 25.0 24.8
Turnover Ratios
Debtors (Days) 54.6 50.7 46.5 46.0 47.9
Inventory (Days) 83.6 81.1 76.7 76.0 79.1
Creditors (Days) 31.7 25.8 23.1 19.7 16.5
Working Capital (Days) 117.2 121.2 113.6 112.8 119.5
Asset Turnover (x) 0.8 0.8 0.7 0.7 0.7
Leverage Ratio
Debt/Equity (x) 1.9 1.7 1.4 1.2 1.0
Source: Company, Anand Rathi Research
Anand Rathi Financial Services Limited does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Disclosures and analyst certifications are located in Appendix 1 Anand Rathi Research India Equities
India I Equities
Key standalone financials
Year end 31 March FY09 FY10 FY11e FY12e FY13e
Sales (`m) 2,928 4,131 4,592 5,647 6,759
Net profit (`m) 415 786 642 820 1,026
EPS (`) 5.8 11.0 9.0 11.5 14.3
Growth (%) -4.2 89.6 -18.3 27.8 25.1
PE (x) 12.3 6.5 7.9 6.2 5.0
PBV (x) 3.0 2.2 1.8 1.5 1.2
RoE (%) 24.5 34.0 22.7 23.5 23.5
RoCE (%) 27.0 29.9 21.5 23.2 24.4
Dividend yield (%) 2.1 2.8 2.2 2.5 2.7
Net gearing (%) 13.4 35.1 35.1 34.4 24.6
Source: Company, Anand Rathi Research Prices as on 18 February 2011
Auto Components
Initiating Coverage
22 February 2011
Banco Products, India
Temporary dip, bright prospects; initiate with Buy
Banco Products, India, is a leading manufacturer of radiators and primed to benefit from steady auto growth at home as well as better demand globally. Strong ties with OEMs, de-risked business and inexpensive valuations make the stock attractive. We initiate with a Buy and a target of `103.
Well placed in the auto segment. Being a leading manufacturer of automobile radiators in India, particularly in the heavy vehicle & equipment segment, Banco is set to benefit from the sustained automobile growth (a 13.7% demand CAGR over FY11-13e).
Diversification benefits. Besides benefiting from demand from OEMs, increased penetration in the non-auto space would de-risk revenue concentration in autos. The acquisition of NRF, Holland, would provide Banco better access to the European market.
Growth to recover. Despite a disappointing FY11, we expect Banco to see a strong recovery in FY12 and register standalone CAGRs of 21.3% in revenue and 26.4% in profit over FY11e-13e.
Valuation and risks. We value the stock at `103, based on 9x FY12e EPS of `11.5. It trades at an attractive 6.2x FY12e standalone PE. After a disappointing FY11, we expect the PE multiple to be re-rated, given stable growth ahead. We initiate with a Buy. Risks: decline in auto demand; negative surprises from a cement venture in Tanzania and rise in commodity prices.
22 February 2011 Banco Products (India) - Temporary dip, bright prospects; initiate with Buy
Anand Rathi Research 144
Investment Argument and Valuation Banco is India’s leading manufacturer of radiators and is poised to benefit from the steady automobile growth at home as well as the better demand overseas. A less-regulated competition and strong ties with OEMs coupled with inexpensive valuations make the stock attractive. We initiate coverage on Banco with a Buy and a target price of `103.
Banco is a leading supplier of engine-cooling components and all types of gaskets in addition to radiators, intercoolers, oil-coolers, etc. Its products are used in the auto and non-auto segments: auto (55% of off-take), earthmoving equipment and construction (20%), industrial engines and others (30%).
In FY10, 78% of Banco revenue came from radiators, 22% from gaskets. Key customers for gaskets were Maruti Suzuki, Tata Motors, Hero Honda and TVS Motors; for radiators, Tata Motors, Ashok Leyland, M&M, BEML, TAFE and the Indian Railways were the main clients. The company’s operations are well-diversified: no customer contributes more than ~10-12% to revenue.
Well placed in the auto segment
Being a leading manufacturer of auto radiators, Banco would continue to benefit from the sustained auto growth ahead, especially as it caters to the heavier vehicle segment (India M&HCV CAGR expected at 11.5% and LCV CAGR at 14.4% over FY11-13e).
The automotive sector is a key customer, contributing ~55% to Banco’s sales. Of this, two-thirds arise at home, the balance from exports. In the CV segment, Banco has a significant 30-35% market share.
The engine-cooling segment is concentrated among the large regulated manufacturers. Stringent design and performance requirements of OEMs and a less active replacement market limit the scope for unregulated players of lower quality.
With the Indian automotive industry seeing robust growth (~25.1% in FY11, and expecting a 13.7% CAGR over FY11-13e), the domestic growth potential for Banco is upbeat. Higher off-take for the non-auto segment would help faster growth than in the auto industry. The share of exports slipped from 37% in FY08-09 to 33% in FY10, attributable to the robust domestic growth and relatively subdued overseas markets.
Diversification benefits
In addition to benefiting from demand from OEMs, increased penetration in the non-auto space would serve towards de-risking revenue. The share of non-auto radiators has risen to ~45-50% of Banco’s revenue (from 25-30% in the past few years).
Even after such fast growth, the industrial segment still has the potential to be a major growth driver, with user industries Railways and Power adding mass to the present business owing to huge spending. The Railways contribute 4-5% of domestic radiator sales; in view of the aggressive targeted capex by the Railways, its share has the potential to rise to 8-10% in the medium term (even on the expanded auto base).
Good presence in the automotive segment and increased presence in
the non-auto segment over the past few years augurs well for Banco’s
growth ahead
22 February 2011 Banco Products (India) - Temporary dip, bright prospects; initiate with Buy
Anand Rathi Research 145
Acquisition gives access to overseas market
The acquisition of NRF, Holland, would give Banco better access to the European market. Further, it would help in product diversification into the non-auto segment, with NRF’s area of expertise being in the quick-supply business as well as in end-products utilised in industries (air-coolers and air-conditioners).
Recovery from the lows for the European auto market (EU regions being major customers) and continuing replacement demand on a further build-up in the automotive base would benefit Banco. (In exports, most of its sales are in the replacement market.)
Valuation
We value the stock at `103, based on 9x FY12e EPS of `11.5. At present, it trades at an attractive 6.2x FY12e standalone PE. After a disappointing FY11, we expect the PE multiple to be re-rated, given the stable growth expected. We initiate with a Buy.
Risks
Banco is looking at new business opportunities in Europe as well as new customers through its acquisition. It would target OEMs in the marine sub-segment. However, this would take at least two years to start contributing to revenue.
Upward trend in commodity prices.
Delay in ramp-up at the acquired company.
Domestic or international auto demand slowdown.
Cement venture in Tanzania may provide negative surprises.
With 33% of revenue from exports, Banco would be subject to a currency-fluctuation risk.
22 February 2011 Banco Products (India) - Temporary dip, bright prospects; initiate with Buy
Anand Rathi Research 146
Well placed in the auto segment Being a leading manufacturer of auto radiators, particularly catering to the heavier vehicle sub-segment, Banco would continue to benefit from the sustained auto growth (13.7% demand CAGR over FY11-13e).
To benefit from auto industry growth
The automotive industry is a key customer, with ~55% of Banco’s sales going to this segment. Of this, two-thirds come from the home markets, the rest from exports.
With the Indian automotive industry in the midst of robust growth (~25.1% yoy growth in FY11e, and 13.7% demand CAGR expected in the next two years), the domestic growth potential for Banco is good. The share of exports has declined from 37% in FY08-09 to 33% in FY10, attributable to the robust domestic growth and relatively subdued overseas markets.
Most of the growth in FY10 net sales was driven by better volumes, introduction of value-added products and competitive pricing. With the rapid transition in technology norms and increase in efficiency standards in the automotive industry, the company has to cater to the much more complex and demanding gaskets and radiators sub-segments of Indian OEMs.
The engine-cooling segment is concentrated among large organised manufacturers. Stringent design and performance requirements of OEMs and a less active replacement market limit the scope for unorganised players of lower quality.
Four decades of experience have resulted in Banco’s better understanding of the business. The company is one of the largest in the organised radiator business, offering a wide range of products and innovative processes.
Tata Motors, M&M and Ashok Leyland are some of its major clients, the first two contributing ~11% each. Banco’s market share in the CV segment ranges from 30% to 35%.
Fig 7 – Comparison of BPIL’s revenue growth and auto industry growth
-30
-20
-10
0
10
20
30
40
50
60
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
e
FY12
e
FY13
e
Banco's revenues CV volumes Auto volumes
(%)
Source: Company, Anand Rathi Research
Banco’s revenue growth trend till FY10 largely mirrored the
Indian CV sector’s. Ahead, we expect its increased non-auto
presence and higher exports to help de-risk operations
22 February 2011 Banco Products (India) - Temporary dip, bright prospects; initiate with Buy
Anand Rathi Research 147
Diversification benefits Besides benefiting from demand from OEMs and exports, increased penetration in the non-auto space would effectively de-risk revenue.
Non-auto share has increased
The industrial segment would be a major growth driver, with user industries Railways and Power adding to the existing business owing to the vast expenditure expected in those sectors. The Railways contribute ~5-7% of domestic radiator sales; ahead, this could rise to 8-10% in the medium term.
Banco’s penetration in the OTR/construction engines sub-segment would boost growth, as these have high sensitivity to capex and infrastructure cycles. The slow and steady foray into the Railways and other heavy engines would be a key growth driver for high-value components and ensure that incremental revenue has a higher EBITDA margin.
In the next 2-3 years, Banco expects to benefit from NRF’s marine-components-supply business and diversify its Indian revenue streams through this vertical. It looks forward to monetize the technology and market access that it would gain through this acquisition.
Cement foray
More controversial in nature is Banco’s decision to venture into the African cement market via setting up a 500,000-ton plant in Tanzania. At present, this has not been factored into our estimates. Some highlights of the project are:
The project cost is US$70m. Of this, equity would be US$24m. Banco’s investment in the cement venture would be US$12.3m. The rest would be borrowed.
Banco would have a 51% stake in the venture; the balance would be with local companies.
The payback period is expected to be three years, with project breakeven predicted at 28% capacity utilisation.
On full production, this plant would cater to 10% of Tanzania’s demand. However, competition would include large players such as Lafarge.
Lake Cements would be run by professionals appointed from India, and would be financed by local banks in Tanzania.
As this is a venture into an unrelated field for the company, we reserve our judgement on the project while factoring in the execution risk as one that might impair financial performance ahead.
22 February 2011 Banco Products (India) - Temporary dip, bright prospects; initiate with Buy
Anand Rathi Research 148
NRF gives access to global markets The acquisition of NRF, Holland, would give Banco better access to European markets through a local base. As NRF specializes in non-auto heat exchanges, this acquisition would help de-risk Banco’s operations.
Exports, overseas presence to increase
The acquisition of NRF, Holland, would give Banco better access to European markets through a local base. NRF has been operating in the business for more than 80 years. Though it specializes in the marine/shipbuilding industry, 50% of its revenue comes from the automotive segment, 25% from Marine and 25% from others. Replacement demand accounts for +50% of sales.
Banco acquired Nederlandse Radiateuren Fabriek B.V. (NRF), which was incorporated in the Netherlands and manufactures heat transfer products. NRF was owned by a US company, now undergoing Chapter 11 proceedings. Banco acquired NRF without any liabilities, for €17.70m, funded via debt and equity.
The European auto market recovering from its lows (EU regions being major customers) and the continuing replacement demand owing to a further build-up in the automotive base would benefit Banco. (In exports, most of its sales come from the replacement market.)
Banco is looking at new business opportunities in the European markets as well as new customers through this acquisition. NRF has subsidiaries all over Europe and a main warehouse in Holland. Banco aims to improve NRF’s product line and business, though 2-3 years would be required for that. Similarly, NRF would benefit from Banco’s cost-cutting measures, synergies, and management initiatives.
22 February 2011 Banco Products (India) - Temporary dip, bright prospects; initiate with Buy
Anand Rathi Research 149
Financials Growth ahead would be driven by growth in user industries such as the automobile sector, marine requirements, the Railways, construction equipment and other industrials. The acquisition of NRF would contribute to growth by increasing operations in Europe, North America and other areas.
Most of Banco’s FY10 sales growth was driven by better volumes, new value-added products and competitive pricing. With the rapid transition in technology norms and the increase in efficiency standards in the automotive industry, Banco has to cater to the complex and demanding gaskets and radiator segments of Indian OEMs.
Banco now operates at ~70-75% utilization. Despite a disappointing FY11, we expect it to recover in FY12 and register standalone CAGRs of 21.3% in revenue and 26.4% in profit over FY11e-13e.
The continuing good performance of OEMs would augur well for Banco, in terms of sustained revenue growth. Growth opportunities from the Railways and Power have further potential for revenue.
Additional positives are Banco’s adapting to changes in technology via investing in R&D and following globally competitive pricing and timely delivery.
Fig 8 – Trend in revenue and profit growth
-20.0
0.0
20.0
40.0
60.0
80.0
100.0
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
e
FY12
e
FY13
e
Revenues Profit
(%)
Source: Company, Anand Rathi Research
Fig 9 – Trend in EBITDA margins
10
14
18
22
26
30
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
e
FY12
e
FY13
e
EBITDA Margin
(%)
Source: Company, Anand Rathi Research
22 February 2011 Banco Products (India) - Temporary dip, bright prospects; initiate with Buy
22 February 2011 Banco Products (India) - Temporary dip, bright prospects; initiate with Buy
Anand Rathi Research 152
Company Background & Management Banco supplies engine-cooling components and all types of engine gaskets, besides radiators, inter-coolers, oil-coolers, etc. Its products are used across auto and non-auto segments.
Banco started in 1962. It has four modern manufacturing plants at Baroda, with state-of-the-art facilities. It collaborates with Elring Klinger, Germany and Japan Metal Gaskets for the Indian market. It has ~600 employees.
Promoter and chairman Vimal Patel has an M.Sc. (Economics) from the London School of Economics and wide experience in automotive components. Shailesh Thakker is the executive director and CFO. Co-promoter Mehul K Patel is a post graduate in engineering from England. The promoter holding in Banco is 69.5%.
Product range
1. Gaskets: The company manufactures and exports a wide range of gaskets for diesel engines (automotive and agriculture).
2. Radiator: It also manufactures and exports radiators for all sorts of applications (automotive, industry, agriculture). It supplies radiators and air coolers to all major OEMs in India and some leading companies in Europe. It also addresses the replacement market, with an extensive range covering popular German, French and Japanese cars.
3. Compressed Fibre Jointing Sheets (CFJS): It manufactures compressed jointing sheets using non-asbestos raw materials, exporting many varieties, covering a range of automotive and industrial applications world-wide.
Anand Rathi Financial Services Limited does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Disclosures and analyst certifications are located in Appendix 1 Anand Rathi Research India Equities
India I Equities
Key financials
YE 31 March FY09 FY10 FY11e FY12e FY13e
Sales (`m) 5,267 7,031 9,500 12,221 15,112
Net profit (`m) 56 240 282 407 566
EPS (`) 0.8 3.3 3.9 5.7 7.9
Growth (%) -26.7 329.1 17.2 44.6 39.1
PE (x) 54.2 12.6 10.8 7.5 5.4
PBV (x) 2.1 1.9 1.7 1.4 1.2
RoE (%) 3.9 15.7 16.3 20.6 24.1
RoCE (%) 8.3 16.7 15.4 20.2 23.1
Dividend yield (%) 1.7 2.0 2.4 2.9 3.5
Net gearing (%) 103.4 82.9 81.9 77.2 63.5
Source: Company, Anand Rathi Research Prices as on 18 February 2011
Auto Components
Initiating Coverage
22 February 2011
Gabriel India
A leading shock-absorber manufacturer; initiate with Buy
We initiate coverage on Gabriel, with a Buy recommendation and a target of `62. Gabriel is one of the leading manufacturers of shock absorbers and likely to see a 42% earnings CAGR over FY11-13e supported by a strong brand catering to stable demand, its location advantage and expansion.
Stable auto demand. India’s auto sector is likely to see a 13.7% volume CAGR over FY11-13e, boosted by two-wheelers and cars. The country is already one of the world’s largest two-wheeler markets and an established small-car global manufacturing hub. We expect the nascent recovery in export demand to gather steam as US/EU auto demand recovers in FY11 after hitting bottom in CY08/CY09.
Strategic plant location; timely delivery. Gabriel’s plants are strategically located, in proximity to original equipment manufacturers (OEMs). This results in timely delivery to clients at lower costs.
Adding capacities. The boom in the automobile industry has led to Gabriel investing `1.5bn-2bn in the next 3-4 years to enhance capacity to cater to the booming demand.
Valuation and risks. At our target price of `62, the stock would trade at 11x FY12e earnings and EV/EBITDA of 4.9x. The target PE is at a slight discount to the stock’s five-year average PE. Key risks: higher interest rates and rise in raw material prices
22 February 2011 Gabriel – A leading shock-absorber manufacturer; initiate with Buy
Anand Rathi Research 155
Investment Argument and Valuation We initiate coverage on Gabriel India with a Buy and a target price of `62. Gabriel is one of the leading manufacturers of shock absorbers and likely to see a 42% earnings CAGR over FY11-13e on the back of a strong brand catering to the stable demand, locational advantage and expansion.
Stable auto demand – positive for Gabriel
Most of the domestic demand for shock absorbers comes from the OEM market; 80% stems from fresh demand in case of Gabriel. With the revival in the auto sector, prospects for the shock-absorber segment seem bright. India’s auto sector is likely to see a 13.7% volume CAGR over FY11-13e, boosted by two-wheelers and cars. Various launches in the past year have attracted a healthy response; with OEMs likely to see further launches, we expect healthy volume off-take for the company.
India is already one of the world’s largest two-wheeler markets and an established small-car global manufacturing hub. We expect the nascent recovery in export demand to gather steam as US/EU auto demand recovers in FY11 after hitting bottom in CY08/CY09.
Leveraging its strategic plant location for timely delivery
Gabriel’s largest plant, at Hasur (Tamil Nadu) supplies suspension products to OEMs Suzuki, Yamaha and TVS Motors. Its plant at Nashik supplies front forks and shock absorbers to Bajaj Auto and Yamaha. Maruti’s plant at Mansesar is being supplied shock absorbers by Gabriel’s Khandsa plant; similarly, Tata Motors, Bajaj Auto, Renault, Volkswagen and the Indian Railways are being served struts and shock absorbers from the company’s Chakan plant at Pune. Gabriel’s plants are strategically located, in proximity to OEMs. Hence, it boasts of timely delivery at lower costs.
Adding capacities
Gabriel plans to leverage its strong brand by targeting more exports. (‘Gabriel’ is India’s most recognized shock-absorber brand.) The company has, through its long experience in shock absorbers, built units to further strengthen its product range. It is #2 in shock absorbers (dominated by Munjal Showa, which primarily supplies Hero Honda), with a 30% share of the organized set-up and a past five-year CAGR of 11-12% (largely volume-driven). It aims at a consistent 25% annual growth in the next three years, mainly via increased domestic volumes and improved exports.
In the past three years, Gabriel has added three plants: Parwanoo, Khandsa and Sanand. This expansion in shock-absorber capacity has driven growth (ytd FY11 revenue up 35% yoy).
The boom in the automobile industry has resulted in the company planning investment of `1.5bn-2bn in the next 3-4 years to enhance capacity to cater to the rising demand.
22 February 2011 Gabriel – A leading shock-absorber manufacturer; initiate with Buy
Anand Rathi Research 156
Outlook and Valuation
The domestic automobile industry saw a strong 12.7% growth over FY02-10 (against a slight decline in FY08). We expect the trend to continue, boosting demand for shock absorbers in OEM and replacement markets. Consequently, we estimate the domestic shock absorber sector to see a 20-25% CAGR over FY10-13e. Gabriel would benefit from the emerging domestic demand and increased exports opportunity.
Gabriel’s leading position, proximity to OEM clients and capacity expansions lead us to believe that there is substantial upside to the stock. Also, it has bagged orders and increased capacities to cater to the rising demand. This would boost its sales volumes. Profitability would improve on account of the operating leverage, increased exports and after-sales contribution. Given the better long-term growth prospects for shock absorbers, we expect healthy return ratios.
At our target price of `62, the stock would trade at 11x FY12 earnings and EV/EBITDA of 4.6x. We assign some discount to the stock’s five-year average multiple. Gabriel’s one-year-forward PE in the past five years has largely ranged between 2x and 40x. P/BV has ranged between 0.3x and 2.4x. At the current market price of `42, the stock trades at PE of 10.8x and 7.5x FY11e and FY12e earnings respectively and EV/EBITDA of 5.1x and 3.6x. We initiate coverage with a Buy recommendation and a target price of `62.
Fig 7 – Twelve-month forward PE: Mean and standard deviations
Mean
+1SD
+2SD
-1SD
-2SD-5
0
5
10
15
20
25
30
35
40
45
Apr-0
5
Sep-
05
Feb-
06
Jul-0
6
Dec
-06
May
-07
Oct
-07
Mar
-08
Aug-
08
Jan-
09
Jun-
09
Nov
-09
Apr-1
0
Sep-
10
Feb-
11
Source: Bloomberg, Anand Rathi Research
Risks
OEM risk. Nearly 80% of Gabriel’s sales are to OEMs, while only 20% to the replacement market (original equipment suppliers). Hence, low volume growth for OEMs would trim the company’s revenue.
Interest-rate risk. A substantially high percentage of vehicles is purchased through auto finance; as such, with an increase in interest rates, cost of financing rises. This affects volume growth of auto manufacturers, thereby impacting Gabriel’s growth.
High raw-material prices. Raw material costs being as high as 70-75% of sales play a large part in pricing and margins. Steel, aluminium, rubber and oil are key raw materials. Any adverse movement in prices would lead to eroded margins.
We value Gabriel at 11x 12-month-forward earnings;
Target price: `62
22 February 2011 Gabriel – A leading shock-absorber manufacturer; initiate with Buy
Anand Rathi Research 157
Stable auto demand India’s auto sector is likely to see a 13.7% volume CAGR over FY11-13e, boosted by two-wheelers and cars. Demand for shock absorbers in India largely comes from the OEM market; 80% from fresh demand in case of GIL. With the auto revival, prospects for the shock-absorber segment look bright. The launch of many vehicles last year has seen a good response; also, based on further launches in the pipeline for OEMs, we expect healthy volume offtake for Gabriel.
Catering to the booming OEM and replacement markets. The domestic automobile industry has been growing rapidly. The replacement market has broadened, with the number of old vehicles in India increasing (average life of ride-control products is 4-5 years). In such an ever-increasing replacement market, where Gabriel supplies ~20% (including supplies to OES) of its products, it could see 30% revenue growth in the next two years. In the replacement market, it commands higher margins.
Fig 8 - Demand drivers in place
Source: Company, Anand Rathi Research
The company has a healthy market share in all segments it operates in. The market size of the ride-control-equipment segment is `23.5bn, of which Gabriel’s market share is 29.7%. It has the lion’s share of 84% in the commercial-vehicle (CV) segment and 44% in the passenger-car segment. Even in the two- and three-wheeler segments, it has an 18% market share, despite not supplying to Hero Honda, the market leader. (Munjal Showa is Hero Honda’s sole supplier.)
“Gabriel” is the most recognized shock-absorber brand
22 February 2011 Gabriel – A leading shock-absorber manufacturer; initiate with Buy
Further, with fresh orders from CV OEMs Mahindra Navistar, Tata Motors, Ashok Leyland and Daimler Commercial Vehicles, Gabriel has secured good business. Also, it is bidding for new products from passenger-car manufacturers Tata Motors and Maruti Suzuki. Gabriel expects 25-30% growth in the next two years, mainly through volumes. It has already secured new business for FY11 worth `1.97bn, and `3.16bn for FY12.
22 February 2011 Gabriel – A leading shock-absorber manufacturer; initiate with Buy
Anand Rathi Research 159
Strategic plant location; timely delivery Gabriel’s plants are strategically located, in proximity to OEMs, resulting in timely delivery to clients at lower costs.
Gabriel has established strong relationships with major OEMs Maruti Suzuki, Ashok Leyland, Tata Motors, TVS Motors, Yamaha, Bajaj Auto and M&M. Diverse clients in various segments mitigates the impact of a slowdown in one segment or a single client.
Fig 13 – Key OEM customers (percentage of FY10 revenue)
Maruti Suzuki, 16%
TVS motors, 18%Yamaha, 11%
Bajaj Auto, 11%
SMIL, 5%
M & M, 4%
TATA motors ltd, 10%
HMSI, 1%
Source: Company
Gabriel’s plants are strategically located in proximity to marquee clients, thereby achieving timely delivery at lower transportation costs. Its largest plant, at Hasur (Tamil Nadu), supplies suspension products to OEMs Suzuki, Yamaha and TVS Motors. The plant at Nashik supplies front forks and shock absorbers to Bajaj Auto and Yamaha. Maruti’s plant at Mansesar is being supplied shock absorbers by Gabriel’s Khandsa plant; similarly, Tata Motors, Bajaj Auto, Renault, Volkswagen and the Indian Railways are being served struts and shock absorbers from its Chakan plant at Pune.
Parwanoo (TVS, Tata Motors, M&M and after-sales market) 5.18 1.98
Dewas (CV: Tata Motors, Eicher, Ashok Leyland, Force Motors, Nano, exports and after-sales market)
4 2.44
Hosur (TVS, Suzuki, HMSI, Yamaha) 4.68 3.83
Sanand, (Tata Nano)
Source: Company
22 February 2011 Gabriel – A leading shock-absorber manufacturer; initiate with Buy
Anand Rathi Research 160
Consistently superior margins to Munjal Showa
On account of its diversified clientele, Gabriel has always enjoyed superior margins to Munjal Showa, which obtains 70% of its revenue from Hero Honda.
Fig 15 – Competitive margin profile
0
2
4
6
8
10
12
FY05
FY06
FY07
FY08
FY09
FY10
Munjal Showa Gabriel India
(%)
Source: Company
22 February 2011 Gabriel – A leading shock-absorber manufacturer; initiate with Buy
Anand Rathi Research 161
Adding capacities The boom in the automobile industry has resulted in the company planning investment of `1.5bn-2bn in the next 3-4 years to enhance capacities to cater to the rising demand.
Gabriel plans to leverage its strong brand by increasing its focus on exports. It built units to further strengthen its product range. It is the second-largest manufacturer of shock absorbers (dominated by Munjal Showa, which is the chief supplier to Hero Honda) and commands a 30% share of the organized set-up. It has seen an 11-12% annual growth for the past five years, largely driven by volumes. It aims at a consistent 25% annual growth for the next three years, chiefly via increased domestic volumes and improved exports.
In the past three years, Gabriel has added three plants (Parwanoo, Khandsa and Sanand); this expansion in shock-absorber capacity has driven growth (ytd FY11 revenue up 35% yoy).
The boom in the automobile industry has resulted in Gabriel planning investment of `1.5bn-2bn for the next 3-4 years to enhance capacities to cater to the booming demand.
A just-in-time approach is vital to contain freight costs, critical in the auto sector. To tap the vast and mounting demand from OEMs, the company has strategically set up its plants in proximity to its clients.
New factory to come up in Gurgaon; expansion at Hosur
The company is setting up a factory at Gurgaon to cater to the swelling demand from Maruti there. Utilization at Gabriel’s present plants is ~90%. To capitalise on expected growth, the company plans to expand capacity at both plants (Gurgaon and Hosur). It aims to increase capacity at all its plants by 15% every year for the next three years.
Gabriel plans to invest `1.5bn-2bn in the next 3-4 years on expanding capacity and R&D. The growth in the industry would entail new plant launches and capacity expansions. Current capacity utilization being significantly high, in line with the high market demand, the company aims at increasing annual capacity by 45% in the next three years to meet the increasing demand from automakers. It is looking to set up a new plant in the Gurgaon region for one of its biggest customers, Maruti Suzuki. Also, it plans expanding capacity at its Hosur plant, which is a supplier to two-wheeler companies. Of the investment, `0.4bn-0.5bn has been earmarked for R&D, while the bulk is for fresh capacity additions. In FY11, the company invested `0.6bn-0.7bn. The expansion would be funded through both internal accruals and debt.
Increasing focus on exports and after-market sales
Ahead, Gabriel is looking to increase its global footprint and increase focus on exports. In the next two years, we estimate the share of exports-to-sales to increase to 5% in FY13e from 2% at present. In the exports market, Gabriel supplies to the OEM and replacement segments. It supplies to Renault in Iran as well as to North America and an OEM motorcycle manufacturer in Bangladesh. Also, the company supplies replacement
Expansion in shock absorbers to drive growth.
Full impact of enhanced capacity would be seen in FY13
Auto industry to drive demand
22 February 2011 Gabriel – A leading shock-absorber manufacturer; initiate with Buy
Anand Rathi Research 162
equipment (shock absorbers) to most Indian vehicles exported.
Fig 16 – Growth in share of exports
0
100
200
300
400
500
600
700
FY05
FY06
FY07
FY08
FY09
FY10
FY11
e
FY12
e
FY13
e
0
1
1
2
3
4
4
5
Exports % of sales (RHS)
(%)(`m)
Source: Company, Anand Rathi Research
22 February 2011 Gabriel – A leading shock-absorber manufacturer; initiate with Buy
Anand Rathi Research 163
Financials Robust demand from the auto sector coupled with Gabriel’s capacity expansion to cater to this demand offer assurance of revenue for the next two years. We expect the company to see CAGRs of 26% in revenue and 42% in net profit over FY11-13e. We believe volumes would increase, with slightly better margins.
26% revenue CAGR over FY11-13e
Following expansion in its shock-absorber capacity on escalating demand, we expect Gabriel to register a robust revenue performance. We expect a 26% revenue CAGR over FY11-13e. We believe the share of exports as well as that of the after-sales market would increase in the next two years.
Fig 17 – Revenue and revenue growth
0
4,000
8,000
12,000
16,000FY
08
FY09
FY10
FY11
e
FY12
e
FY13
e
-15
0
15
30
45
Revenue Revenue Growth % (RHS)
(%)(`m)
Source: Company, Anand Rathi Research
Slight increase in margins due to operating leverage
We expect an FY11-13e EBITDA margin at a strong 8.2-8.5%, owing to healthy margins in new orders and revenue increases in the replacement and exports segments.
Fig 18 – EBITDA and EBITDA margin
0
200
400
600
800
1,000
1,200
1,400
FY09
FY10
FY11
e
FY12
e
FY13
e
0.0
1.6
3.2
4.8
6.4
8.0
9.6
11.2
EBITDA EBITDA margin (RHS)
(`m) (%)
Source: Company, Anand Rathi Research
We expect a 26% CAGR in revenue from FY11 to FY13e
We expect EBITDA margins at a strong 8.2-8.5% over FY11-13e
22 February 2011 Gabriel – A leading shock-absorber manufacturer; initiate with Buy
Anand Rathi Research 164
42% CAGR in net profit over FY11-13e
We expect Gabriel to post a 42% CAGR in net profit over FY11-13e. This growth would be reflected in expanded return ratios. We expect RoE to rise to 24.1% (from 16.3%) and RoCE to 23.1% (from 15.4%) over FY11-13e.
Comfortable balance sheet
The FY10 net debt-to-equity holds at a manageable 0.8x and falls within the industry range of 0.2x to 2x. We expect it to gradually slip to ~0.6x in FY13e. Working capital days are also lower than peers (70-120). Over FY12-13e, this is expected to further fall below FY10 levels.
Fig 21 – Working capital days
0
10
20
30
40
50
60
70
FY09
FY10
FY11
e
FY12
e
FY13
e
(days)
Source: Company, Anand Rathi Research
Fig 22 – Debt and net debt-to-equity
0
500
1,000
1,500
2,000
2,500
FY09
FY10
FY11
e
FY12
e
FY13
e
0
20
40
60
80
100
120
Debt Net Debt/Equity (RHS)
(`m) (%)
Source: Company, Anand Rathi Research
Fig 19 – Net profit and net-profit margin
0
100
200
300
400
500
600
FY09
FY10
FY11
e
FY12
e
FY13
e
0.00
0.70
1.40
2.10
2.80
3.50
4.20
PAT PAT Margin (RHS)
(`m) (%)
Source: Company, Anand Rathi Research
Fig 20 – Return ratios
0
5
10
15
20
25
FY09
FY10
FY11
e
FY12
e
FY13
e
RoE RoCE
(%)
Source: Company, Anand Rathi Research
We expect Gabriel to post a 42% CAGR in net profit over
FY11-13e
22 February 2011 Gabriel – A leading shock-absorber manufacturer; initiate with Buy
22 February 2011 Gabriel – A leading shock-absorber manufacturer; initiate with Buy
Anand Rathi Research 166
Fig 25 - Cash flow statement (`m) Year end 31 March FY09 FY10 FY11e FY12e FY13e
PAT 56 240 282 407 566
+Depreciation 153 202 216 251 281
+Deferred tax 2 35 - - -
Cash profit 211 477 498 658 848
-Increase/(Decrease) in WC (156) 11 179 202 215
Operating cash flow 367 466 319 456 633
-Capex 456 271 379 500 500
Free cash flow (89) 196 (59) (44) 133
-Dividend 59 71 86 103 123
+Equity raised - (0) - - -
+Debt raised 108 (81) 200 200 200
+Minority interests - - - - -
-Investments (10) - 0 - -
-Miscellaneous items - - - - -
Net cash flow (31) 43 55 53 209
+Opening cash 122 91 134 189 242
Closing cash 91 134 189 242 451
Source: Company, Anand Rathi Research
Fig 26 - Ratio analysis @ `42 Year end 31 March FY09 FY10 FY11e FY12e FY13e
Basic (`)
EPS Fully Diluted 0.8 3.3 3.9 5.7 7.9
Cash EPS 2.9 6.2 6.9 9.2 11.8
EPS Growth (%) (26.7) 329.1 17.2 44.6 39.1
Book Value per Share 19.9 22.8 25.5 29.7 35.9
DPS 0.7 0.9 1.0 1.2 1.5
Valuation (x)
P/E 54.2 12.6 10.8 7.5 5.4
Cash P/E 14.6 6.9 6.1 4.6 3.6
EV/EBITDA 9.0 5.0 4.9 3.5 2.8
EV/Sales 0.7 0.5 0.4 0.3 0.2
Price to Book Value 2.1 1.9 1.7 1.4 1.2
Dividend Yield (%) 1.7 2.0 2.4 2.9 3.5
Profitability Ratios (%)
RoE 3.9 15.7 16.3 20.6 24.1
RoCE 8.3 16.7 15.4 20.2 23.1
Turnover Ratios
Debtors (Days) 53.6 41.4 34.8 35.5 36.2
Inventory (Days) 38.8 38.2 36.0 36.7 37.4
Creditors (Days) 58.4 54.5 47.4 48.3 49.3
Working Capital (Days) 66.3 45.9 37.6 34.9 33.3
Asset Turnover (x) 0.8 0.6 0.5 0.5 0.4
Leverage Ratio
Debt/Equity (x) 1.1 0.9 0.9 0.9 0.8
Source: Company, Anand Rathi Research
22 February 2011 Gabriel – A leading shock-absorber manufacturer; initiate with Buy
Anand Rathi Research 167
Company Background & Management Gabriel India is one of the leaders in shock absorbers, struts and front forks (ride-control products) in India. Operating in all sub-segments of automobiles: commercial vehicles, two- and three-wheelers, passenger cars and utility vehicles All its six plants are strategically located, in proximity to OEM units, thereby leading to just-in-time delivery of products and spares. To benefit from the present robust automobile volumes, the company has expanded capacities of its products.
Brief history and business
Established in 1961, the flagship company of the Anand Group and the market leader in the four-wheeler shock-absorber sub-segment, Gabriel India has six plants manufacturing over 20m shock absorbers, struts and front forks. It caters to the booming auto industry (two-, three- and four-wheelers) as well as to the Indian Railways. Shock absorbers and struts constitute the bulk of its sales. Over FY06-10, Gabriel saw CAGRs of 9% in revenue and 28% in net profit. The promoters have raised their stake by 10% through acquiring, in two tranches, Gabriel International’s stake.
Fig 27 – Key management Key Person Designation Background
Prakash Kulkarni Executive Chairman Mechanical engineer; 37 years’ experience in operations and project management. Was MD, Thermax; director, Sulzer India and Praj Industries
Arvind Walia Managing Director CA, 30 years’ experience in finance, tax, operations, legal matters and project management. Has been associated with Gabriel since 2006. Also associated with Anfilco, Anchemco and Henkel Teroson India.
Deepak Chopra Director Member, ICAI, and The Institute of Company Secretaries of India, New Delhi. Elevated as Anand Group CEO. Has been associated with the company since 2008. Specializes in finance and serves as director in many companies.
Russi Jal Taraporewala
Independent Director An eminent economist. Has been associated with Gabriel since 1962. 48 years’ experience in economics, finance, management. Also serves as chairman of the Investor Grievance Committee of Gabriel and Stanrose Mafatlal Investments & Finance and the Remuneration Committee of Standard Industries.
Padmini Khare Kaicker
Independent Director She is a CA and a Certified Public Accountant from USA. She is a partner in M/s B. K. Khare & Co., a reputed CA firm in Mumbai. She has 17 years of rich experience in Auditing, Company Law and Taxation. She has also served as a Chairperson of the Audit Committee of IndusInd Bank. She is associated with GIL since 2005 and is the Chairman of the Audit Committee of Gabriel India Limited.
Rajeev Vasudeva Independent Director CA with MBA and LLB degrees. Specializes in recruitment and assessment of CEOs, COOs and critical leadership talent in the technology and private equity sectors. Has been associated with Gabriel since 2008.
Gurdeep Singh Independent Director B.Tech, Chemical Engineering, IIT, Delhi. Has been associated with Unilever for over 38 years holding key positions. Specializes in project implementation, HR & industrial relations, business development and technical support. Has been associated with the company since 2009. Serves as director of Blue Star, Halonix, Tecnova India Pvt. Ltd., Everest Kanto Cylinders and Gateway Rail Freight.
Source: Company, as of Dec ’10
22 February 2011 Gabriel – A leading shock-absorber manufacturer; initiate with Buy
Anand Rathi Research 168
Fig 28 – Shareholding pattern
Promoter, 54.6%
Public, 31.1%
Foreign holding, 5.9%
Indian Institutions, 0.6%
other corporate bodies, 7.8%
Source: Company, as of December ’10
Anand Rathi Financial Services Limited does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Disclosures and analyst certifications are located in Appendix 1 Anand Rathi Research India Equities
Source: Company, Anand Rathi Research Prices as on 18 February 2011
Chemicals
Update
22 February 2011
Phillips Carbon Black
Powering ahead; maintain Buy
We maintain a Buy on Phillips Carbon Black, with a revised target of `246 (from `261). We are upbeat about the company, given its healthy volume growth and improving high-margin power division. We expect a 23% net profit CAGR over FY11-13e.
Benefiting from rising demand. Demand for tyres would continue rising, in line with the buoyant auto industry. Hence, PCB is likely to benefit from economies of scale. To sustain its leadership and benefit from mounting demand, both domestically and globally, PCB is further expanding capacity.
Capacity expansion to fuel volume growth. PCB’s 360,000tpa expanded capacity now runs at 90% utilization. Another 50,000tpa would be operational by end-1QFY12. Given rising demand, we see the capex as suitably timed.
Power – reduces commodity risk. PCB generates 60.5MW, of which 10.5MW is utilized internally, the rest sold at ~`3/unit. It plans to set up two more plants of 16MW (total) by 2QFY12. We expect this to boost earnings, given the division’s high margin, of up to 80%. Further, PCB plans to tie up some of its spare power capacity through PPAs.
Valuation and risks. At our target of `246, the stock trades at FY12e PE of 5.6x and EV/EBITDA of 4x. We value PCB at FY12e P/BV of 1.25x. Key risks: Volatility in key raw material prices and capacity under-utilization.
22 February 2011 Phillips Carbon Black – Powering ahead; maintain Buy
Anand Rathi Research 171
Investment Argument and Valuation We maintain our Buy recommendation on Phillips Carbon Black, the leader in carbon black production. We revise our target price to `246 and re-iterate our bullish stance, given the company’s capacity expansion and growing high-margin power division. We estimate PCB to register a 23% net profit CAGR over FY11-13e.
Benefiting from mounting demand
In step with the buoyant demand for automobiles, demand for tyres is set to continue rising. Economies of scale would allow PCB to benefit from the upswing in the tyre sector. To retain its dominance in carbon black production and to benefit from rising demand globally and domestically, PCB is further expanding capacity.
Fig 7 – Domestic ranking (FY10) Players Capacity '000 tons Production '000 tons Production share % Exports '000 tons
PCBL 360 258.4 42 41
Hi-Tech 230 233.4 38 43
Continental 65 55 9 0
Himadri Chemicals 50 26 4 -
Cabot 52 44 7 0
Total 757.0 617.2 100.0 84
Source: Industry, Company, Anand Rathi Research Note: The Himadri plant commenced in the Jul ’09 quarter
Capacity expansion to fuel volume growth
PCB’s 360,000-tpa carbon black capacity is running at 90%, and another 50,000tpa would be operational by FY12. Given the buoyant demand, the capacity expansion is suitably timed.
Fig 8 – PCBL: Production and utilization trend
100,000
150,000
200,000
250,000
300,000
350,000
400,000
450,000
FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY13e
71
75
79
83
87
91
95
Capacity Production Utilisation (RHS)
(%)(MT)
Source: Company, Anand Rathi Research
Power – reduces commodity risks
Utilizing waste heat, PCB generates 60.5MW, of which 10.5MW is used internally and the rest sold to exchanges/traders at ~`3/unit. It plans to set up two more power plants by 2QFY12, of total capacity of 16MW. Given that the division generates margins as high as 80% (with negligible costs), we expect such expansion to be earnings-accretive.
Being the market leader, PCB enjoys economies of scale
PCB plans to set up two more power plants of 16MW (total) by
2QFY12
22 February 2011 Phillips Carbon Black – Powering ahead; maintain Buy
Anand Rathi Research 172
Change in Estimates and Valuation
On interaction with the management, we have trimmed our EBITDA estimates for FY11 and FY12 by 3.5% and 5.7% respectively, to factor in the increase in costs. We have also reduced our power tariff (`3.2/unit in FY11 and `3.5 from FY12). We lower our target price to `246 from `261 earlier.
During 9MFY11, PCB’s domestic volumes grew 12.7%. At our target of `246, the stock would trade at FY12e PE of 5.6x and EV/EBITDA of 4x. We value PCB at target multiple of 1.25x one-year-forward P/BV, in line with the past four-year average.
At the current market price of `134, the stock trades at FY11e and FY12e PE of 4x and 3x and an EV/EBITDA of 3.5x and 2.9x respectively.
Fig 10 – Twelve-month forward P/BV: Mean and standard deviations
Mean
+1SD
+2SD
-1SD
-2SD0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
Apr-0
5Ju
l-05
Oct
-05
Jan-
06Ap
r-06
Jul-0
6O
ct-0
6Ja
n-07
Apr-0
7Ju
l-07
Oct
-07
Jan-
08Ap
r-08
Jul-0
8O
ct-0
8Ja
n-09
Apr-0
9Ju
l-09
Oct
-09
Jan-
10Ap
r-10
Jul-1
0
Source: Bloomberg, Anand Rathi Research
Risks
Volatility in key raw material prices. PCB imports most of its key raw material (carbon black feed-stock, CBFS) requirement. Prices of CBFS strongly co-relate with those of crude. Though a pricing mechanism is in place, any sharp increase in CBFS would affect PCB’s margin if not passed on to end-customers.
Capacity utilization. PCB’s greenfield 90,000tpa plant at Mundra has commenced production. If unable to optimally utilize capacity, profitability would be substantially affected.
Forex fluctuation. PCB imports ~90% of its raw material; hence, any depreciation in exchange rates may squeeze margins.
22 February 2011 Phillips Carbon Black – Powering ahead; maintain Buy
Anand Rathi Research 173
To benefit from strong industry outlook In step with the buoyant demand for automobiles, demand for tyres is set to continue rising. Its economies of scale would allow PCB to benefit from the upswing in the tyre sector. To retain its dominance in carbon black production and benefit from rising demand globally and domestically, the company is further expanding capacity.
Through FY04-08, the domestic carbon black sector saw a 5% CAGR in capacities added. Yet by FY07, the industry was flooded with excess demand; hence, major players planned capacity expansions. Over FY09-12, capacity additions are expected at ~10.8%. Of all domestic players, only PCB has planned expansions, 50,000tpa at Mundra, to commence in 3-4 months.
On the other hand, in Jun’10, Cabot India closed its 50,000tpa Thane plant. Setting up a carbon black plant involves a gestation period of 18-24 months. Hence, overall effective capacity addition in the next two years would be only 85,000tpa.
The domestic automobile industry is expected to post a 13.7% volume CAGR over FY11-13e following the 25% growth in FY10 and FY11. Based on this, we estimate the carbon black sector to again see 90% capacity utilization by FY13. Further, the domestic carbon black sector would export the surplus to neighboring countries, at a 26% CAGR over FY10-12e. Growth in carbon black production has followed the trend in tyres and automobiles.
Rise in tyre offtake to propel carbon-black growth
The buoyant domestic automobile sector has triggered off capex programs, both greenfield and brownfield, in the tyre sector (the principal consumer of carbon black). Most tyre companies are expected to commence production at their greenfield units in the next three years. Planned capex by tyre companies is `110bn-120bn. Further, expansions in the Asia-Pacific region would trigger demand for carbon black, both in the OEM and replacement markets.
PCB’s fortunes are directly linked to growth in the auto sector
domestically. Automobiles have seen a quick recovery in demand. We expect a 13.7% CAGR in auto
sales in the next two years
Carbon black is ~25% (by weight) and 16% (by value) of the raw
materials used in manufacturing automobile tyres
22 February 2011 Phillips Carbon Black – Powering ahead; maintain Buy
Anand Rathi Research 174
Capacity expansion likely to fuel volume growth PCB, the domestic market leader in carbon black, would be a key beneficiary of the revival in tyre sales in India. Its 360,000tpa carbon black capacity is running at 90%. The Mundra plant is being expanded by 50,000 tons, scheduled to be operational by end-1QFY12. Given the better demand scenario, this capacity addition is opportune. We expect PCB’s carbon black sales volumes to grow 25.4% in FY11 and another 9% in FY12. We believe the expansion would further strengthen its dominance.
Expansion boosts volumes; focus on gaining strong global foothold
We expect an 8-9% demand CAGR over FY11-13 in the domestic carbon black sector, based on demand increasing in OEM and replacement markets. To address this, PCB embarked on aggressive capacity expansion. In Oct ’09, it commissioned phase-1 of its 90,000-tpa greenfield Mundra plant, boosting carbon-black capacity to 360,000tpa. It is further expanding capacity at Mundra by 50,000 tons, to be commissioned by end-1QFY12.
The capacity addition would enhance economies of scale and bolster sales (by volume) by 25.4% in FY11e and a further 9% in FY12e. Moreover, with carbon black plants shifting from developed to developing countries, the export potential has substantially risen. On expansion, PCB would be able to fortify its global footprint by leveraging its established brand and leading position vs. earlier being largely restricted to its home market.
Revenue from the expansions would start flowing in from FY12. PCB has already incurred capex of `1.8bn on phase-1 of the Mundra capacity augmentation; the next 50,000 tons would entail `750m-800m, funded by debt-equity of 2:1.
Capacity addition at Mundra to boost export volume
PCB’s new 90,000-tpa carbon black plant, which commenced in FY10, has arrested the volume decline in carbon black exports, which was due to rising domestic demand and capacity constraints. With the Mundra capacity addition, we expect exports to rise to 22% (as percent of sales) in FY11e and ~31% in FY12e (from 16% in FY10).
PCB’s 50,000-ton expansion at Mundra is likely to be
commissioned by end 1QFY12and would raise plant capacity to
410,000 tons
22 February 2011 Phillips Carbon Black – Powering ahead; maintain Buy
Anand Rathi Research 175
Fig 12 – Exports (as percent of volumes)
Export Volumes
14
18
22
26
30
34
38
FY07
FY08
FY09
FY10
FY11
e
FY12
e
FY13
e
Export Volumes
(%)
Source: Company, Anand Rathi Research
Carbon black exports (by volume) have improved manifold (Fig 22). In 1HFY10, exports were only 10,200 tons. On the commissioning of the Mundra plant in 2HFY10, exports more than tripled to 30,947 tons and have shown a positive trend after four consecutive quarters of volume declines. Now, quarterly exports have moved to the 17-18,000tpa range.
Fig 13 – Pick-up in exports on commissioning of Mundra plant
Fig 14 – Proposed carbon-black capacity expansion Current capacity
Location Carbon Black (tons/annum) Commencement
Durgapur 140,000
Baroda 90,000
Kochi 40,000
Mundra 90,000
Total 360,000
Expansion
Mundra 50,000 June’11
Domestic capacity after expansions 410,000
Vietnam International (phase-1) 55,000 (not factored in calculations)
Source: Company, Anand Rathi Research
Exports show a positive trend after four consecutive quarters of volume
declines
22 February 2011 Phillips Carbon Black – Powering ahead; maintain Buy
Anand Rathi Research 176
Power – reduces commodity risk PCB generates 60.5MW (via waste-heat recovery), of which 10.5MW is utilized in house with the rest sold to exchanges at ~`3/unit. It plans to set up two more plants of 16MW (total) by 2QFY12. We expect such expansions to be earnings-accretive, given that the division generates margins as high as 80%.
PCB has considerably reduced power costs by converting waste gases released during carbon-black production into steam (used as fuel) against releasing/flaring such hazardous gases. Its power generation capacity is now 60.5MW. Of this, 10.5MW is utilized in-house and the rest sold to exchanges. Production cost for PCB is only `0.3/unit (mainly for O&M; no raw material costs).
It plans to set up two more power plants: 6MW at Mundra (to be operational by 2QFY12) and 10MW at Kochi (to be operational from 1QFY12). The expansions would boost capacity to 74MW. Of this, it is likely to sell 53MW and 58MW in FY12 and FY13 at ~`3.5/unit respectively.
PCB’s further forward integration into power would expand its margins, mainly from revenue in power percolating to the net profit, leading to a ~80% EBIT margin, given that there are no raw material costs. Hence, besides stabilizing earnings, the sale of power would shore up margins.
Not merely into commodities; Power to drive profitability, reduce volatility
PCB is no more only a carbon-black (commodities) story. It is also a play on Power, which would drive profitability. Over the years, it has improved its performance. Price volatility in CBFS as well as slow off-take of carbon black (with the auto sector slowing down, compounded by global dumping of carbon black in India) hit earnings in 2HFY09.
Hence, it has prudently shifted focus to power. With additional power capacity coming up, its earnings potential has improved as the share of power in EBIT is likely to rise, from 27% in FY10 to 36% in FY12e. During 2QFY11 and 3QFY11, its revenue from power declined as realizations from exchanges were low, at `2.5/unit. In 4QFY11, though, we expect it to be `3/unit and, from FY12, we expect realizations to improve further to `3.5/unit as the company is looking at entering into a short-term PPA.
PCB is setting up two more power plants:6MW at Mundra (to be operational by 2QFY12) and
10MW at Kochi (to be operational from 1QFY12), taking its power
capacity to 74MW
22 February 2011 Phillips Carbon Black – Powering ahead; maintain Buy
Anand Rathi Research 177
Financials PCB’s capacity expansion in carbon black coupled with rising demand offers assurance of decent revenue in the next two years. We expect it to register revenue and net profit CAGRs of 10% and 23% over FY11-13e.
Revenue CAGR of 10% over FY11-13e
With the carbon black capacity expansions and rising demand from the auto industry, we expect robust revenue growth in PCB, underpinned chiefly by 7% volume CAGR through FY11-13e to 366,536 tons. The utilization level is likely to improve to 90% in FY13e from an estimated 72% in FY10. We expect a 10% revenue CAGR over FY11-13e. We believe the revenue mix would be tilted towards carbon black, but in the next two years the share from Power could inch up to 7-8% of sales.
Fig 15 – Revenue and revenue growth
6,000
8,000
10,000
12,000
14,000
16,000
18,000
20,000
22,000
FY07
FY08
FY09
FY10
FY11
e
FY12
e
FY13
e
0
5
10
15
20
25
30
35
40
Revenue Revenue growth (RHS)
(Rsm) (%)
Source: Company, Anand Rathi Research
Revenue from the high-margin power segment is set to grow exponentially, from `545m in FY10 to ~`1.4bn in FY13e as operations at Kochi and Mundra gather steam.
We expect a 10% revenue CAGR over FY11-13e
Fig 16 – Revenue breakup (FY10)
Power4%
Carbon black96%
Source: Company, Anand Rathi Research
Fig 17 – PBIT breakup (FY10)
Power27%
Carbon black73%
Source: Company, Anand Rathi Research
22 February 2011 Phillips Carbon Black – Powering ahead; maintain Buy
Anand Rathi Research 178
Stable margins
With the contribution from Power, we expect a healthy EBITDA margin of 14% over FY12-13e.
Fig 18 – EBITDA and EBITDA margin
-1,000
-500
0
500
1,000
1,500
2,000
2,500
3,000
3,500
FY07
FY08
FY09
FY10
FY11
e
FY12
e
FY13
e
(10)
(5)
0
5
10
15
20
EBITDA EBITDA Margins (RHS)
(Rsm) (%)
Source: Company, Anand Rathi Research
Net profit CAGR of 23% expected over FY11-13e
We expect PCB to report a 23% net profit CAGR over FY11-13e. Growth in net profit would be reflected in healthy return ratios. From negative return ratios in FY09, we expect the RoE in FY13 at a healthy 23.3%, with RoCE at 17.3%.
Comfortable balance sheet
The high FY10 net debt-to-equity of 1.7x would fall to 0.9x in FY11. We expect the ratio to gradually slip to ~0.6x in FY12. As most of the capacity expansion is complete and funds for future expansion tied up, we expect debt to fall.
We expect the EBITDA margin over FY12-13e to be 14%
We expect PCB to report a 23% net profit CAGR over
FY11-13e
Fig 19 – Net profit and net-profit margin
-1,000
-500
0
500
1,000
1,500
2,000
FY07
FY08
FY09
FY10
FY11
e
FY12
e
FY13
e
(10)
(5)
0
5
10
15
PAT PAT Margin (RHS)
(Rsm) (%)
Source: Company, Anand Rathi Research
Fig 20 – Return ratios
(30)
(20)
(10)
0
10
20
30
40
50
FY07
FY08
FY09
FY10
FY11
e
FY12
e
FY13
e
RoE RoCE
(%)
Source: Company, Anand Rathi Research
22 February 2011 Phillips Carbon Black – Powering ahead; maintain Buy
Anand Rathi Research 179
Fig 21 – Working capital days
0
5
10
15
20
25
30
35
40
45
50
FY08
FY09
FY10
FY11
e
FY12
e
FY13
e
(Days)
Source: Company, Anand Rathi Research
Fig 22 – Debt and net-debt-to-equity
1,000
2,000
3,000
4,000
5,000
6,000
FY07
FY08
FY09
FY10
e
FY11
e
FY12
e
FY13
e
0.2x
0.5x
0.8x
1.1x
1.4x
1.7x
2.0x
Debt debt - to- equity ratio (RHS)
(Rsm)
Source: Company, Anand Rathi Research
22 February 2011 Phillips Carbon Black – Powering ahead; maintain Buy
Anand Rathi Research 180
Fig 23 – Income statement (`m) Year end 31 March FY09 FY10 FY11e FY12e FY13e
22 February 2011 Phillips Carbon Black – Powering ahead; maintain Buy
Anand Rathi Research 181
Fig 25 – Cash flow statement (`m) Year end 31 March FY09 FY10 FY11e FY12e FY13e
PAT (648) 1,227 1,161 1,541 1,764
+Depreciation 196 312 411 448 491
+Deferred tax (336) 79 - - -
Cash profit (788) 1,617 1,572 1,989 2,255
-Increase/(Decrease) in WC (1,600) 1,441 923 106 173
Operating cash flow 812 176 649 1,883 2,081
-Capex 2,550 1,059 527 800 500
Free cash flow (1,738) (882) 122 1,083 1,581
-Dividend - 165 202 202 202
+Equity raised 402 1 1,236 (0) 0
+Debt raised 1,351 1,299 (800) (700) (700)
+Minority interests - - - - -
-Investments 97 0 (0) - -
-Miscellaneous items (2) (7) - - -
Net cash flow (79) 259 357 181 680
+Opening cash 151 72 331 688 869
Closing cash 72 331 688 869 1,550
Source : Company, Anand Rathi Research
Fig 26 – Ratio @`134 Year end 31 March FY09 FY10 FY11e FY12e FY13e
Basic (`)
EPS Fully Diluted (24) 43 34 45 51
Cash EPS (28) 52 41 53 60
EPS Growth (%) - - (22.4) 32.7 14.5
Book Value per Share 77 115 158 197 242
DPS - 5 5 5 5
Valuation (x)
P/E - 3.1 4.0 3.0 2.6
Cash P/E (4.8) 2.6 3.3 2.5 2.2
EV/EBITDA (13.6) 5.2 4.0 2.9 2.2
EV/Sales 0.8 0.8 0.5 0.4 0.3
Price to Book Value 1.7 1.2 0.8 0.7 0.6
Dividend Yield (%) - 3.7 3.7 3.7 3.7
Profitability Ratios (%)
RoE (28) 45 27 25 23
RoCE (6) 20 15 17 17
Turnover Ratios
Debtors (Days) 62 70 72 73 72
Inventory (Days) 43 47 46 44 44
Creditors (Days) 130 185 157 143 146
Working Capital (Days) 22 18 39 44 44
Asset Turnover (x) 2.4 1.9 2.4 2.7 2.8
Leverage Ratio
Debt/Equity (x) 1.9 1.7 0.9 0.6 0.4
Source : Company, Anand Rathi Research
Appendix 1 Analyst Certification The views expressed in this research report accurately reflect the personal views of the analyst(s) about the subject securities or issuers and no part of the compensation of the research analyst(s) was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst(s) in this report. The research analysts, strategists, or research associates principally responsible for the preparation of Anand Rathi Research have received compensation based upon various factors, including quality of research, investor client feedback, stock picking, competitive factors, firm revenues and overall investment banking revenues.
Anand Rathi Ratings Definitions
Analysts’ ratings and the corresponding expected returns take into account our definitions of Large Caps (>US$1bn) and Mid/Small Caps (<US$1bn) as described in the Ratings Table below.
Ratings Guide Buy Hold Sell Large Caps (>US$1bn) >20% 5-20% <5% Mid/Small Caps (<US$1bn) >30% 10-30% <10%
Anand Rathi Research Ratings Distribution (as of 6 December 10) Buy Hold Sell Anand Rathi Research stock coverage (138) 69% 17% 14% % who are investment banking clients 5% 4% 0% Other Disclosures This report has been issued by Anand Rathi Financial Services Limited (ARFSL), which is regulated by SEBI.
The information herein was obtained from various sources; we do not guarantee its accuracy or completeness. Neither the information nor any opinion expressed constitutes an offer, or an invitation to make an offer, to buy or sell any securities or any options, futures or other derivatives related to such securities ("related investments"). ARFSL and its affiliates may trade for their own accounts as market maker / jobber and/or arbitrageur in any securities of this issuer(s) or in related investments, and may be on the opposite side of public orders. ARFSL, its affiliates, directors, officers, and employees may have a long or short position in any securities of this issuer(s) or in related investments. ARFSL or its affiliates may from time to time perform investment banking or other services for, or solicit investment banking or other business from, any entity mentioned in this report. This research report is prepared for private circulation. It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Investors should note that income from such securities, if any, may fluctuate and that each security's price or value may rise or fall. Past performance is not necessarily a guide to future performance. Foreign currency rates of exchange may adversely affect the value, price or income of any security or related investment mentioned in this report.
This document is intended only for professional investors as defined under the relevant laws of Hong Kong and is not intended for the public in Hong Kong. The contents of this document have not been reviewed by any regulatory authority in Hong Kong. No action has been taken in Hong Kong to permit the distribution of this document. This document is distributed on a confidential basis. This document may not be reproduced in any form or transmitted to any person other than the person to whom it is addressed.
If this report is made available in Hong Kong by, or on behalf of, Anand Rathi Financial Services (HK) Limited., it is attributable to Anand Rathi Financial Services (HK) Limited., Unit 1211, Bank of America Tower, 12 Harcourt Road, Central, Hong Kong. Anand Rathi Financial Services (HK) Limited. is regulated by the Hong Kong Securities and Futures Commission.
Anand Rathi Financial Services Limited and Anand Rathi Share & Stock Brokers Limited are members of The Stock Exchange, Mumbai, and the National Stock Exchange of India.