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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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.

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.

JainMatrix Knowledge Base:

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Disclosure: It is safe to assume that if the JainMatrix website recommends a stock, the researcher has already invested in it.

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