Varroc Engineering IPO – An Auto-matic BUY

  • 25th June 2018
  • Mid Cap of Rs. 13,000 cr.
  • Industry – Auto Ancillary; IPO Opens 26-28th June at Rs. 965-967
  • Valuations: P/E 28.9 times TTM
  • Advice: SUBSCRIBE

JainMatrix Investments, Varroc IPOSummary of Report

  • Overview: Varroc Engineering is a global tier-1 auto component firm. They design, make and supply exterior lighting systems, plastic and polymer, electricals-electronics and precision metallic components to passenger car, CV, 2W, 3W and off highway vehicle OEMs directly worldwide.
  • India and global revenues are split 35:65 so they have good international presence.
  • Varroc’s FY18 revenue, EBITDA and PAT were Rs. 10,417 cr., Rs. 985 cr. and Rs. 451 cr. resp., and they grew at 13.1%, 12.9% and 18.2% CAGR in 4 years.
  • At a FY18 PE of 28.9x, valuations appear fair. It has a healthy balance sheet with conservative financials. It has good Indian and global presence.
  • Key Risks: 1) High Competition 2) Currency Risks 3) Downturn in macro-economic environment.
  • Opinion: Investors can SUBSCRIBE to this IPO with a 2 year perspective.

Other Auto Sector reports from JainMatrix Investments

Here is a note on Varroc Engineering (Varroc) IPO. You may also Download the PDF file – JainMatrix Investments_Varroc Engineering IPO_June2018

IPO highlights

  • The IPO opens: 26-28th June 2018 with the Price band: Rs. 965-967 per share.
  • Shares offered to public number 2.01 cr. The FV of each is Re. 1 and market lot is 15 numbers.
  • The IPO will raise Rs. 1,955 cr. while selling 15% of equity. The offer will be completed via an Offer for Sale (OFS) by existing shareholders of Rs. 1,955 cr. and there is no fresh issue of shares.
  • The promoter (Tarang Jain) owns 86.3% of Varroc which will fall to 85% post-IPO. The other investors 1) Omega TC Holdings (a PE firm) and 2) Tata Capital Fin. Serv. are fully exiting their 13.7%.
  • The selling shareholders are both Tata group firms that invested in Varroc in Mar 2014. The cost of acquisition was Rs. 162.4/share, so they are getting ~5x returns in 3+ years.
  • The IPO share quotas for QIB, Non Institutional Buyer (NIB) and Retail are in ratio of 50:15:35.
  • The unofficial/ grey market premium for this IPO is Rs. 55-60/share. This is a positive.

Introduction

  • Varroc is a global T1 (tier-1 companies directly supply to OEMs) automotive component group. It’s FY18 revenue, EBITDA and PAT were Rs. 10,417 cr., Rs. 985 cr. and Rs. 451 cr. resp.
  • They design, mfg. and supply exterior lighting systems, plastic-polymer, electricals-electronics, and precision metal components for PVs, CVs, 2W, 3W and off highway vehicle OEMs worldwide.
  • They are the 2nd largest Indian autocomp. group and a leading T1 mfg. and supplier to Indian 2-3W. It is also the 6th largest global auto lighting firm with 4% market share and $1 billion in sales and one of the top 3 independent exterior lighting players (by market share in 2016). Source: News reports.
  • Varroc started with the polymer business in 1990, and grew organically by adding business lines, like electrical and metallic and diversified products. Inorganic expansions – in 2012 Varroc acquired Visteon’s global lighting business, now known as Varroc Lighting Systems (VLS). In 2013, they acquired Visteon’s holding in a 50/50 JV with Beste Motor Co. Ltd. for auto lighting in China, Varroc TYC (China JV). They acquired 70% in auto accessories firm Team Concepts in 2018.
  • Varroc has 2 primary business lines, namely (i) VLS with the design, mfg. and supply of exterior lighting systems to passenger car OEMs worldwide. VLS has a portfolio of lighting products including Halogen, Xenon/high-intensity discharge, LED, OLED, Flex LED and LED pixel headlamp, catering to 5 segments in external automotive lighting. (ii) India Business with the design, mfg. and supply of auto components in India, to 2W and 3W OEMs, including exports. This offers products across 2 product lines, polymers/plastics, electrical/ electronics and metallic components. See Fig 1.

Fig 1- Varroc’s FY18 Segment Revenue/ Fig 2 – Varroc Geographic Revenue

  • Varroc has a global footprint of 36 mfg. facilities spread in 7 countries, with 6 facilities for the VLS, 25 for their India Business and 5 for others. In FY18, their largest customer contributed 18.6% of their revenue and their top 5 customers contributed 59.9% of revenue.
  • VLS has relationships with auto OEMs across the premium, mid-range and mass market pricing spectrum, like Ford, Jaguar Land Rover, Volkswagen, Renault-Nissan-Mitsubishi, Groupe PSA, FCA, a European car and an American electric car maker. The global lighting business has 185 patents.
  • Within India the 25 mfg. and 5 R&D centers form a footprint in the auto hubs, close to customers. Varroc has supplied to Bajaj Auto for 28 years across product lines, it is the largest customer contributing 18.6% and the top 6 are 50%. Other 2W customers are Honda, Royal Enfield, Yamaha, Suzuki and Hero. Export are to global 2W makers namely KTM and Volvo.
  • Leadership is Tarang Jain (MD age 56), Naresh Chandra (Chairman, 83), Ashwani Maheshwari (CEO India), T.R. Srinivasan (CFO) and Arjun Jain (head, electricals, 28). Tarang, Naresh and Arjun are related as Promoter, father and son. Stephane Vedie is the CEO of Varroc lighting, based out of USA.

Endurance Technologies – Snapshot and Varroc connection

  • Endurance Technologies is an India-based company, which makes aluminum casting (including alloy wheels), suspension, transmission and braking products. Endurance is connected with Varroc as Anurang Jain (MD Endurance) is the twin brother of Tarang Jain (Founder promoter of Varroc).
  • Income and PAT has grown at 11.6% and 17.5% CAGR resp. over 5 years. Endurance Tech had  its IPO in Oct 2016 at Rs. 472, the share has gained 176% since to Rs. 1,304.

JainMatrix Investments, Varroc IPO

  • Endurance Tech is perceived as a stable, fast growing and a high quality firm.
  • The Varroc promoters are related to the promoters of Bajaj Auto & Endurance. However even though Endurance Tech is owned by a brother, the two firms have separate businesses and different product offerings for the same customers, so they don’t compete directly. The two brothers had an amicable business split in 2002.

News, Business Notes and Strategies of Varroc

Varroc’s business strategies are:

  1. To focus on growth markets for VLS with new plants in Brazil and Morocco, to supply the South American, southern European and North African markets.
  2. To focus on increasing customer revenue for the India business.
  3. To invest in R&D, design, engineering and software capabilities and capitalize on future trends.
  4. Pursue strategic JV’s and inorganic growth opportunities.
  • In Feb 2018, Varroc entered into a JV in India with Dell’Orto S.p.A., a customer, for the development of electronic fuel injection control systems for 2W’s and 3W’s.
  • Varroc is setting up a mfg. facility in Brazil, one in Morocco and 2 in India.
  • Varroc in June 2018 opened an office in Tokyo to expand its global footprints. With this, they can now target Japanese OEMs for project management and engineering, lighting and electronics.
  • As per Tarang Jain, in the lighting business they want to be in the top 3 globally, while for the 2W business, they want to grow in India and also tap South-East Asia as they are the biggest markets. The revenue target is Rs. 20,000 cr. by FY21, double from FY18, through organic & inorganic growth.
  • Organic investments are going be about Rs 850 crore annually. Varroc has four successful acquisitions in the past, of the lighting business of US-based Visteon Corp, Tri OM for 2W lighting, IMES Poland & Italy for forging business and a small Indian firm which indicates their M&A success.
  • Varroc’s chief of Sales & Marketing Vikas Marwah quit in Apr 2018 after just 5 months. It appointed T R Srinivasan in Oct2017 as CFO taking over from B Padmanabhan, who retired after a 10-year stint.
  • Varroc is eyeing surface LEDs to drive future growth. Surface-LED technology uses thin layers of micro-optic filters and conventional LED light sources to achieve the homogeneous appearance generally associated with OLEDs. The metallic division is also targeting to grow 30% CAGR.

Automotive Exterior Lighting Industry Outlook

  • The global auto exterior lighting market had revenues of USD 17.8 bn. in 2016. Revenue grew 4.5% (FY11-16) CAGR and is expected to grow at 4.3% (FY16-21).
  • Globally, the market growth drivers are (a) increased LED penetration (b) technology innovation (c) design differentiation and (d) higher lighting content per vehicle.
  • The global auto exterior lighting industry comprises more than 20 players around the world. The main 8 players are Koito Mfg. Co., Magneti Marelli, Valeo, Stanley Electric Co., Hella KGAA Hueck & Co, Varroc Lighting Systems, SL Corporation and ZKW, which generated US$16.3 bn. in revenue, representing 91% of the total global auto exterior lighting revenue.
  • Varroc’s market share in the exterior lighting segment in India at present is reported to be 8%.

Financials of Varroc

  • Varroc’s revenues, EBITDA and PAT grew at 13.1%, 12.9% and 18.2% CAGR in 4 years, see Fig 4.
  • The 3 year PAT growth is modest. Varroc as a part of its strategy focuses on cost optimization.
  • Margins are in a range of 7.5-9.5% for EBITDA and 3-4.5% for PAT over the last 4 years. The margins are low, but at par with other OEM suppliers in the industry.

JainMatrix Investments, Varroc IPO

Fig 4 – Financials

  • Note: The FY15 figures are Indian GAAP, and FY16-18 are IND-AS numbers.
  • Varroc has a RoE of 15.9% for FY18 while the 3 year average RoE stood at 16.1% (FY16-18). The RoCE stands at 16.2% for FY18. These return ratios are moderate.
  • Varroc has been Operational Cash flow (CFO) positive in last few financial years. This is a positive. They have typically been investing available CFO for CAPEX i.e. funding expansion plans from internal accruals. It has generated FCFE in the last 3 years. See Fig 5.
  • The current D/E ratio is 0.42 which is moderate. There is ample room for the management to grow faster by raising debt. However Varroc has guided that they would not want a D/E of over 1.
  • The dividend payout ratio is low because of CAPEX needs, the FY18 ratio was 1.37%.

JainMatrix Investments, Varroc IPO

Fig 5 – Varroc’s Cash Flow  

Benchmarking

We benchmark Varroc against other comparable Indian auto ancillary companies. See Exhibit 6.

  • The PE post IPO is fair. PE ratio of Varroc is in the mid-range amongst its peers.
  • The 3 year sales and PAT growth are next to only Motherson indicating stability.
  • Margins in FY18 have improved and are also in the mid-range. The RoE for FY18 stood at 15.9% and RoCE at 16.3%. The return ratios are fair, not very low. The dividend yield at 0.05% is low.
  • In many ways, Varroc appears to be executing a strategy similar to Motherson, but are at about 1/5 the size in terms of revenue, PAT and target market cap.

JainMatrix Investments, Varroc IPO

Exhibit 6 – Benchmarking

Positives for Varroc and the IPO

  • IPO pricing and valuations are fair and at lower end of the peers.
  • Varroc has shown good financial performance and operating efficiency recently.
  • The MD appears to be hiring professionals at the next level / reporting to him, which should strengthen the firm and enable it to grow to the next level.
  • Varroc has a consistent track record of organic and inorganic growth. It has strong customer relationships with high quality OEMs in India, NorthAm and Europe.
  • Varroc has a proven business model and strategy, as seen with the success of Motherson Sumi. There is ample room to grow for Varroc in the sector globally.
  • Strong competitive position in attractive growing markets for VLS.
  • Low cost, strategically located mfg. and design footprint. Varroc has located its facilities primarily in low-cost countries but near major auto markets. They are making investments to expand into Brazil and Morocco, which would keep costs low yet deliver easily to their customers.
  • Robust in-house technology, innovation and R&D capabilities. The VLS business has 964 engineers located in 9 R&D centers, which are located in the Czech Republic, India, China, Mexico, Germany, the USA and Poland. Their R&D teams are focused on quick adoption of technology, enabling them to grow their product portfolio in line with customer expectations and industry developments.
  • Focus on expansion in auto electronics, an important trend in the industry.
  • The Varroc teams including the MD have good experience in the auto component sector.

Risks and Negatives for Varroc and the IPO

  • General economic conditions like the global trade war and protectionism.
  • Auto ancillary sector is considered a working capital and an asset heavy business. New orders involve big additions to working capital, so Varroc will need to manage growth and financial health.
  • Competition is high and Varroc may face pressure on price or margins in future.
  • Varroc is subject to environmental and safety regulations that it has to adhere to.
  • Their success depends on the success and survival of the auto models launched by OEMs. Thus several key success factors for Tier-1 suppliers are out of their control.
  • Varroc’s business is dependent on certain principal customers, especially Bajaj Auto in India. Sales to their top 3 customers for VLS were 50.7% of revenue for FY18, indicating client concentration. However this is a typical auto B2B situation.
  • Labour unrest is always a challenge in a firm with many employees. We came across news of strikes or unrest in Varroc factories in Aurangabad in 2009 and 2017. However these were quickly resolved.

Overall Opinion and Recommendation

  • The Indian auto ancillary mfg. is a high potential space with fair domestic size and growth; there are also significant global opportunities. India has many competitive & comparative advantages, so many global auto firms have set up here; there is also a vibrant two wheeler OEM sector here.
  • In this sector, Varroc has grown to a good size, has improving margins and marquee customers. It has a healthy balance sheet with conservative financials. It has both Indian and global presence.
  • Management quality is excellent with a global vision, eye for controlled growth and financial prudence and in sync with key global auto trends. Governance appears good and transparent.
  • At a FY18 PE of 28.9x, valuations appear fair, but are not cheap. We do not see a near term gain.
  • Key risks are 1) High Competition 2) Currency Risks 3) Downturn in macro-economic environment.
  • Opinion: Investors can SUBSCRIBE to this IPO with a 2 year perspective.

DISCLAIMER AND DISCLOSURE

This document has been prepared by JainMatrix Investments Bangalore (JM), and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of JM. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, JM has not independently verified the accuracy or completeness of the same. JM has no stake, ownership or any other known financial interests in Varroc or any group company. Neither JM nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient’s particular circumstances and, in case of doubt, advice should be sought from an Investment Advisor. Punit Jain is a registered Research Analyst under SEBI (Research Analysts) Regulations, 2014. JM has been publishing equity research reports since Nov 2012. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com.

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Endurance Technologies (IPO) – the Firm has Stamina

  • Date: 04th Oct 2016
  • IPO Period: 5th-7th October, IPO Price range: Rs. 467-472
  • Sector: Auto Components
  • MidCap: Rs 6,639 cr. Mkt cap 
  •  Advice: Investors may BUY with a 1 year perspective.

endurance-technologies-logo

Summary

  • Overview: ETech is the largest 2 and 3-wheeler auto component manufacturer in India, with 25 plants across India, Italy and Germany.
  • ETech had revenues and profits of Rs 5,241 cr and Rs 291 cr. resp. in FY16. Its revenue, EBITDA and PAT have grown 8.1%, 7.8% and 12.4% CAGR from FY12 to FY16.
  • ETech has a significant size, improving margins and marquee customers. It has a healthy balance sheet indicating conservative financials. It has good Indian and global presence.
  • It is not well-known, but with this IPO it may emerge among the leading firms in the segment.
  • At a FY16 PE of 22.8 times, the pricing & valuations leave something on the table for investors.
  • Negatives include sector high competition, cyclical business and currency & global biz risks.
  • Overall, ETech is a good offering and is a high stamina player in the auto ancillary space. As an investment, the ETech IPO is rated a medium risk, high return type of offering.
  • Outlook: Investors can go ahead and BUY this ETech IPO with a 1 year perspective.

Here is a note on Endurance Technologies (ETech).

IPO highlights

  • IPO opens: Wed 5-7th Oct 2016 with Issue Price band: Rs. 467-472 per share.
  • Shares offered are 2.46 crore nos of Face Value Rs. 10 per share and the market Lot is of 30.
  • Shares offered are 17.5% of equity. The IPO will raise Rs 1,162 cr. (upper band) which is a sale by promoter Mr Anurang Jain and investor Actis; there is no fresh issue of shares. So the IPO does not benefit the company directly.
  • The promoter of ETech is Mr Anurang Jain who holds 62%. Actis also holds 14% stake.
  • The IPO shares are available to institutional, non-inst. and retail in ratio of 50:15:35. Post IPO shareholding will be Anurang Jain 58%, Naresh Chandra 12%, Suman Jain 12%, IPO QIB 9%, IPO retail 6% and IPO NIB 3%. Actis is completely exiting.

Introduction

  • ETech is one of the largest 2 & 3 wheeler auto component manufacturer.
  • It had revenues and profits of Rs 5,241 cr and Rs 291 cr. resp. in FY16. Its revenue, EBITDA and PAT have grown 8.14%, 7.83% and 12.42% CAGR from FY12 to FY16.
  • ETech has 25 plants across India, Italy and Germany. The 18 plants in India are located in the auto belts, comprising Aurangabad (8), Pune (5), Pantnagar, Uttarakhand (2) and 1 each in Manesar, Chennai and Sanand. Also, ETech has plants in Germany (2), and Torino, Italy (5).
  • ETech is also setting up a new plant at Halol (Gujarat), possible completion in FY18; a new plant in Germany (FY17) and are planning an auto proving ground (test track) in Aurangabad.
  • Utilization levels in current plants appear in the 20-30% range, indicating growth will be easy.
  • ETech is a tier one supplier for most of their products, and supply directly to OEMs.
  • For FY15, FY16 and Q1 FY17, their revenue contribution from India was 71.5%, 70.1% and 66.8%, resp., while the contribution from Europe was 28.5%, 29.9% and 33.2%, resp.
  • ETech manufactures the following products: (See Fig 1)
    1. Aluminium castings and alloy wheels.
    2. Suspension components: Shock absorbers, Front forks and hydraulic dampers.
    3. Transmission components: Clutch assemblies, friction plates and CVT’s.
    4. Braking Systems: Hydraulic disc brakes, rotary disc brakes and hydraulic drum brakes.
JainMatrix Investments, Endurance Tech IPO

Fig 1 – Geographic Revenue / Fig 2 – Category wise product revenue 

  • In India, ETech manufactures auto components for the 2 & 3 wheeler segments. In Europe, they mostly cater to four-wheeler OEMs, focusing on engine and transmission components.
  • In FY16, ET’s large customers in India were Bajaj, Royal Enfield, Honda Motorcycle and Yamaha. Baja Auto is their largest customer. In addition they supply other OEMs in India, such as Hero, Mahindra, Tata, Suzuki, H-D Motor and Fiat India. In Europe, their largest customer is FCA Italy S.p.A., who in turn supply to Jeep, Chrysler, Alfa Romeo, Abarth, Fiat, Lancia and Daimler. They also supply a few other four-wheeler Europe OEMs.
  • According to the Aluminium Casters’ Association of India, they are the #1 aluminium die-casting firm in India in terms of actual output and installed capacity in FY16.
  • ETech is an innovation-driven company with a focus on R&D, which allows them to develop new products suited to customer requirements. ETech’s R&D process includes design, development, validation, testing, manufacturing, delivery and aftermarket sale service.
  • ETech has been successful in diversifying their products due to their R&D and technology capabilities. Their tech partners include WP Performance Systems GmbH a leading global brake and suspension firm and Adler SpA, a European brakes technology provider.
  • They employ 167 R&D engineers, designers, technicians and support staff in India & overseas.
  • In India, ETech has been granted 4 patents with another 41 patents pending approval. They also have 1 design registration granted and 3 design registrations pending.
  • ETech’s long-term bank facilities are rated CRISIL AA-/Positive and short-term are CRISIL A1+.
  • Leadership is Anurang Jain (MD), Satrajit Ray (ED & CFO), and Ramesh Gehaney (COO). For FY16, the following amounts were aggregate compensation to the executive directors:
JainMatrix Investments, Endurance Tech IPO

Exhibit 3 – Executive Compensation in Rs

  • Over time, ETech has grown organically in India, including consolidating its promoter’s companies into one firm. ETech diversified its capabilities by introducing suspension products in 1996, transmission products in 1998 and braking systems in 2004. Starting from one mfg. facility in 1985, they have grown to now operate 18 facilities in India.

News and Updates for ETech

  • The management of ETech in Feb 2016 discussed their five-year business plan in which they are targeting a turnover of Rs 10,000 cr. for ETech by 2020, obtained through organic growth.
  • ETech is banking upon advancements in product technologies such as braking (combined braking systems (CBS / anti-lock braking systems) and suspension systems (adjustable damping front forks) for growth in the near and medium term.
  • According to ETech, mandatory legislative requirement for ABS of 125cc and above 2-wheelers is good news for ETech as scooters is a growing segment.
  • Mr Naresh Chandra is the father of Anurang Jain, and holds 12% stake (pre and post IPO). Thus ETech is a family controlled business which has a structure in which the family would continue to control 82% of the business (post IPO). Mr Rahul Bajaj (Chairman of Bajaj Group) is the maternal uncle of Mr Anurang Jain. Bajaj Auto was the only client of ETech until 2004.
  • Actis is a leading private equity investor in growth markets across Africa, Asia and Latin America. It had invested Rs 372.5 cr. in ETech 5 years ago buying equity from StanChart PE. The cost of acquisition per equity share for Actis was Rs 190.8. They will gain 147% in 5 years from the IPO.
  • ETech had prepared for an IPO in 2011 but perhaps opted for Actis PE instead.
  • The unofficial/ grey market premium is in the range of Rs 60-65. This is a positive indication.

Two and Three Wheeler Industry Outlook in India    

  • In FY16, auto production in India was 2.45 cr. with 2-wheelers (motorcycles, mopeds and scooters), accounting for over 75%. India’s 2-wheelers industry revenue was Rs 82,000 cr., with a production of about 1.9 cr. 2-wheelers growing at a moderate 5.1% CAGR from FY12-16 mainly due to two years of bad monsoon in 2014 and 2015.
  • It is estimated that two-wheeler production will grow at a CAGR of 8-10% from the period FY16 to FY19. Motorcycles continued to dominate the two-wheelers industry. Source RHP
  • India’s 3-wheeler industry comprises of passenger three-wheelers and cargo three-wheelers. Industrial demand is a key growth driver for the three-wheeler industry.
  • It is expected that consumption would pick up in FY17 with lower commodity prices, inflation and softer interest rates. Currently the capacity utilization is low and these factors will prove to be the growth trigger.
  • India is the largest 3-wheeler industry in terms of production, with a large domestic market and export base. In FY16, India’s 3-wheeler production volume was 9.33 lakh. Over the past five years, India’s 3-wheeler production has grown at 3% CAGR, with steadily rising exports as well as domestic demand. It is estimated that the overall three-wheeler production will grow at a CAGR of 7-8% during the period of FY16 to FY19. Source RHP
  • Rapid technology changes are taking place in automobiles with demand for fuel efficiency, lightweight bodies and a shift from fossil fuels to electric/ renewables.

Financials of ETech

  • ETech revenue, EBITDA and PAT have grown 8.1%, 7.8% and 12.4% CAGR from FY12 to FY16. (Note: The projected FY17 data is a simple extrapolation from the Q1 FY17 results). See Fig 4.
  • The revenue growth is moderate, and margins have been stable to improving over the years.
  • ETech has free cash flows in 4 out of last 5 financial years. This is a positive. Fig 5.
  • ETech has generated high ROE of 20% (FY16). The dividend growth in 5 years has been good considering the cyclical of the nature of the business. Fig 5.
JainMatrix Investments, Endurance Tech IPO

Fig 4 – ETech Financials

JainMatrix Investments, Endurance Technologies IPO

Fig 5 – ETech cash flows

  • The cash per share including Reserves & Surplus and Cash on Balance sheet as on June 2016 is Rs 114/share. So operations of ETech are available at (472-114) = Rs 358/share (at UMP).

Benchmarking

JainMatrix Investments, Endurance Tech IPO

Exhibit 6 – Benchmarking (to enlarge, click image)

We benchmark ETech against Indian listed peers, See Exhibit 6.

  • ETech seems to be fairly priced in terms of P/E and P/B, about 30-40% cheaper than the leaders, Motherson Sumi and Bharat Forge and similar range as Sundaram Clayton.
  • On growth parameters and margins, ETech is fair. Debt is medium and in control.
  • Consistently high RoE and RoCE is a positive. Dividend yield is also impressive in comparison.
  • With an IPO, ETech may achieve visibility and recognition putting it on par with well-known leaders.

Positives for ETech and the IPO

  • IPO pricing and valuations look reasonable.
  • ETech has a consistent track record of organic and inorganic growth. It has strong customer relationships with high quality OEMs in India and Europe.
  • ETech offers products in 4 broad segments which helps to expand customers relationships.
  • ETech has strong R&D and technological capabilities. It has invested in high-quality testing equipment, software, human resources, in its R&D centers for each of their product segments.
  • The balance sheet looks healthy with good cash/share and fair debt.
  • The firm is led by a team with good experience in the auto component industry. The MD has been in the industry since 1985. The next line of management has experience in their respective areas, and have been with ETech for over 5 years. Executive compensation is high but fair compared to profits.
  • The firm has successfully executed a large overseas acquisition in Europe and gained as customers reputed OEMs, and has a fast growing and profitable European business.

Internal Risks 

  • Auto ancillary sector is considered a working capital and asset heavy business. New orders involve big additions to working capital, so ETech has to manage growth and financial health.
  • Competition is high in this space and ETech may get pressured on price or margins in future.
  • ETech is subject to environmental and safety regulations that may adversely affect business.
  • ETech’s business is dependent on certain principal customers, especially Bajaj Auto in India and FCA Italy S.p.A in Europe. Sales to their top 3 customers was 65.3%, 61.8% and 62.1% of their revenue for FY14, FY15 and FY16 resp. However this is a typical auto B2B situation.
  • Their success depends on the success of the models launched by OEMs. Thus several key success factors for Tier-1 suppliers are out of their control.

External Risks

  • The cyclical and seasonal nature of auto sales and production can adversely affect business.
  • As a primarily Tier-1 supplier to OEMs, ETech may be exposed to price and demand squeeze during cyclical slowdowns. In comparison, the replacement/ aftermarket business is typically much steadier and more profitable, while being smaller in size.
  • Forex fluctuations and international issues could negatively impact their business.
  • Current expectations are that the domestic market’s current uptrend will continue for 2-3 years. However if it slows earlier, domestic business will be affected.

Overall Opinion

  • Indian auto ancillary mfg. is a high potential space with ample domestic demand and global opportunities. India has many competitive & comparative advantages. Two wheelers and small cars – R&D and manufacture will shift here with many global players already present.
  • ETech has a significant size, steadily improving margins and marquee customers. It has a healthy balance sheet with conservative financials. It has good Indian and global presence.
  • It is not well-known, but with the IPO may emerge among the leading firms in the segment.
  • Current equity market conditions are positive for IPOs, and auto-ancillaries is a good sector.
  • At a FY16 PE of 22.8 X, valuations appear right and leave something on the table for investors.
  • The negatives include high competition, cyclical sales and currency & global business risks.
  • Overall, we feel that ETech is a good offering and is a high stamina player in the auto ancillary space. As an investment, the ETech IPO is rated a medium risk, high return type of offering.
  • Investors can go ahead and BUY this ETech IPO with a 1 year perspective.

JAINMATRIX KNOWLEDGE BASE 

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  17. Syngene IPO: Good Pharma R&D spinoff from Biocon

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Disclaimer

This document has been prepared by JainMatrix Investments Bangalore (JM), and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of JM. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, JM has not independently verified the accuracy or completeness of the same. JM has no known financial interests in Endurance Technologies Ltd. or any group company. Neither JM nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient’s particular circumstances and, in case of doubt, advice should be sought from an Investment Advisor. Punit Jain is a registered Research Analyst under SEBI (Research Analysts) Regulations, 2014. JM has been publishing equity research reports since Nov 2012. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com.

Motherson Sumi Systems – Global Auto Ancillary Growth

________________________________________________________________________

  • Report Date: 25 Feb’14
  • Market Price: 220
  • Large Cap – Mkt Cap 19,460 crores
  • Advice: Buy with a Mar’16 target of 451, a 104% appreciation

Motherson Sumi Systems is an Indian auto ancillary firm that is growing rapidly through global acquisitions. It cut its teeth as a Maruti Suzuki vendor, then expanded capabilities, product lines and customer base. In recent years it bought undervalued global plants and rapidly turned them around, and now has operations in 25 countries, supplying to all major auto firms. Revenues, EBITDA and Net profits have grown at 77%, 57% and 20% CAGR over the last 5 years. The current high debt should be reduced soon to comfortable levels. MSS is a BUY at current levels.

Description and Profile

  • Motherson Sumi Systems (MSS) is a Noida UP based Auto Ancillary firm operating in 25 countries.
  • FY13 consolidated Revenues were Rs 25,200 cr, EBITDA 1,798 cr and Net Profit 451 cr.
  • The flagship of the Samvardhana Motherson group, MSS consolidates business with Samvardhana Motherson Peguform (SMP) and Samvardhana Motherson Reflectec (SMR), owns 51% of both. MSS is a JV with Sumitomo Wiring Systems (Japan), and has JVs with Japanese, German and U.K. firms.
  • Vivek Chand Sehgal is the Vice Chairman of MSS. The shareholding pattern in % is: Promoters is 65.6% (Indian 40 & Foreign 25.6) FIIs 17.2, DIIs 7.8, Individuals (Retail/HNI) 5.8, and Others 3.6%.

Business Notes

Business Segments

Fig 1 – Business Segments

  • MSS is a major supplier of components, modules and systems to the auto industry globally. These include Polymer Components, Mirrors, Wiring Harness and Rubber & Metal products. Fig 1.
  • The diversified customer base includes most dominant Auto firms. Fig 2.

Customers

Fig 2 – Excellent Customer Base

  • The company offers products in both automotive and non-automotive segments. However non-automotive is very small at about 2%.
  • In non-automotive segment, the company is the largest supplier to industrial forklifts and material handling manufacturers. It also manufactures and assembles water purifier for HUL in India.

Strategies and Events

  • MSS has strong customer relationships and is focused on increasing its Content Per Car. It is mostly the OEM supplier, and this simplifies the Auto company’s vendor management process.
  • Revenues from overseas operations in MSS consolidated grew to 83% (FY13) from 66% (FY11). MSS expanded its global operations and acquired undervalued assets, with 9 acquisitions in 10 years.
  • Post-acquisition of loss making auto ancilliary assets, the MSS management was extremely focused on a plant by plant turnaround, which has been the main reason for MSS success.
  • But the international focus hasn’t hurt the company’s local operations, which are growing fast and setting up new plants. MSS is a key supplier to Hyundai, Maruti Suzuki, M&M and Tata Motors. The domestic auto sector slump did not affect it as exports posted a 25% growth.
  • MSS has an excellent de-risking strategy – the growth should happen such that no Single Customer, Single Country or Single Commodity should constitute more than 15% of the turnover.
  • According to the plan of MSS, by 2015 the company will become a $5b company, increase the global presence to 27 countries, and achieve a ROCE of 40%. It is already close to achieving many of these targets.
  • In May’12, an IPO of Samvardhana Motherson Finance, a group firm, was withdrawn due to poor investor response. MSS is the only India listed firm from this group.

Stock Evaluation, Performance and Returns

The price history of MSS is mapped here.

  • After the 2008 economic slowdown MSS share price fell to a low of 25. It has been on a steady recovery path to a recent Feb 2014 price of 231.
  • In 5 years, the share price has appreciated at 50% CAGR, providing excellent returns to investors.
  • Three bonus issues in the last 7 years (and 4 in last 10) have also accelerated the returns.

Financials

Fig 3 – Quarterly Sales, Margins and EPS

  • Revenues, EBITDA and Net profits have grown at 77%, 57% and 20% CAGR over the last 5 years.
  • The quarterly financials of MSS Fig 3, reveal periodic surges in revenues, due to new acquisitions. In 2009, Visiocorp became a part of MSS (renamed SMR). In 2011, Peguform was acquired (SMP).
  • Margins are on recovery path, along with a massive growth in volumes, reflecting in the adjusted EPS.
  • MSS has been investing heavily in its operations, Fig 4, even so it is enjoying good Cash flow from Operation, and a positive Free Cash Flow.
  • Dividends have steadily increased over the last 6 years. Including bonuses, it is up almost 3.5 times.

Cash Flow

Fig 4 – Cash Flow & Dividend – Standalone

Price and PE_1

 Fig 5 – Price and PE movements

  • The Price and PE chart, Fig 5, reveals the variations in PE values along with the steady share price appreciation. In the last 5 years, the PE ratio has been in a range of 15-35 times, while this historical average is 25 times.
  • Today it is at 29 times, on the upper half of this range.
  • In the Price and EPS chart, Fig 6, we can see a sharp surge in EPS over the last 2 years. The share price has also been in line with this. The EPS growing within a channel represented by two lines.

EPS_1

Fig 6 – Price and EPS movements

  • Total debt is Rs 4071 cr, and D/E high at 1.78. However this is a spike, required to acquire firms, and is expected to be reduced to manageable levels in the next 1-2 years.
  • Return on Capital Employed is 17.4% while Return on Net Worth is 19.4%. These are good ratios.
  • PE is 29.6 currently, and PEG based on PE and EPS growth is at 0.98 – indicates a fairly valued stock.

Benchmarking

In the benchmarking exercise we compare MSS with industry plays like Bharat Forge, Bosch and Exide.

Benchmarking

Fig 7 – Industry Benchmarking

  • With its acquisitions in the recent past, MSS leads in terms of revenue growth. The cost of acquisitions reflects in the high debt.
  • With good cash management, the revenue growth should soon reflect on the profits and debt reduction. Good inventory turnover means factory assets are being well utilized.

Financial Estimate

The business financials are projected in Fig 8.

Projections

Fig 8 – Financial Projections

  • In the next 2-3 years, MSS will consolidate its acquisitions, steady the new operations, grow business volumes and repay debt from cash flows.
  • The recent revenues jumps will soon translate into profit increases.
  • MSS forex revenues is a plus as the INR over 2-3 years will be stable or may even depreciate a little.

Risks

  • Current expectations are that the domestic market’s current slowdown will end in 1-2 quarters, but if it extends for a longer period, domestic investments will be affected.
  • Foreign Exchange volatility. MSS has 83% of revenues in non INR currencies. A significant portion of debt is also in Forex. We can see large unpredictable quarterly gains and losses due to this.
  • Economic environment needs to be stable in key markets of USA, UK, Europe, China and India.
  • Complex corporate structure of group with many cross holdings, JVs and subsidiaries across firms.

Opinion, Outlook and Recommendation

  • The global automobile market recovered significantly in 2013 from the impact of the global financial crisis, buoyed by economic recovery and pent-up demand in the U.S. and Asia.
  • The automobile sector in India has many unique advantages – good local small car demand and production, export momentum, presence of many global names and design skills. Clearly the auto ancilliary industry also incorporates all of these.
  • MSS is a visible, dynamic player in auto ancillaries. They started as a vendor for Maruti Suzuki, and built capability, corporate maturity and finally global growth from this strong base.
  • By all indications, MSS is a successful Indian auto ancillary firm that has made bold moves to grow internationally, acquire technologies, listen to their customers and manage manufacturing well.
  • While the PE at 29.6 appears high, we expect profits growth to exceed this over the next 2-3 years
  • MSS is a buy with a Mar 2016 price target of 451, a 104% appreciation from today (25 Feb’14).

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This document has been prepared by JainMatrix Investments (JM) of Bangalore, India, and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior written permission of JM. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, JM has not independently verified the accuracy or completeness of the same. Neither JM nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein.Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient’s particular circumstances and, in case of doubt, advice should be sought from an independent expert/advisor. Either JM or its affiliates or its directors or its employees or its representatives or its clients or their relatives may have position(s), make market, act as principal or engage in transactions of securities of companies referred to in this report and they may have used the research material prior to publication. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com

SMFL IPO: Complex Auto Conglomerate, Retail can Avoid

  • Date: May 3, 2012
  • Offering:  IPO is of Price Range Rs 113-118, available from May 2-4
  • Description: SMFL is a mid sized Auto ancilliary firm with a complex Private Equity style business model
  • Opinion: Retail investors need to avoid the IPO

SMFL – Description and Profile

  • Samvardhana Motherson Finance is into Auto components design/ manufacture. It is the holding company of the Samvardhana Motherson Group, started in 1975 by Chairman & ED V.C. Sehgal. Group turnover is 13,500 crores, and SMFL revenue 8,300 cr. (FY11).
  • The group is growing organic/ inorganically into an integrated autocomp supplier.
  • In Dec’11, SMFL had 18 Subsidiaries, 19 JVs and 86 other Consolidated Entities. Top holdings, along with SMFL stake and the Revenue contribution are:
    • Motherson Sumi Systems (Listed) – MSSL – 36.12 % stake, 51.2% revenues
    • Samvardhana Motherson Reflectec (SMR) – 63% stake, 33.7% revenues
    • Samvardhana Motherson Peguform (49% stake) contributed 10%.
  • The products suite includes wiring harness, polymer processing, rear-view vision systems, dropdown cabins, metalworking and elastomers. Mfg locations number 120 including 48 abroad.
  • Customers include the Volkswagen Group, BMW, Daimler, Renault Nissan, Ford India, Volvo Car, Maruti Suzuki, Tata Motors, Honda Siel, Toyoto-Kirloskar, etc. They are spread over 25 countries, and in FY12, 76.6% of income was from abroad.
  • About 4% of revenues are from non-auto industry like mfg of cabins for off-highway vehicles, refrigeration systems, and IT and engineering/ design services.

To understand this IPO offer, let us first review the listed group company, MSSL for its business and share performance. See Fig 1.

Motherson Sumi Systems – Financial Snapshot

A 5-year view of the share price of Motherson Sumi Systems in Fig1 shows us:

Motherson Sumi Systems Stock Price, JainMatrix Investments

Fig 1 – Motherson Sumi Systems Stock Price

  • Share price has risen 19% per annum over 5 years. Current market cap is 6700 cr.
Motherson Sumi, JainMatrix Investments

Fig 2 – Motherson Sumi, JainMatrix Investments

  • Revenues appreciated – Fig2 – by 41% CAGR, due to both acquisitions and organic growth. P/E has been in the 12-24 times range. EPS has grown, except for FY12.
  • The FY12 loss was on account of currency fluctuations and acquisition expenses.
  • In short, MSSL has been a good investment over the last 5 years.

SMFL – Financial Snapshot

Samvardhana Motherson Finance, JainMatrix Investments

Fig 3 – Samvardhana Motherson Finance, JainMatrix Investments

  • We can see, while revenues have grown rapidly, profitability has been lumpy.

IPO Offering Outline and Valuations:

  • The offer is of 14.7 crore shares in price range Rs 113-118, from May 2-4
  • The 25% dilution will get Rs 1665 cr. at upper end, for a 6930-cr market cap.
  • With the firm showing losses in FY12, the PE valuation is meaningless. The Price to Book ratio is 3.7, which is 40% lower than that of MSSL, and in the range of Bharat Forge (3.8) and Exide (3.3).
  • ICRA graded the IPO 4/5, indicating above-average fundamentals

Why Is SMFL going for an IPO?

  • The money raised will be used for the following:
    • Pre & repayment of debt availed by SMFL and subsidiaries – Rs 338 cr
    • Investments in SM Polymers (JV) & SM Holding (Subsidiary) – Rs 627 cr
    • Investments in Rear View Vision systems business – Rs 156 cr
    • General corporate purpose – Rs 222 cr
    • Reduction in holdings, by Promoter firm Radha Rani Holdings – Rs 321 cr.
  • The recent acquisition of Peguform has pushed up debt. D/E is at 2.7 times from 0.7 times in previous years. The IPO proceeds will be used to reduce this.
  • SMFL will meet the new listing norms as promoters will have < 75% stake.

Industry Overview

  • India is developing as an important Auto demand & supply center. For small and fuel efficient cars, India leads with R&D and mfg excellence from firms like Maruti, Hyundai and Tata Motors – JLR.
  • Firms like Bharat Forge, Exide, Amtek and the SMG are the Ancillaries support firms in this space. As per CRISIL Research there are over 46 Indian firms of turnover > 500 cr.
  • CRISIL Research projects domestic autocomp mfg. at 14-16% CAGR from 2011-16.
  • Quick calculations give the SMG a rough Market share of 7.4% with SMFL at 4.5% of the Indian autocomp market.

Key Strengths of SMFL and IPO offer

  • Motherson group is an established firm in the autocomp space. The first generation entrepreneur promoter has strong industry experience.
  • MSSL is a listed entity since many years, and has provided good return to investors.
  • The Autocomp sector is cyclical in nature, but is now coming out of a trough, and the outlook over the next few years looks positive
  • Multiple technologies, partnerships and mfg facilities provide a big growth opportunity.
  • SMFL has already raised Rs 222 cr. through issue of shares to four anchor investors – the Govt. of Singapore, Royal Bank of Scotland, US-based IVY Pacific Opportunities Fund and Birla Sun Life.

Key Weaknesses/ Issues/ Challenges of SMFL and IPO offer

  • SMFL is a holding company with a very complex clutch of JVs and subsidiaries. While we can sense the opportunity in the sector, a Valuation of the group and projection of growth is very difficult.
  • Future prospects of the group are embedded within multiple firms, and will be unlocked only on internal exploitation of synergies, successful integration of acquisitions and coordinated marketing.
  • Current revenue concentration is Europe centric (50%) with a poor economic outlook there.
  • The current plunge in profits is another sign of this risky M&A model
  • Will this firm transition from a Family business to a professionally managed one? As SMFL grows from mid cap to large, this may be required to manage a complex global business.

Opinion, Outlook and Recommendation

  • The IPO was subscribed only 9% till EOD 3rd May. This is not a good sign, and the firm may struggle to attain the numbers on the final day. Also there may be no pop on listing.
  • The business model of SMFL is like that of Private Equity, with multiple acquisitions and integrations. Profitability is currently 1-2 years away.
  • Retail investors should not enter into such businesses as this is a high risk model, with very unsteady financials and long gestation investments.
  • Retail investors interested in the group can either enter MSSL, or watch the SMFL listed stock for 4-6 quarters and enter once the business stabilises.

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Bharat Forge – the Forging Giant Returns

CMP: 291          Date: 12-08- 2011          Advice: Invest in SIP fashion

  • Till 2006 Bharat Forge (BF) was primarily an auto components firm. A number of mergers and acquisitions in the 2004-07 periods saw BF also enter in several new geographies. Manufacturing is in 11 locations and 5 countries: India (4), Germany (3), China (2), Sweden (1) and USA (1).
  • In the last 3 years, BF has executed a de-risking plan and enter into new verticals. For BF the focus in the Non-Auto business is on growing sectors like Power Plants, Marine, Construction & Mining, Oil & Gas, Energy, Aerospace and Railways, and Import substitution for BHEL.  JVs are with respected partners, like NTPC for power, Alsthom for Thermal/ Nuclear turbine/ generation sets and UK based David Brown for gear box manufacturer
Bharat Forge

Change in Revenue Segments

Fig 1 – Business Segments in 2011 (click chart to expand)

 Bharat Forge has successfully diversified from Auto into other verticals, de-risking their overall business profile

Current Business Outlook

  • The fall in auto demand in 2007-09 saw cost cutting measures rolled out to lower the break even for manufacturing facilities. Capacity utilization improved from 53% in 2009, to 70% for standalone and 45% for international entities in 2010. Additional improvements have contributed significantly to profits. All overseas subsidiaries, including its JV in China, FAW Bharat Forge, have see a turnaround and have started contributing to the bottom line, a year ahead of the 2012 target.
  • The auto market began to revive in 2009, and BF was best placed to take advantage of this trend.
  • In June 2011, Bharat Forge quarterly revenues surged to 857 crores, an all time high.
  • The Business environment and demand situation has now become very positive. BF is able to take advantage of surging demand due to spare capacities, low cost production, global presence and nimble design capabilities. Also a series of well timed entries into new non-automotive markets.
Bharat Forge

Quarterly sales and Net Profits

 Fig 2 – Quarterly revenues have surged (click chart to expand)

 Business is surging, in both Auto and non-Auto segments. Profit growth follows in a phased manner, as investments in new businesses break even

Valuations are low, growth is high

  • The stock price peaked in 2006 and has not touched those levels since. But BF has seen a dramatic business recovery in the last two years in terms of Earnings per share – EPS, which has already risen to all time highs.
  • While the BF stock has given investors only 11% CAGR returns over a 7-year period, the aggressive nature of this firm means that the initial period of rapid gain was followed by a period of restructuring and consolidation. The expectation now is another period of rapid gain on all parameters.
  1. Adjusted EPS has seen a recovery post ‘09 and is now into all time high territory
  2. Debt-equity is 0.74 as of Mar’11 (down from 1.21 in ‘10). This is comfortable, and safe.
  3. ROCE and RONW are in 15-17% range indicating healthy returns.
  4. PE has fallen to reasonable levels (compared to historical) indicating safety in investments at this level.
  5. PEG is in the range of 0.3, indicating indicates high safety and undervalued status
Bharat Forge

Fig 3 - EPS and Cash Flow

Bharat Forge

Fig 4 - Price and PE

Fig 4 – PE has fallen to attractive levels, and combined with robust business performance gives us a very good entry point for long term investments – (click chart to expand)

Bharat Forge

Fig 5 - Price and EPS

Fig 5 – Adjusted EPS has retraced rapidly and is into all time high territory

Projection

  • Bharat Forge has been in a period of consolidation, and will see a break out soon
  • EPS has moved to all time highs. With a suitable lag, this will be followed by stock price also moving into new highs. The stock will appreciate to Market Price of 700 in 12-14 months. This is based on an expected PE of 30 range and continued EPS growth seen since the bottom of June 2009.
  • This is an excellent entry point for this stock as it is currently underpriced and ‘out of favour’. The current market weakness has dragged down the market price of the stock. With overall Sensex / market recovery expected in 6-9 months, this share price is expected to recover rapidly.

Risks

  • Auto sector demand in India has been tapering off in recent months. It is expected to have lower growth for 2-3 quarters before recovering. Auto Exports however from India are accelerating.
  • Headwinds, such as Higher raw-material costs like steel and power may restrict margin expansion and EPS growth. The rising commodity costs have hit manufacturers like Bharat Forge.
  • In recent months the increase in interest rates and slowdown in the economy has slowed the growth of the auto industry, particularly in India.
  • However, both these events appear to have played out/peaked, and will stabilise/ reduce in the near future.
  • Business complexity has increased due to addition of a number of new verticals. However, BF is already seeing exciting success from the new ventures.
  • An increase in working Capital in the firm in 2011 saw the Cash Flow fall this year. This stems from investments in new businesses as well as new investments in the Auto business to increase capacity and de-bottlenecking.
  • External factors like stock market sentiments. However our current view is that this will revert to a positive state over the next 9-12 months.
  • Check back on the website www.jainmatrix.com for updates.
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These reports and documents have been prepared by JainMatrix Investments Ltd. They are not to be copied, reused or made available to others without prior permission of JainMatrix Investments. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com Also see: https://jainmatrix.wordpress.com/disclaimer/

Bharat Forge – CMP: 361 – Invest with an 18 month target of 700

Introduction

  • Bharat Forge is a Pune based manufacturer of forged and machined – engine & chassis components. It is the largest exporter of automotive forgings and chassis components from India. It is the second largest in the world, after ThyssenKrupp of Germany.
  • Manufacturing facilities are spread across 11 locations and 5 countries – four in India, three in Germany, one each in Sweden, USA and two in China.
  • The company manufactures a wide range of safety and critical components for passenger cars, SUV’s, light, medium & heavy commercial vehicles, tractors and diesel engines. The company also manufactures specialized components for the aerospace, power, energy, oil & gas, rail & marine, mining & construction equipment, and other industries. Parts are made of steel and aluminium.
  • Business growth has been steady over the last 7 years. The fall from end 2008 to end 2009 due to a global slowdown, and this has been followed by a rapid recovery thereafter.
  • Pre- 2004, Bharat Forge was focused on increasing capacity and the Pune facility became the largest single forging and casting plant.

Fig 1 – In Sept 2010, Bharat Forge achieved all time high revenues of Rs 719 crores, signaling full recovery.

Fig 2 – Business Segments in 2009

M&A

  • A number of mergers and acquisitions in the 2004-2007 period saw Bharat Forge expand to new geographies. In the process it added a number of prestigious customers and was able to supply products to almost all the major automotive firms worldwide as OEM

Diversification

  • Till 2006 Bharat Forge was primarily an auto components firm. The auto demand collapse and forward looking corporate de-risking plans saw the firm fast track entry into other verticals in the period from 2006 to date.
  • Internal targets are to double non-automotive business from 20% in 2008 to 40% by 2012.
  • For Bharat Forge the focus in the Non-Auto business is on fast growing sectors like Power Plants, Marine, Construction & Mining, Oil & Gas, Energy, Aerospace and Railways. Also on Import substitution for BHEL which itself is a big opportunity. Diversification into these sectors is through a series of JVs with respected partners (eg NTPC for power and Alsthom for Thermal/ Nuclear turbine/ generation sets

Current Business Outlook

  • The fall in auto demand in 2007-09 saw cost cutting measures rolled out to ensure a lower break even for these facilities. Capacity utilization was 53% in 2009. This has improved to 70% for the standalone entity and 45% for international entities in 2010. From here all improved utilization will contribute significantly to profitability. We do not anticipate a need for auto capacity increase for several years.
  • As a result of these business initiatives, when the market began to revive in 2009 for auto industry, Bharat Forge has been best placed to take advantage of this trend.
  • Demand is increasing from both domestic business – Commercial Vehicles and Passenger cars, as well as international – UK and USA. Demand growth is led by India and China, and developed economies have stabilized and are expected to slowly recover in terms of business volumes.
  • The Society of Indian Automobile Manufacturers (SIAM) releasing the 2010 sales growth data of 14.82 million units as against 11.32 million units registered in 2009. Sales of passenger vehicles segment grew by 31.34 percent, commercial vehicles segment by 45.24 percent, three-wheelers by 22.03 percent and two-wheelers by 30.51 percent. They said that the growth was due to increasing dispensable incomes, low interest rates and increase in sales base at par with the pre-recession era.
  • The firm has seen all of its overseas subsidiaries, including its joint venture in China, FAW Bharat Forge, turn around and start contributing to the bottom line, a year ahead of the 2012 target
  • India is emerging as a small car-manufacturing hub, with a number of new entrants and a slew of product launches. The luxury market too has grown rapidly. As the market matures, mid sized sedan volumes too will grow. Bharat Forge is a supplier to virtually all the auto manufacturers in India as OEM.
  • Demand for Bharat Forge’s auto components is a derived demand – dependant upon the Auto manufacturers for sales. The India domestic auto market is doing well with many auto models having a ‘waiting period’ of 2-4 months for delivery after booking by the consumer.

Conclusions, projections and Investment advise

Valuations and conclusions

  • The chart (Fig 3) plots the market price (adjusted) against EPS (adjusted) over a 7-year period.
  • The stock price peaked in 2006 and has not touched those levels since. But we can see the dramatic business recovery of Bharat Forge in the last one year in terms of EPS
  • The PE of Bharat Forge (Fig 4) has been at high levels of late – rising to as high as 80 times. However if you see this in the light of the short-term squeeze in business environment, this is a passing phase.
  • The Business environment and demand situation has now become very positive. Bharat Forge is well placed to take advantage of surging demand due to sufficient spare capacities, low cost production facilities, global presence and nimble design and manufacturing capabilities. Also a series of well timed entries into new non-automotive markets.
  • We expect EPS to continue recovery and move to all time highs. This will be followed by stock price also moving into new highs territory.
  • Net Cash From Operating Activities has shown a positive trend, barring FY 2009.
  • Debt equity is 1.21 as of March 2010. This is not too high and is 3.5 times the Net Cash From Operating Activities

Fig 3 – Current PE looks high but seen in the context of a rapidly increasing EPS, improving capacity utilization and positive business outlook, it will soon settle to lower levels.

Fig 4  – Adjusted EPS has retraced rapidly and is nearing the 2008 peak.

Projection

  • We expect the stock to appreciate to Market Price of 700 in 18 months.
  • This is an excellent entry point for this stock as it is currently underpriced and ‘out of favour’. The the next 2-3 quarterly results will be positive and the share price may start to reflect it’s true worth.

Risks

  • Higher raw-material costs like steel and power  may restrict margin expansion and EPS growth.
  • Low cost domestic capacity may get exhausted, requiring additional capital investments.
  • Business complexity has increased due to addition of a number of new verticals. Management bandwidth and Vertical/ Technical skill-sets need to be upgraded to meet the business challenges.
  • New subsidiaries and JVs need to rapidly add capacity and win deals – early stage of new businesses are uncertain and need management attention before business stabilizes.
  • External factors like stock market sentiments. However our current view is that this will be positive over the next 12 months at least

Disclaimer:

These reports and documents have been prepared by JainMatrix Investments Ltd. They are not to be copied, reused or made available to others without prior permission of JainMatrix Investments. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com Also see: https://jainmatrix.wordpress.com/disclaimer/