India Auto Components Overweight - Myirisbreport.myiris.com/ARSL/AMTAUTO_20110222.pdf · Anand...

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India I Equities

Auto Components

Sector Report

22 February 2011

India Auto Components

Overseas sales – Paving growth

Overweight

Nifty/Sensex: 5459 / 18212


India I Equities Auto Components

Sector Report

22 February 2011

India Auto Components

Overseas sales – Paving growth

The Indian auto components sector is primed to benefit from recovery in overseas sales and continuing growth in the domestic auto sector. Streamlining of costs and improving productivity have led to healthier financials; also, diversification in non-auto segment and wider exports coverage are new revenue drivers.

Overseas sales to strengthen. On the ongoing recovery in US and Europe, we expect a rise in auto demand from OEMs/ tier-1 suppliers, fueling overseas revenue for Indian auto-part players. We expect a 28.1% CAGR in standalone exports over FY11-13e for our auto-parts coverage vs. 19.7% for domestic sales.

Steady growth in domestic auto sector. After two years of swift growth, the Indian auto sector has now entered a steady growth phase. We expect a 13.7% CAGR in industry volumes over FY11-13e, thereby providing firm support to auto components.

Improved efficiencies, de-risking. Auto-parts companies are benefiting from efforts to conserve cash, reduce costs and raise productivity. Also, de-risking via entry into the non-auto segment and prudent investments would lead to 21.5% sales CAGR in FY11-13e vs. 15% for the auto industry.

Stock picks. Our top picks: Motherson Sumi (diversified), Setco (replacement demand), Gabriel (demand growth), Bharat Forge (good business model), and Amtek Auto (overseas recovery, attractive valuations). Risks are demand slowdown, commodity cost pressures, delay in export ramp-up due to slowdown.

Overweight

Nifty/Sensex: 5459 / 18212

Auto sector vs Sensex

BSE Auto

Sensex

90

100

110

120

130

140

150

Feb-

10

Apr-1

0

Jun-

10

Aug-

10

Oct

-10

Dec

-10

Feb-

11

Source: Bloomberg

Valuation matrix - India auto components Amara Raja Amtek

Auto* Banco

Products Balkrishna

IndsBharat Forge*

Exide Inds

Gabriel India

Mahindra Forgings*

Motherson Sumi*

NRB Bearings*

Phillips Carbon

Setco Auto*

Rating Buy Buy Buy Hold Buy Hold Buy Buy Buy Buy Buy Buy

Current price (`) 165 117 71 127 319 130 42 65 185 46 134 117

Target price (`) 210 225 103 144 396 149 62 137 221 68 246 182

M. Cap. (m US$) 313.0 545.1 113.8 274.7 1,649.1 2,464.1 71.1 133.2 1,591.9 97.1 97.0 45.8

EPS CAGR (FY11-13e, %) 22.7 23.7 26.4 8.5 49.1 19.5 41.8 239.6 32.8 18.7 14.9 29.3

PE (x) 7.8 6.0 6.2 7.7 16.1 15.3 7.5 11.8 15.1 7.3 3.0 5.8

EV/EBITDA (x) 4.4 3.6 3.3 5.5 7.1 8.9 3.5 4.2 7.0 4.0 2.9 3.5

RoE (%) 22.3 8.3 23.5 16.4 20.0 21.7 20.6 6.0 31.5 23.4 25.2 33.1

RoCE (%) 29.0 11.1 23.2 15.0 20.5 30.1 20.2 8.5 29.4 27.6 16.8 25.0

Asset Turnover (x) 2.2 0.6 1.1 1.2 1.3 1.7 0.5 2.0 3.5 0.8 2.7 0.7

Source: Company, Anand Rathi Research; Note: Ratios are based upon FY12e earnings, * consolidated Prices as on 18 February 2011

22 February 2011 India Auto Components – Overseas sales – Paving growth

Anand Rathi Research 2

India Auto Components Overseas sales – Paving growth

Investment Argument and Valuation .............................................3

Overseas sales to strengthen................................................................... 3

Steady domestic auto growth ................................................................... 3

Improved efficiencies, diversification ........................................................ 4

Valuation .................................................................................................. 5

Overseas sales to strengthen .......................................................7

Increased optimism among OEMS and suppliers ................................ 7

Auto components – Upbeat outlook ..................................................... 8

Strong pipeline of some European manufacturers could add to demand............................................................................ 8

India still a considerably attractive low-cost base................................. 9

Quality no longer an issue.................................................................... 9

Steady domestic growth ..............................................................11

Resilient domestic auto demand... ..................................................... 11

Improved efficiencies...................................................................13

Steps taken in tough times would now help ....................................... 13

Operating performance to sustain ...................................................... 13

Company Profiles ........................................................................16

Motherson Sumi..................................................................................17

Bharat Forge .......................................................................................31

Exide Industries ..................................................................................46

Amtek Auto .........................................................................................58

Amara Raja Batteries..........................................................................74

Balkrishna Industries...........................................................................85

Mahindra Forgings .............................................................................98

NRB Bearings ...................................................................................113

Setco Auto ........................................................................................127

Banco Products.................................................................................142

Gabriel .............................................................................................153

Phillips Carbon Black .......................................................................169



Investment Argument and Valuation The Indian auto components sector is primed to benefit from continuing growth in the domestic auto sector and recovery in overseas sales. Streamlining of costs and improving productivity have led to healthier financials; also, the non-auto segment and wider exports coverage are new revenue drivers. Our top picks are Motherson Sumi Systems, Bharat Forge, Gabriel India, Amtek Auto and Setco Auto.

Overseas sales to strengthen A steady revival in auto-component exports and overseas revenue improvement from end-FY10, despite overseas demand (excluding incentive schemes) not significantly improving, has been a notable feature of FY11. Ahead, we expect the nascent recovery in export demand to gather steam as auto demand in the US/EU picks up, after having hit bottom through CY08 to CY10.

We expect the recovery to benefit dually – first, by driving exports and second, by improving growth in overseas subsidiaries. We expect our auto-parts universe to see a 28.1% standalone exports CAGR over FY11-13e vs. 19.7% CAGR for domestic sales.

Moreover, with skilled manpower readily available, India continues to retain its edge as a low-cost manufacturing base. A key area where India scores over China is in the better protection afforded to intellectual property rights (IPRs).

Fig 1 – India among the lowest labour-cost countries

0

10

20

30

40

50

60

Indo

nesi

a

Philip

pine

s

Indi

a

Thai

land

Mex

ico

Chi

na

Rom

ania

Arge

ntin

a

Mal

aysi

a

Hun

gary

Indonesia Philippines India Thailand MexicoChina Romania Argentina Malaysia Hungary

Source: globalproduction.com, Note: on a scale of 1 to 100;m as of CY09

Steady domestic auto growth After two years of rapid growth, the Indian auto sector has now entered a sturdy growth phase. We expect industry volumes to see a 13.7% CAGR over FY11-13e, providing a firm backbone to the sector.

Likely key growth drivers are:

1. Sustained two-wheeler demand: We expect two-wheeler demand in India to continue to swell, while penetration and expansion into new areas globally would boost export growth. In the two-wheeler sector, we expect a 13.7% volume CAGR over FY11-13e.



2. India, a global small-car hub: India has emerged as a small-car-manufacturing hub as all major global auto companies have set up manufacturing bases here (VW, Skoda and Nissan among the latest) with the dual aim of capturing local demand and benefiting from the low-cost manufacturing facilities here. Hence, they are likely to use India as an export base. We expect a 13% CAGR over FY11-13e in India’s passenger vehicle sales.

3. Replacement demand: Replacement demand would continue to fuel non-cyclical demand for auto-component companies, especially for batteries and tyres. The replacement demand trajectory would follow an increasing trend due to the robust 14% CAGR in India’s auto sales over FY02-11e.

Fig 2 – Auto sector: volume CAGR over FY02-11

0.0

5.0

10.0

15.0

20.0

25.0

PV LCV M&HCV 2wh 3wh Total

(%)

Source: SIAM

Improved efficiencies, diversification Lower demand in 2HFY09 and spiralling raw material costs just prior to this period led to companies rapidly adopting measures to conserve cash, reduce costs and improve productivity. These steps helped auto-component companies survive the downturn; this augurs well for enhanced profitability ahead. Hence, as compared to a revenue CAGR of 21.5% over FY11-13e, we expect a higher profit CAGR of 28.4%.

Given the cyclical trends in the auto industry, players are diversifying/de-risking their business models; Bharat Forge, Amtek Auto, Rico Auto and MSSL have already taken such measures in the past two years. We expect this to be an even more widespread trend.

We believe that diversified companies would be better performers. Diversifying into the non-auto sub-segment, upgrading to non-commoditised products and broadening the product range would lead to companies emerging stronger.

Also, de-risking via entry into the non-auto segment and prudent investments would lead to 21.5% revenue CAGR in FY11-13e vs. 15% for the auto industry.



Fig 3 – Improvement in companies’ RoE (FY09-13e)

-10

-5

0

5

10

15

20

25

30

35

40

FY09

FY10

FY11

FY12

FY13

Balkrishna Inds Bharat Forge* Gabriel IndiaMotherson Sumi* NRB Bearings* Setco Auto*

(%)

Source: Company, Anand Rathi Research, Note: * consolidated

Valuation The auto-components sector trades at PE of 11.4x FY12e and 9x FY13e earnings (compared with 11.4x FY12e and 10.2x FY13e EPS for the automobile sector, distorted mainly by Tata Motor’ cheap valuations). We expect revenue CAGR of 21.5% over FY11-13e, and a higher profit CAGR of 28.4% for our coverage universe. .

Valuations of companies in our coverage universe are still at a discount to their past averages. We expect the discount to reduce and surpass past averages as the auto-components sector sustains a high-growth phase over FY11-13e despite external factors.

Company valuations

Motherson Sumi (Buy; TP: `221): We have a Buy rating on MSS, with a target of `221 (18x target PE, on par with its past six-year average). At the current price, the stock trades at a PE of 15.1x FY12e EPS.

Bharat Forge (Buy; TP: `396): We value the stock at 20x FY12e PE. Our target price is `396. At present valuations, BFL trades at 16.1x FY12e EPS. We believe that current valuations do not reflect the significant upside that would accrue from FY13 from the joint ventures with NTPC, Areva, etc., commencing full-scale operations.

Exide Industries (Hold; TP: `149): We value the standalone business at one-year forward PE of 16x. We value Exide’s stake in ING Vysya Life Insurance at `12. Our target price is `149 (from `128). We retain our Hold.

Amtek Auto (Buy; TP: `225): We cut our target price from `254 to `225 (10x FY12e EPS, and `29 as value of 38% stake in Amtek India). We value Amtek Auto at 10x FY12e earnings, a 50% discount to the target PE multiple for Bharat Forge. Our current EPS estimate excludes Amtek India, and on considering the recent dilution and change in estimates. At the current market price, the stock trades at attractive valuations of 6x FY12e EPS.

Amara Raja Batteries (Buy; TP: `210): We value ARB at 10x FY12e EPS (a 40% discount to the target multiple for market leader Exide Industries). At the ruling market price, the stock trades at 9.5x FY11e and 7.8x FY12e earnings.



Balkrishna Industries (Hold; TP: `144): We value the stock at `144 (8.25x FY12e standalone EPS of `16.5 and `8 as value of its paper business). At the CMP, the upside is not too compelling. We initiate coverage with a Hold.

Mahindra Forgings (Buy; TP: `137): We value MFL at `137 (25x FY12e EPS of `5.5). Future re-rating is likely on: i) proven ability to sustain consolidated profitability and ii) likely restructuring of MFL as part of Mahindra Systech. We initiate coverage with a Buy.

NRB Bearings (Buy, TP `68): At our target price of `68, the stock would trade at 11x 12-month-forward earnings. NRB’s one-year-forward PBV in the past five years has ranged between 0.7x and 3.8x. At `46, NRB trades at PE of 8.9x and 7.3x FY11e and FY12e earnings, respectively, and EV/EBITDA of 4.8x and 4x.

Setco Auto (Buy, TP `182): At our target price, the stock would trade at 9x 12-month forward earnings and EV/EBITDA of 5.1x. The target PE is in line with the three-year average.

Banco Products (Buy, TP `103): We value the stock at `103, based on 9x FY12e EPS of `11.5. It trades at an attractive 6.2x FY12e standalone PE. After a disappointing FY11, we expect the PE multiple to be re-rated, given stable growth ahead. We initiate with a Buy.

Gabriel (Buy, TP `62): At our target price, the stock would trade at 11x FY12e earnings and an EV/EBITDA of 4.8x. The target multiple is at a slight discount to the stock’s five-year average.

Phillips Carbon Black (Buy, TP `246): At our revised target of `246, the stock trades at FY12e PE of 5.6x and EV/EBITDA of 4x. We value PCB at FY12e P/BV of 1.25x.

Risks

Rising commodity costs may squeeze margins, particularly in domestic operations.

Increasing fuel prices and interest rates may arrest auto demand due to higher costs of acquisition and ownership.

Slower-than-expected recovery in Europe and US auto demand would delay the growth trajectory for export-oriented companies.

Fig 4 – Auto component sector: Valuation matrix Amara Raja Amtek

Auto* Banco

Products Balkrishna

IndsBharat Forge*

Exide Inds

Gabriel India

Mahindra Forgings*

Motherson Sumi*

NRB Bearings*

Phillips Carbon

Setco Auto*

Rating Buy Buy Buy Hold Buy Hold Buy Buy Buy Buy Buy Buy

Current price (Rs) 165 117 71 127 319 130 42 65 185 46 134 117

Target price (Rs) 210 225 103 144 396 149 62 137 221 68 246 182

M.Cap. (m US$) 313.0 545.1 113.8 274.7 1,649.1 2,464.1 71.1 133.2 1,591.9 97.1 97.0 45.8

EPS CAGR (FY11-13e, %) 22.7 23.7 26.4 8.5 49.1 19.5 41.8 239.6 32.8 18.7 14.9 29.3

PE (x) 7.8 6.0 6.2 7.7 16.1 15.3 7.5 11.8 15.1 7.3 3.0 5.8

EV/EBITDA (x) 4.4 3.6 3.3 5.5 7.1 8.9 3.5 4.2 7.0 4.0 2.9 3.5

RoE (%) 22.3 8.3 23.5 16.4 20.0 21.7 20.6 6.0 31.5 23.4 25.2 33.1

RoCE (%) 29.0 11.1 23.2 15.0 20.5 30.1 20.2 8.5 29.4 27.6 16.8 25.0

Asset Turnover (x) 2.2 0.6 1.1 1.2 1.3 1.7 0.5 2.0 3.5 0.8 2.7 0.7

Source: Anand Rathi Research; Note: Ratios are based upon FY12e earnings, * consolidated Prices as on 18 February 2011



Overseas sales to strengthen Despite the few short-term growth catalysts in Europe and the US and withdrawal of incentive schemes, we expect increased optimism among OEMs/suppliers regarding long-term growth prospects. This, along with market share gains, would drive overseas revenue for most Indian auto-parts companies. We expect our auto-parts universe to see a 28.1% standalone exports CAGR over FY10-13e vs. 19.7% CAGR for domestic sales.

Increased optimism among OEMS and suppliers

After a decent demand trend in ’10, export growth for auto components would be further underpinned by a cyclical recovery in the US in the next two years and continued optimism among European OEMs/suppliers.

In Jan ’11, CSM, a widely followed auto-production forecaster, raised its CY11 European production expectations for vehicles to 19m (Dec ’10: 18.6m, May ’10: 17.3m) and for CY12 to 19.7m (Dec ’10: 19.5m May ’10: 18.4m), suggesting a 10% and 7% increase in estimates respectively since May and a 2% and 1% increase respectively since December. For North America, mainly the US, CSM expects vehicle production for CY11 to increase to 12.9m (May’10: 12.7m) and for CY12 to 13.9m (May’10: 13.5m), implying a 2% and 4% increase in estimates respectively since May ’10.

Although we do not see significant short-term growth catalysts in Europe, given the withdrawal of scrappage/incentive schemes by the UK, France, Germany and Italy, we continue to believe that CSM’s estimates are conservative. The revision of CSM’s estimates reiterates our view that European and US auto volumes are expected to be better in CY11 and CY12, demonstrating CAGRs of more than 5% for Europe and ~13% for North America over FY09-12e.

Direct exports constitute 22.9% of the sector’s standalone revenue; total overseas revenue drives this share to nearly 50% for some big auto-component players (like Bharat Forge, Motherson Sumi and Amtek Auto and Mahindra Forgings). We are upbeat on auto-component exports and overseas revenues, due to the upswing in auto demand, as well as the on-going inventory restocking by European and US OEMs.

Fig 5 – CSM global light vehicle production summary by Region (‘000s) CY10 CY11e CY12e CY13e CY14e CY15e CY16e CY17e CAGR

CY10-13 %CAGR

CY11-13 %Europe 18,732 19,042 19,715 20,776 21,956 22,753 23,334 23,867 3.5 2.9Greater China 14,791 16,268 18,139 19,689 20,997 22,003 22,919 23,775 10.0 6.6Japan/Korea 13,162 12,793 13,524 13,965 13,966 14,180 14,181 14,046 2.0 3.0Middle East/Africa 2,105 2,159 2,406 2,334 2,409 2,486 2,573 2,665 3.5 2.6North America 11,943 12,944 13,919 14,743 15,493 16,078 16,147 16,265 7.3 4.4South America 4,140 4,376 4,623 5,055 5,332 5,595 5,786 6,006 6.9 4.9South Asia 6,709 7,653 8,614 9,525 10,129 10,802 11,515 12,101 12.4 7.6Grand Total 71,582 75,237 80,940 86,087 90,280 93,897 96,453 98,725 6.3 4.6

Source: CSM Auto



Fig 6: Direction of India’s exports

Asia22%

Europe39%

North America21%

Oceania0%

Australia1%South America

3%Middle East

7%Africa

7%

Source : ACMA

Auto components – Upbeat outlook In the base-case scenario for Western-Europe car demand, anecdotal evidence suggests that there are ~200m cars in the region. Of this, an average 6% is scrapped annually, leading to replacement demand of ~12m vehicles. This includes fleet rental car demand. This generates certain cyclical demand of ~12m vehicles annually.

The European population is expected to increase by 10m in the next 10 years. On average, one car per two individuals would create demand of ~5m cars, translating to structural demand of 0.5m cars a year. Apart from certain sovereign-debt concerns, European GDP growth is now showing a positive trend, and unemployment, after peaking in ’09, is on the decline.

The above structural growth along with eased macro concerns would prove an important demand catalyst, implying that West European car demand would see further green shoots. Western Europe has a substantial positive impact as the region constitutes ~70% of the total European car-demand pie.

A steady revival in auto-component exports and overseas revenue improvement from end-FY10, despite overseas demand (excluding incentive schemes) not significantly improving has been a notable feature of FY11. Ahead, we expect the nascent recovery in export demand to gather steam as auto demand in the US/EU picks up, after having hit bottom through CY08 to CY10.

We expect the recovery to benefit dually – firstly by driving exports and secondly by improving growth in overseas subsidiaries. We expect our auto-parts universe to see a 28.1% standalone exports CAGR over FY11-13e vs. 19.7% CAGR for domestic sales.

Fig 7 – Eurostat GDP growth estimates Eurostat estimates for real GDP growth CY08 CY09 CY10 CY11e CY12eEuropean Union (27 countries) 0.5 -4.2 1.8 1.7 2.0Euro area (16 countries) 0.4 -4.1 1.7 1.5 1.8United States 0.0 -2.6 2.7 2.1 2.5

Source: Eurostat Data

Strong pipeline of some European manufacturers could add to demand European OEMs such as Peugeot (20% of product pipeline up for renewal in CY11), BMW (three new models) and Volkswagen have a healthy

In Europe, people still need a car. Prospects for auto component

manufacturers look upbeat



pipeline. We expect the India auto-components segment to benefit as a result, winning new long-term contracts to supply components for some of these platforms. Indian auto component companies could also benefit by supplying to foreign manufacturers Faurecia, Delphi and Magna, which in turn supply components to these new platforms.

India still a considerably attractive low-cost base India is one of the hottest three destinations for automobile-component manufacturing, on parameters such as lower wage rates, access to cheaper raw materials, availability of engineers and design capabilities, than other low-cost locations. This gives auto-ancillary manufacturers an edge in costs while competing with rivals, who supply to European manufacturers. This helps protect margins. The key cons now are the higher costs of electricity (which has come down over time) and the high transit time to other auto hubs (a location disadvantage). India’s advantages lead to a minimum 20% lower cost, versus the US and other developed nations.

Quality no longer an issue Indian auto-ancillary product offerings are now benchmarked to stringent global standards. This transformation is partly due to technology tie-ups with global automotive manufacturers, leading to transfer of sophisticated technology, in turn helping produce high-end products, meeting requirements of tier-I manufacturers Daimler, BMW, VW and Volvo.

A JD Power survey shows that problems per 1,000 products supplied by Indian manufacturers have reduced 50% from 1997 levels. Auto component companies maintained high standards even while handling huge orders.

As a result global auto-component manufacturers Delphi, Bosch and Visteon have operations in India. Ford, Toyota and General Motors have also set up their international purchasing offices in India.

Fig 8 – Labour costs sustain Rank Country Index 1 Indonesia 14.0 2 Philippines 17.2 3 India 18.7 4 Thailand 20.2 5 Mexico 23.2 6 China 29.2 7 Romania 33.8 8 Argentina 35.9 9 Malaysia 38.3 10 Slovakia 50.3 11 Russia 53.3 12 Hungary 54.8 13 Poland 56.1 14 Hong Kong 59.8 15 Turkey 64.9 16 Brazil 65.8 17 Czech 70.5 18 South Africa 74.6 19 Taiwan 76.3 20 Singapore 80.4 21 Slovenia 86.2 22 South Korea 100.0

Note: Hourly wage cost in major agglomerations, Index hourly wage cost, South Korea = 100 Source: Global Production, Mar ’08



Fig 9 – Automotive specialization: Global Rank Country Index 1 Argentina 4.51 2 Mexico 3.71 3 Slovakia 3.62 4 Czech 3.23 5 Poland 3.12 6 Hungary 3.08 7 Brazil 2.88 8 Turkey 2.85 9 Slovenia 2.61 10 South Africa 2.51 11 South Korea 1.95 12 Thailand 1.25 13 Romania 0.97 14 Russia 0.68 15 India 0.49 16 Indonesia 0.38 17 Taiwan 0.22 18 Philippines 0.21 19 China 0.14 20 Malaysia 0.07 21 Singapore 0.05 22 Israel 0.05 23 Saudi Arabia 0.04 24 Hong Kong 0.01 25 Pakistan 0.01

Note: Measures the country's specialization in exporting automotive products on a scale of 0 to 5 Source: Global Production, Mar ’08



Steady domestic growth After two years of swift growth, the Indian auto sector has now entered a steady growth phase. We expect an industry volume CAGR of 13.7% over FY11-13e, which would strengthen the sector base.

Resilient domestic auto demand... India’s auto demand has proved resilient despite the challenging FY08-10 environment. This was mainly owing to:

continuance of the stimulus package through FY10 and its success;

lower interest rates; and

release of pent-up demand.

The likely key growth drivers for the auto segment are:

1. Sustained two-wheeler demand: We expect two-wheeler demand in India to continue, while penetration and expansion into new areas globally would boost export growth. In the two-wheeler sector, we expect a 13.7% volume CAGR over FY11-13e.

2. Turning into a global small-car hub: India has emerged as a small car manufacturing hub as global giants General Motors (plant of 225,000-unit capacity annually set up at Talegaon near Pune), Volkswagen (plant at Pune), Nissan (plant at Chennai) and Renault (in partnership with Nissan) have joined the existing India old-hands Suzuki and Hyundai. These companies would not only cater to domestic demand but also use India as an export base in the long run. We expect a 13.7% CAGR over FY11-13e in India’s passenger vehicle sales.

3. Replacement demand: would continue to fuel non-cyclical demand for auto-component companies, especially for batteries and tyres. The replacement demand trajectory would follow an increasing trend due to the robust 14% CAGR in India’s auto sales over FY02-11, particularly in batteries and tyres, continue to fuel non-cyclical demand for auto-component companies. Direct replacement demand would occur from upgradation of mode of transport, new entrants and additional vehicle purchases.

Fig 10 – Auto OEM demand

0.0

5.0

10.0

15.0

20.0

25.0

30.0

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

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FY12

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FY13

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FY14

e

-5.0

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Total Auto volumes yoy change (%)

(m units) (%)

Source: SIAM, Anand Rathi Research

Fig 11 – FY11-13e auto sales growth CAGR

10%

11%

12%

13%

14%

15%

16%

PV LCV M&HCV 2wh 3wh Total Autovolumes




4. CV demand in mid-cycle: M&HCV sales have reached mid-cycle, with good demand growth expected on infrastructure development, GDP growth, and the healthy domestic economy.

Replacement demand to be an important growth driver . . .

The automobile sector has seen robust growth in the past few years, with a volume CAGR of 14% over FY02-11. The healthier growth rate portrays durability in India’s auto demand over the long-term, even after factoring in cyclical slumps. This high built-up base of automobiles would translate into replacement demand for tyres, batteries, etc., every 3-4 years, thereby bolstering demand for tyres.

Replacement demand constitutes almost two-thirds of tyre and battery sales annually. These are non-cyclical segments that would contribute towards steady company revenue, both in an economic downturn and during a high-growth phase.

Fig 12 – Volume CAGR: (FY02-11)

10.0

12.0

14.0

16.0

18.0

20.0

22.0

24.0

PV LCV M&HCV 2wh 3wh Total

(%)

Source: Company

. . . but speed-breakers ahead

While demand growth is likely to be sustained, it would not be entirely smooth sailing as speed-breakers are now visible.

Key factors that may constrain growth are:

Rise in interest rates – would raise the cost of ownership for vehicles, thereby potentially constraining demand growth.

Rise in commodity costs – would necessitate further increase in vehicle prices, thereby increasing the cost of acquisition.

Regulatory changes – Increase in excise duty rates to pre-stimulus levels (0% to 2% up) would result in passing on of this cost increase to end-users.



Improved efficiencies Auto-parts companies are benefiting from efforts to conserve cash, reduce costs and improve productivity. Also, de-risking via entry into the non-auto segment and prudent investments would lead to 21.5% sales CAGR in FY11-13e vs. 15% for the auto industry.

Steps taken in tough times would now help Lower demand in 2HFY09 and spiraling raw material costs just prior to this period led companies to rapidly adopt measures to conserve cash, reduce costs and improve productivity. Even as these steps helped them survive the downturn, they augur well for enhanced profitability ahead.

Another step that gained traction during this period was the need to diversify/de-risk business models to account for cyclical trends. Bharat Forge and MSS had already taken such steps; we expect this to be even more widespread.

We believe that ‘diversified’ companies would be better performers. Diversifying into non-automobile segments, upgrading to non-commoditized products and a broad product range are some of the characteristics of companies that would emerge stronger despite the slowdown.

Operating performance to sustain A pick-up in demand and lower channel inventories have led to greater capacity utilization and short-term capacity constraints in certain segments. While higher commodity costs would lower EBITDA margins from the peak, we expect them to sustain at FY11 levels.

Hence, we expect a 21.5% sales CAGR in FY11-13e vs. 15% for the auto industry. Similarly, the profit CAGR at 28.4% would be higher than that for the auto industry (17.6%).

Fig 13 – EBITDA margin trend (FY09-13e)

12

13

14

15

16

17

FY09

FY10

FY11

e

FY12

e

FY13

e

Auto components universe

(%)

Source: Company, Anand Rathi Research



Fig 14: Auto-components sector investments (`m)

0

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100,000

150,000

200,000

250,000

300,000

350,000

400,000

FY04

FY05

FY06

FY07

FY08

FY09

FY10

e

Source: ACMA

Fig 15 – Auto-components sector, improved RoE

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-5

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25

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35

FY09

FY10

FY11

e

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FY13

e

Balkrishna Inds Bharat Forge* Gabriel IndiaMotherson Sumi* NRB Bearings* Setco Auto*

(%)

Source: Company, Anand Rathi Research * consolidated

Fig 16 – ….. and higher asset turnover

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Source: Company, Anand Rathi Research * consolidated



Fig 17 – Earnings and revenue growth (FY07-12e)

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Company Profiles


India I Equities

Auto Components

Update

22 February 20011

Motherson Sumi Systems

Good performance to continue; Buy

Motherson Sumi Systems is expected to continue on its steady growth path, boosted by robust domestic demand and new order implementation at Samvardhana Motherson Reflectec in FY12 and subsequent operating leverage from FY13. We re-iterate our Buy on the stock, with a target price of `221.

Benefits of good domestic car growth. Motherson Sumi has benefited from revved-up growth in domestic passenger cars. Domestic car volumes have risen at a healthy ~31.3%, ytd FY11, and are expected to register a 13% CAGR over FY11e-13e. With a 65% share, MSS dominates the market in passenger-car-wiring harnesses. Further, as it is well-established with upcoming models being launched in India, MSS would register higher-than-industry growth.

Steady at SMR. Samvardhana Motherson Reflectec, the rearview-mirror business, has turned around faster than expected after its acquisition by MSS. In ytd FY11, an appreciating rupee capped revenue growth at SMR, but the outlook is robust on new order implementation commencing in FY12 and subsequent operating leverage from FY13.

Valuation and risks. We have a Buy rating on MSS, with a target of `221 (18x target PE, on par with its past six-year average). At the current price, the stock trades at a PE of 15.1x FY12e EPS. Risks: slowdown in European demand or delay in new model launches there, currency risk, and the complicated company structure.

Rating: Buy Target Price: `221 Share Price: `185

Key data MSS IN /MOSS.BO

52-week high/low `209/`120Sensex/Nifty 18212 / 54593-m average volume US$0.8mMarket cap `72.6bn/US$1.6bnShares outstanding 387.5mFree float 34.8%Promoters 65.2%Foreign Institutions 9.1%Domestic Institutions 9.5%Public 16.2%

Motherson Sumi vs Sensex

MSS

Sensex

120130140150160170180190200

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Source: Bloomberg

Key Financials - Consolidated

Year end 31 March FY09 FY10 FY11e FY12e FY13e

Sales (`m) 26,397 68,509 82,774 102,551 121,913

Net profit (`m) 1,310 1,880 3,373 4,741 5,947

Diluted EPS (`) 3.4 4.9 8.7 12.2 15.3

Growth (%) -24.6 43.5 79.4 40.6 25.4

PE (x) 55.4 38.6 21.5 15.1 12.2

PBV (x) 8.5 6.0 5.0 4.0 3.1

RoE (%) 28.2 20.0 27.7 31.5 31.9

RoCE (%) 12.4 15.1 24.9 29.4 31.6

Dividend yield (%) 0.7 1.0 1.2 1.3 1.5

Net gearing (%) 61.2 51.0 48.4 47.2 42.5

Source: Company, Anand Rathi Research Prices as on 18 February 2011

Change in Estimates Target Reco

22 February 2011 Motherson Sumi Systems – Good performance to continue; Buy


Quick Glance – Financials and Valuations Fig 1 – Consolidated Income Statement (`m)


Net sales 26,397 68,509 82,774 102,551 121,913Sales growth (%) 28.6 159.5 20.8 23.9 18.9- Op. expenses 23,120 63,056 74,323 91,779 108,732EBIDTA 3,278 5,454 8,451 10,772 13,181EBITDA margins (%) 12.4 8.0 10.2 10.5 10.8- Interest 354 573 645 645 645- Depreciation 979 2,601 2,471 2,594 2,854+ Other income 50 463 139 156 176- Tax 348 1,094 1,728 1,922 2,465Rep PAT before MI 2,212 2,334 4,031 5,767 7,394Adjusted PAT 1,310 1,880 3,373 4,741 5,947Adj PAT growth (%) -24.6 43.5 79.4 40.6 25.4FDEPS (`/share) 3.4 4.9 8.7 12.2 15.3CEPS (`/share) 9.0 13.2 16.8 21.6 26.4DPS (`/share) 1.4 1.8 2.3 2.5 2.8Source: Company, Anand Rathi Research

Fig 2 – Consolidated Balance Sheet (`m)

Year to 31 March FY09 FY10 FY11e FY12e FY13e

Share capital 356 375 388 388 388Reserves & surplus 7,476 11,275 14,173 17,943 22,822Shareholders’ fund 7,831 11,649 14,560 18,330 23,210Debt 8,951 8,179 7,979 7,979 7,979Deferred tax / others 1,880 2,049 2,049 2,049 2,049Capital employed 18,662 21,878 24,589 28,359 33,238 Fixed assets 15,412 16,356 17,077 19,482 21,628Investments 81 471 471 471 471Working capital 402 1,620 3,134 4,162 5,166Cash 2,766 3,431 3,906 4,244 5,973Capital deployed 18,662 21,878 24,589 28,359 33,238No. of shares (m) 356 375 388 388 388Net Debt/Equity (%) 79.0 40.8 28.0 20.4 8.6W C turn (days) 26 19 19 19 19Source: Company, Anand Rathi Research

Fig 3 – Cash flow statement (`m)

Year end 31 March FY09 FY10 FY11e FY12e FY13eOp. pr/(loss) bef. tax 2,299 2,853 5,980 8,178 10,327+ Depreciation 979 2,601 2,471 2,594 2,854Cash profit 3,278 5,454 8,451 10,772 13,181+ Incr/(Decr) in WC 2,531 -970 -1,514 -1,027 -1,004+ Others 2,146 -23 -1,304 -1,766 -2,289Operating cash flow 7,956 4,460 5,633 7,979 9,888+ Capex -10,077 -3,545 -3,192 -5,000 -5,000Free cash flow -2,122 915 2,441 2,979 4,888+ Dividend -480 -674 -872 -969 -1,066+ Chg in net worth 740 2,158 -248 -1,028 -1,449+ Debt raised 4,060 -772 -200 0 0+ Misc. items -386 -963 -645 -645 -645Net cash flow 1,813 664 476 337 1,729+ Opening cash 954 2,766 3,431 3,906 4,244Closing cash 2,766 3,431 3,906 4,244 5,973Source: Company, Anand Rathi Research

Fig 4 – Consolidated PE Band

Motherson Sumi 10x

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Fig 6 – MSSL vs. BSE Sensex

MSS

BSE Auto

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Source: Bloomberg



Investment Argument and Valuation Motherson Sumi Systems is expected to continue on its steady growth path, boosted by robust domestic demand and new order implementation at SMR in FY12, and subsequent operating leverage from FY13. We re-iterate our Buy on the stock, with a target price of `221.

Benefits of good domestic car growth

MSS is a key vendor to almost all passenger-car and two-wheeler OEMs and caters to a wide spectrum of the vehicular industry. It has benefited from revved-up growth in domestic passenger cars.

Domestic car volumes have risen at a healthy ~31.3% in ytd FY11, and are expected to register a 13% CAGR over FY11e-13e. With a 65% share, MSS dominates the market in passenger-car-wiring harnesses. Further, as it is well-established with upcoming models being launched in India, MSS would register higher-than-industry growth.

Steady at SMR

On acquiring Samvardhana Motherson Reflectec, the rearview-mirror business, MSS is one of the largest manufacturers of automobile rearview mirrors in the world, with a market share of ~22%. SMR has raised MSS’s ability to supply high-level assemblies. Post-acquisition, the latter has been able to turn around operations at Samvardhana faster than expected, and the rapid pace of improvement in operations is expected to be sustained.

In ytd FY11, an appreciating rupee capped revenue growth at SMR, but the outlook is robust regarding new order implementation commencing in FY12 and the subsequent operating leverage from FY13.

Valuation and risks

We have a Buy rating with a target price of `221 (18x target PE, on par with its past six-year average). At the current price, the stock trades at a PE of 15.1x FY12e EPS. The company is securely entrenched in its product segments, with a well-charted five-year plan. In the past, the stock has traded at a premium to the rest of the sector.

Risks

Currency fluctuations: As a considerable proportion of its revenue arises from overseas ventures, MSS is highly exposed to risks posed by currency fluctuations.

Complicated structure: Its numerous subsidiaries and joint ventures make for a complex company structure.

Commodity pressure: With commodity prices on an upward trend, any delay in passing on these costs could affect the short-term operating performance.

Slowdown in demand from Europe: Any slowdown in demand growth from Europe or delay in launching new models would cloud prospects for MSS’ overseas businesses.



Benefits of good domestic car growth Motherson Sumi Systems has benefited from revved-up growth in domestic passenger cars. Domestic car volumes have risen at a healthy ~31.3% in ytd FY11, and are expected to register a 13% CAGR over FY11e-13e. With a 65% share, MSS dominates the market in passenger-car-wiring harnesses. Further, as it is well-established, with models being launched in India, MSS would register higher-than-industry growth.

Leader in the wiring-harness sub-segment

India’s leading passenger-car-wiring harness manufacturer, MSS has a domestic market share of over 65%. It is a key vendor to almost all passenger-car and two-wheeler OEMs and sells to a wide spectrum of the vehicular industry. (It also operates in the non-automobile segment, with customers in earth-moving and material-handling sub-segments; and supplies material-handing markets in Europe.) It has more than 25 manufacturing facilities in India, Sharjah, Ireland and the UK to ensure timely supplies to OEMs in India as well as in Europe.

The company provides complete in-house design services, which results in quicker development. It benefits from having carried out backward integration for critical inputs for wiring harnesses such as wires, connectors, terminals, fuses and fuse-boxes.

It has a technology partnership with Sumitomo of Japan, a leader in wiring harnesses worldwide. It has also tied up with Kyungshin Industrial of South Korea, the wiring-harness supplier to Hyundai Motors in Korea.

The wiring-harness business is the second most important business segment for MSS, till FY08 bringing in 73% of its revenue (standalone; and 66% consolidated). However, on acquiring Visiocorp’s rearview-mirror business, the share of the wiring-harness revenues diminished significantly from FY10. Revenue from its consolidated-wiring-harness sub-segment has seen a robust 27.5% CAGR over FY04-10.

Revenue growth has arisen from revved-up growth domestically in passenger cars, its strong presence in Europe’s two-wheeler and material-handling-equipment markets, faster growth in exports and capacity expansion by key customers Hyundai and Nissan.

Fig 7 – MSS’ wiring harness business growth (FY04-FY10)

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Outlook

Even though auto volumes in 2HFY09 slowed considerably, MSS retained its market share in wiring harnesses. Subsequently, as volume growth strongly recovered in India, good revenue growth followed. New model launches from Ford and Nissan would continue to drive MSS’ revenue growth. Domestic car volumes in India have risen at a healthy 31.3% ytd in FY11. Over FY11e-13e, they are expected to touch a 13% CAGR. As the company is well established with upcoming models being launched in India it would register higher-than-industry growth.

A recovery in auto demand, globally, in CY10/11 would significantly boost MSS’ overseas revenue. Moving up the value chain to manufacture progressively more complex products and modules, and capitalising on SMR’s overseas relationships to supply more content per car in the medium term would further enhance volumes and realizations for MSS’s wiring-harness division.

Other business segments

Apart from the wiring harness and mirror sub-segments, MSS’ other business segments are plastic and polymer components, and rubber components. After acquiring SMR, these divisions now constitute a smaller share of MSS’ revenue.

Fig 8 – MSS’ revenue mix (%)

Mirrors & modules, 53

Polymer tooling, 9

Wiring harness, 28

Others, 4

IT, design, & manufacturing

support, 1

Metal working, 1

Elastomer processing, 2

Source: Company

Fig 9 – MSS’ polymer business growth (FY04-FY10)

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Fig 10 – MSS: Growth, rubber components and other products (FY04-10)

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Tie-ups with global leaders hold the technological edge

MSS has technology tie-ups/joint ventures with globally leading companies Magna, Sumitomo, Kyungshin Industrial, Continental, Calsonic. Its JVs/tie-ups served the multiple purposes of securing technology, penetrating overseas markets and venturing into new product categories in India. At present, MSS has 24 joint ventures with various partners.

Its recent joint venture with Calsonic Kansei has commenced operations, currently supplying to Ritz, Micra. The JV supplies HVAC systems as complete assemblies. (This includes other components such as audio systems, etc., in addition to ACs.)



Steady at SMR Samvardhana Motherson Reflectec, the rearview-mirror business, has turned around faster than expected after its acquisition by MSS. In YTD FY11, an appreciating rupee capped revenue growth at SMR, but the outlook is robust for new order implementation commencing in FY12 and subsequent operating leverage in FY13.

Samvardhana Motherson Reflectec, the rearview-mirror business, is one of the largest manufacturers of passenger car rearview mirrors in the world, with a ~22% market share globally, and ~53% in India. Samvardhana has enhanced MSS’ ability to supply high-level assemblies. After the acquisition, MSS has been able to turn around operations at Samvardhana faster than initially expected.

In ytd FY11, an appreciating rupee capped revenue growth at SMR, but the outlook is robust for new order implementation commencing in FY12 and subsequent operating leverage in FY13.

Benefits of the acquisition

With the SMR acquisition, the MSS Group is now one of the largest manufacturers of automobile rearview mirrors in the world. Also, SMR has raised to a higher level MSS’ ability to supply high-level assemblies. Some of the key benefits to MSS from this acquisition are:

The MSS Group is now the largest manufacturer of passenger car mirrors in India.

SMR supplies products to nearly every OEM, nearly 400 individual products. It is a technology leader with 300 patents and a history of innovation.

SMR is a market leader in exterior rearview mirror systems and brings with it cutting-edge technology, covering the complete range of mirrors from low-end entry segments to high-end luxury segments.

The acquisition was made at favourable valuations. Therefore, substantial value-unlocking potential exists under normal conditions in the near future.

Since MSS had been in the business in India for over 13 years in partnership with the erstwhile Visiocorp, it built up certain competencies.

The acquisition brings with it synergies. “Mirrors” is a synergistic product and brings re-sourcing value into the already existing lines of wiring harness (€28m annual buying), polymer processing and elastomers.

The acquisition has opened up new markets such as China, Mexico, the USA, Japan, Spain, France and Hungary.

Since SMR is an established tier-I supplier globally, the acquisition has propelled MSS into the worldwide tier-I league.

There is good potential for MSS to supply more components to SMR’s customers, thereby increasing the content supplied per car.



SMR: 3Q performance

SMR’s performance continued to steadily improve. Full recovery, however, was affected by the unfavorable exchange rate. In 3Q, revenue was flat yoy, but was up 8% qoq. Sales in India grew 74.1% yoy, while sales outside India fell 2.7% yoy, the effect of the exchange rate. EBITDA margin was 6% (-50bps, both yoy and qoq). Net profit attributable to MSS was `134m (+47.7% yoy and 95.9% qoq).

Fig 12 – SMR: Quarterly performance (`m) 3QFY10 2QFY11 3QFY11 yoy chg (%) qoq chg (%)

Net Sales 11,206 10,403 11,231 0.2 8.0

within India 423 655 737 74.1 12.5

outside India 10,782 9,747 10,494 -2.7 7.7

Total expenditure 10,477 9,721 10,552 0.7 8.5

EBITDA 728 681 679 -6.8 -0.4

EBITDA Margin (%) 6.5 6.5 6.0

Restructuring expenses 90 0 0 -100.0

Depreciation 383 310 313 -18.2 1.1

Interest 59 0 0 -100.0

PBT 197 314 315 60.1 0.2

PBT margin (%) 1.8 3.0 2.8

PBT ex-EO 287 314 315 9.7 0.2

PBT margin (%) 2.6 3.0 2.8

Tax 105 180 61 -42.0 -66.2

ETR (%) 53.4 57.3 19.3

PAT 92 134 254 177.0 89.2

MI 44 66 120 169.8 82.2

MI (%) 48.4 48.9 47.1

PAT after MI 47 69 134 183.7 95.9

Source: Company

Fig 11 – Market share of SMR

India

MSS53%

Others47%

Global

MSS22%

Others78%

Source: Company



Fig 13 – Impact of currency on revenue

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In CY11, MSS will commission four plants in India and one each in South Africa and Hungary. By end-CY12, SMR will commission a plant each in Brazil and Thailand. Total capex involved would be ~`5bn, half of which would be in India, the balance overseas. Business prospects are upbeat on nearing of new-order execution and good demand.

Fig 14 – SMR, a significant revenue driver

SMR’s and MSS’s revenue trends

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3QFY11 performance was impressive MSS registered a good 3QFY11, driven by robust standalone performance and sustained traction at SMR.

Standalone quarterly performance impressive

MSS reported robust sales growth of 72.1% yoy (+15.2% qoq) to `7.5bn, driven by domestic revenue growth of 76.8% yoy (+15.2% qoq) and exports growth of 37.9% yoy (up 14.6% qoq). Standalone exports saw a healthy increase in sales and continued sequential growth. Other operating income increased ~15.9% yoy to `185m.

The EBITDA margin (adjusted for forex) was 16.6%. It fell 100bps yoy to 16.6%, though qoq it was up 200bps. The yoy decline stemmed from higher raw-material-to-sales (by 200bps yoy), partially offset by 70bps lower staff-expenses-to-sales and 50bps lower other-expenditure-to-sales. In absolute terms, EBITDA was up 60.6% yoy and 31.4% qoq. Boosted by healthy revenue growth and higher other income, adjusted profit grew 85.1% yoy to `759m.

Fig 15 – Quarterly standalone performance Y/E 31 March (`m) 3QFY10 2QFY11 3QFY11 yoy change (%) qoq change (%)

Domestic Sales 3,845 5,898 6,796 76.8 15.2

Exports 525 632 724 37.9 14.6

Net Sales 4,370 6,530 7,521 72.1 15.2

Other Operating Income 160 155 185 15.9 19.3

Total Income 4,530 6,685 7,706 70.1 15.3

Total Cost 3,733 5,711 6,426 72.1 12.5

EBITDA 796 974 1,279 60.6 31.4

EBITDA Margin (%) 17.6 14.6 16.6

Other Income 29 103 121 310.2 17.1

Extraordinary Income 237 112 24 (89.9) (78.6)

Extraordinary Loss 0 0 0 NM NM

Total extraordinary income 237 112 24 (89.9) (78.6)

Interest 68 81 100 46.8 23.4

Gross Profit 995 1,109 1,324 33.1 19.5

Less: Depreciation 172 199 211 23.1 5.9

PBT 824 909 1,113 35.1 22.5

Tax 224 250 337 50.8 34.7

Effective Tax Rate (%) 27.1 27.5 30.3

Rep. PAT 600 659 776 29.3 17.8

Adj. PAT 410 580 759 85.1 30.9

Source: Company

While MSS’ 3QY11 EBITDA margin was healthy, the rise in copper prices and general commodity cost hikes could impact the EBITDA margin in the next six months, particularly in the standalone operations.



Consolidated 3QFY11 performance

Net sales in 3Q were up 16.9% yoy (+8.7% qoq) at `20.8bn. Domestic revenue grew 62% yoy, while overseas revenue fell 2.3% yoy.

EBITDA margin improved 110bps yoy and 60bp qoq to 10.4%, while EBITDA grew 31.5% yoy to `2.2bn. The better EBITDA margin and lower tax rate drove MSS’ consolidated profitability 65.6% higher yoy (+27.9% qoq) to `953m.

Fig 18 – Quarterly consolidated performance Y/E 31 March (`m) 3QFY10 2QFY11 3QFY11 yoy change (%) qoq change (%)

Within India 5,334 7,606 8,634 61.9 13.5

Outside India 12,489 11,556 12,197 (2.3) 5.5

Net Sales 17,823 19,162 20,831 16.9 8.7

Other Operating Income 325 415 445 36.7 7.3

Total income 18,148 19,576 21,276 17.2 8.7

Total Cost 16,463 17,657 19,060 15.8 7.9

EBITDA 1,686 1,919 2,216 31.5 15.4

EBITDA Margin (%) 9.3 9.8 10.4

Other Income 48 30 28 (41.5) (4.4)

Extraordinary Income 307 164 281 (8.5) 70.9

Extraordinary Loss 90 0 123 36.0 #DIV/0!

Total extraordinary income 217 164 158 (27.0) (3.7)

Interest 139 152 171 23.5 12.6

Gross Profit 1,812 1,961 2,231 23.1 13.8

Less: Depreciation 642 610 601 (6.5) (1.5)

PBT 1,170 1,352 1,630 39.4 20.6

Tax 389 471 430 10.7 (8.7)

Effective Tax Rate (%) 33.3 34.9 26.4

Rep. PAT bef MI & ASP 781 880 1,200 53.7 36.3

Minority interest 30 21 137 362.9 562.9

Sh of Profit of Associates -2 0 0 (109.1) -

Rep. PAT after MI & ASP 749 860 1,064 42.0 23.7

Adj. PAT 575 745 953 65.6 27.9

Source: Company

Fig 16– Trend in standalone EBITDA margin

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Fig 17– Trend in standalone raw material-to-sales

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Financials We expect a 21.4% CAGR in MSS’ revenue from FY11 to FY13, with its EBITDA margin improving from 10.2% in FY11e to 10.8% two years later. The EBITDA CAGR would hence be 24.9%, while the adjusted net profit CAGR would come in at 32.8%.

Motherson Sumi Systems supplies wiring harnesses and plastic modules to almost all car manufacturers in India. With its acquisition of SMR it has seen rapid growth (a 64.9% CAGR in net sales from FY07 to FY10) as it has been transformed into a one-stop shop for a wide range of critical components.

We expect a 20.7% CAGR over FY11-13 in MSS’ (standalone) revenue, backed by a stable EBITDA margin of 15.3%, and a 23.8% CAGR in (standalone) adj. net profit.

We expect a 21.4% CAGR over FY11-13 in MSS’ (consolidated) revenue. The EBIDA margin would be 60bps higher as operating leverage on the increased capacities would be seen in FY13. Quicker recovery in global automobile markets would boost growth and lead to upsides to our consolidated earnings estimates. We expect a 32.8% CAGR over FY11-13 in the (consolidated) adj. net profit.

Fig 19 – MSS’ EBITDA margin trend (FY05-FY13e)

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e


(%)




Fig 20 – Consolidated Income statement (`m) Y/E MARCH FY09 FY10 FY11e FY12e FY13eNet Sales 25,956 67,022 80,915 100,506 119,664 Change (%) 28.0 158.2 20.7 24.2 19.1Operating Other Income 441 1,487 1,859 2,045 2,250Total Income 26,397 68,509 82,774 102,551 121,913 Change (%) 28.6 159.5 20.8 23.9 18.9Expenditure 23,120 63,056 74,323 91,779 108,732EBITDA 3,278 5,454 8,451 10,772 13,181 Change (%) 1.1 66.4 55.0 27.5 22.4% of Net Sales 12.4 8.0 10.2 10.5 10.8Depreciation 979 2,601 2,471 2,594 2,854Interest & Finance Charges 354 573 645 645 645Other Income 50 463 139 156 176Exceptional Expenses 554 695 216 0 0Non-recurring Income 1,119 1,380 501 0 0PBT 2,560 3,428 5,759 7,689 9,859Tax 348 1,094 1,728 1,922 2,465 Effective Rate (%) 13.6 31.9 30.0 30.0 30.0PAT 2,212 2,334 4,031 5,767 7,394 Change (%) 26.5 5.5 72.7 43.1 28.2Minority interest 449 -91 461 1,028 1,449Income from associate 0 2 2 2 2PAT after MI 1,763 2,428 3,570 4,739 5,945 Change (%) -0.9 37.7 47.1 32.7 25.4Adj. PAT 1,310 1,880 3,373 4,741 5,947 Change (%) -24.6 43.5 79.4 40.6 25.4

Source : Company, Anand Rathi Research

Fig 21 – Consolidated Balance Sheet (`m) Y/E MARCH FY09 FY10 FY11e FY12e FY13eSources of Funds Share Capital 356 375 388 388 388Equity Capital 356 375 388 388 388Reserves 7,476 11,275 14,173 17,943 22,822Net Worth 7,831 11,649 14,560 18,330 23,210Minority interest 2,000 2,027 2,027 2,027 2,027Net Deferred Tax 145 40 40 40 40Loans 8,951 8,179 7,979 7,979 7,979Capital Employed 18,927 21,896 24,606 28,377 33,256 Application of Funds Gross Fixed Assets 30,175 31,821 36,821 41,821 46,821Less: Depreciation 16,276 17,273 19,744 22,338 25,192Net Fixed Assets 13,900 14,548 17,077 19,482 21,628Capital WIP 1,512 1,808 0 0 0Investments 81 471 471 471 471Curr.Assets, L & Adv. 19,139 20,971 24,440 28,999 34,855Inventory 6,112 6,752 8,151 10,125 12,055Sundry Debtors 6,132 7,688 9,281 11,528 13,726Cash & Bank Balances 2,766 3,431 3,906 4,244 5,973Loans & Advances 4,129 3,101 3,101 3,101 3,101Current Liab. & Prov. 15,971 15,921 17,400 20,593 23,716Creditors 10,375 10,925 13,190 16,384 19,506Other Liabilities 1,911 2,134 2,134 2,134 2,134Provisions 3,685 2,861 2,075 2,075 2,075Net Current Assets 3,169 5,051 7,041 8,406 11,139Miscellaneous Expenditures 265 18 18 18 18Application of Funds 18,927 21,896 24,606 28,377 33,256




Fig 22 – Consolidated cash-flow statement (`m) Y/E MARCH FY09 FY10 FY11e FY12e FY13eOP/(Loss) before Tax 2,299 2,853 5,980 8,178 10,327Interest/Div. Received 50 463 139 156 176Depreciation & Amort. 979 2,601 2,471 2,594 2,854Direct Taxes Paid -243 -1,198 -1,728 -1,922 -2,465(Inc)/Dec in Wkg. Capital 2,531 -970 -1,514 -1,027 -1,004Other Items 1,774 27 0 0 0CF from Op. Activity 7,390 3,775 5,348 7,979 9,888Extra-ordinary Items 566 685 285 0 0Other Items CF after EO Items 7,956 4,460 5,633 7,979 9,888(Inc)/Dec in FA+CWIP -10,077 -3,545 -3,192 -5,000 -5,000(Pur)/Sale of Invest. -32 -390 0 0 0CF from Inv. Activity -10,109 -3,935 -3,192 -5,000 -5,000Inc./(Dec) in Networth 740 2,158 -248 -1,028 -1,449Inc/(Dec) in Debt 4,060 -772 -200 0 0Interest Paid -354 -573 -645 -645 -645Dividends Paid -480 -674 -872 -969 -1,066CF from Fin. Activity 3,966 139 -1,965 -2,642 -3,160Inc/(Dec) in Cash 1,813 664 476 337 1,729Add: Beginning Balance 954 2,766 3,431 3,906 4,244Closing Balance 2,766 3,431 3,906 4,244 5,973


Fig 23 – Ratio analysis @ `185 Y/E MARCH FY09 FY10 FY11e FY12e FY13eBasic (`) Diluted EPS Cons. 3.4 4.9 8.7 12.2 15.3Cons. EPS growth (%) -24.6 43.5 79.4 40.6 25.4Cash EPS 9.0 13.2 16.8 21.6 26.4Book Value per Share 22.0 31.1 37.6 47.3 59.9DPS 1.4 1.8 2.3 2.5 2.8Payout % 27.2 27.8 24.4 20.4 17.9Valuation (x) P/E Consolidated (Diluted) 54.7 38.1 21.2 15.1 12.0Cash P/E 20.6 14.0 11.0 8.6 7.0EV/EBITDA 21.9 13.5 8.9 7.0 5.6EV/Sales 2.8 1.1 0.9 0.7 0.6Price to Book Value 8.4 5.9 4.9 3.9 3.1Dividend Yield (%) 0.7 1.0 1.2 1.4 1.5Profitability Ratios (%) RoE 28.2 20.0 27.7 31.5 31.9RoCE 12.4 15.1 24.9 29.4 31.6Turnover Ratios Asset Turnover (x) 1.4 3.1 3.3 3.5 3.6Leverage Ratio Debt/Equity (x) 1.1 0.7 0.5 0.4 0.3

Source : Company, Bloomberg, Anand Rathi Research

Anand Rathi Financial Services Limited does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Disclosures and analyst certifications are located in Appendix 1 Anand Rathi Research India Equities

India I Equities

Key financials


Sales (`m) 47,740 33,276 48,203 59,882 72,168

Net profit (`m) 1,518 153 3,070 4,844 6,827

Diluted EPS (`) 6.2 0.6 12.5 19.8 27.9

Growth (%) -47.1 -89.9 1,906.5 57.8 40.9

PE (x) 51.4 509.8 25.4 16.1 11.4

PBV (x) 4.3 4.9 3.7 3.1 2.4

RoE (%) 2.5 -5.2 15.0 20.0 22.4

RoCE (%) 9.1 3.7 16.0 20.5 24.2

Dividend yield (%) 0.3 0.3 0.5 0.5 0.6

Net gearing (%) 54.4 55.1 45.1 40.5 34.4


Auto Components

Update

22 February 2011

Bharat Forge

Ph-1 complete, ph-2 of re-rating on the anvil; Buy

We expect Bharat Forge, with its diversified business model and domestic market leadership, to register 49.1% consolidated profit CAGR over FY11-13e, given our view that the CV industry would see steady growth over FY11-13e and good overseas demand. We re-iterate our Buy with a target price of `396 (from `317).

To benefit from steady demand. Domestic auto demand is expected to follow a steady growth trend, while overseas markets too are showing signs of improvement. Given that BFL is the domestic market leader and earns ~60% revenue from overseas, we expect it to largely benefit from this growth.

JVs, non-auto demand add to revenue. We expect BFL’s four non-auto JVs to be operational by end-FY13. The JVs, to cater to power sector requirements, have strong revenue growth and profitability potential.

Introducing FY13 estimates. We introduce FY13 estimates and expect sales of `72.2bn, EBITDA margin of 20.7% and EPS of `27.9 (40.9% yoy growth) by FY13.

Valuation and risks. We value the stock at 20x FY12e PE. We believe that commencement of operations of JVs would trigger a re-rating of the stock. Our target price is `396. At present valuations, BFL trades at 16.1x FY12e EPS. Risks: slowdown in execution, delayed overseas recovery.


Key data BHFC IN/BRFG.BO

52-week high/low `413/`232Sensex/Nifty 18212 / 54593-m average volume US$4.1m Market cap `48.97bn/US$1.65bn

Shares outstanding 232.9mFree float 58.0%Promoters 42.1%Foreign Institutions 14.1%Domestic Institutions 18.8%Public 25.0%

Relative price performance

BHFC

Sensex

200

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350

400

450

Feb-

10

Apr-1

0

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10

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10

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-10

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Source: Bloomberg


22 February 2011 Bharat Forge – Ph-1 complete, ph-2 of re-rating on the anvil; Buy


Quick Glance – Financials and ValuationsFig 1 – Income statement (`m)

Year end 31 March FY09 FY10 FY11e FY12e FY13eNet sales 47,740 33,276 48,203 59,882 72,168Sales growth (%) 2.6 -30.3 44.9 24.2 20.5- Op. expenses 42,176 29,891 39,382 48,239 57,232EBIDTA 5,565 3,385 8,820 11,643 14,936EBITDA margins (%) 11.7 10.2 18.3 19.4 20.7- Interest 1,291 1,303 1,694 1,779 1,779- Depreciation 2,517 2,451 2,941 3,089 3,274+ Other income 687 511 537 590 649- Tax 696 119 1,610 2,505 3,687Rep PAT before MI 411 -764 2,989 4,862 6,847Adjusted PAT 1,518 153 3,070 4,844 6,827Adj. PAT growth (%) -47.1 -89.9 1,906.5 57.8 40.9FDEPS (`/share) 6.2 0.6 12.5 19.8 27.9CEPS (`/share) 13.1 7.6 25.5 34.1 43.5DPS (`/share) 1.0 1.0 1.5 1.8 2.0Source: Company, Anand Rathi Research

Fig 2 – Balance sheet (`m)

Year to 31 March FY09 FY10 FY11e FY12e FY13eShare capital 445 445 466 466 466Reserves & surplus 16,223 14,185 19,461 23,830 30,114Shareholders’ fund 16,669 14,630 19,927 24,296 30,580Debt 21,908 22,527 18,510 18,510 18,510Deferred tax / others 2,563 1,754 1,754 1,754 1,754Capital employed 41,140 38,911 40,191 44,560 50,844 Fixed assets 27,902 26,065 22,636 22,048 21,274Investments 2 2,737 2,737 3,737 5,737Working capital 8,352 4,132 9,547 12,195 15,201Cash 4,883 5,977 5,270 6,580 8,631Capital deployed 41,140 38,911 40,191 44,560 50,844No. of shares (m) 223 223 233 233 233Net Debt/Equity (%) 102.1 113.1 66.4 49.1 32.3W C turn (days) 50 43 62 60 60Source: Company, Anand Rathi Research


Year end 31 March FY09 FY10 FY11e FY12e FY13eReported PAT 3,018 -69 4,269 6,050 7,976+ Depreciation 2,517 2,451 2,941 3,089 3,274Cash profit 5,536 2,382 7,211 9,139 11,250- Incr/(Decr) in WC 3,172 -4,220 5,415 2,648 3,007Operating cash flow 2,363 6,602 1,796 6,491 8,243- Capex 6,812 619 -487 2,500 2,500Free cash flow -4,449 5,983 2,283 3,991 5,743- Dividend 260 271 407 475 543+ Chg. in net worth -23 -1,003 2,715 -18 -19+ Debt raised 5,364 618 -4,017 0 0- Investments -2,986 2,735 0 1,000 2,000- Misc. items 1,919 1,499 1,280 1,188 1,129Net cash flow 1,700 1,094 -706 1,310 2,051+ Opening cash 3,183 4,883 5,977 5,271 6,580Closing cash 4,883 5,977 5,270 6,580 8,631Source: Company, Anand Rathi Research

Fig 4 – Standalone PE Band

Bharat Forge

10x

14x

18x

22x

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Source: Bloomberg, Anand Rathi Research

Fig 5 – Standalone Price-to-Book Band

Bharat Forge

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Fig 6 – Bharat Forge v/s BSE Auto

BHFC

BSE Auto

200

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Apr-1

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Source: Bloomberg



Investment Argument and Valuation We expect Bharat Forge, with its diversified business model and domestic market leadership, to register 49.1% consolidated profit CAGR over FY11-13e, given our view that the CV industry would see steady growth over FY11-13e and good overseas demand. We re-iterate our Buy with a target price of `396 (from `317).

Beneficiary of demand improvement

Domestic auto demand is expected to follow a steady growth trend, while overseas markets, too, are showing signs of improvement. Given that Bharat Forge is a market leader in India and that it earns around ~60% of revenue from overseas, we expect it to be a major beneficiary of the industry’s growth ahead.

For example, in 3QFY11, the recovery in CV demand and good PV demand has resulted in BFL’s revenue growing 50.2% yoy and 11.2% qoq. Production tonnage has improved – from a low 18,246 in 4QFY09 to ~35,000 in 3QFY10 and now to ~48,000 tons.

JVs, non-auto demand add to revenues

We expect Bharat Forge’s four non-auto JVs to be operational by around FY13-end. These JVs to cater to the power sector requirements have good revenue growth and profitability potential. These would add significantly to BFL’s revenues and profitability in the long run.

Continued robust operating performance

Bharat Forge has seen a consistent increase in sales for the past seven quarters, driven by strong growth in exports (driven by new products and customers in US and Europe), higher revenues from the non-automotive business, improved market share and programme ramp-up (in both non-automotive and automotive). These, along with the company’s efforts to lower its breakeven point, sustained efforts to reduce costs, better capacity utilization and improved performance of subsidiaries, have helped it regain its past normalised EBITDA margin of ~24% for its standalone operations and ~18% for its consolidated operations.

Valuations

In the past, Bharat Forge has commanded a premium to other forgings companies due to its pioneering dual-shore model, diversified nature and healthy EBITDA margin.

At present, to work out our target price, the JVs have not been taken into account, as they are likely to commence only by FY13-end. They would, however, be significant value-drivers once they begin operations.

We value the stock at 20x FY12e. Our target price is `396. At current valuations, Bharat Forge trades at 16.1x FY12e EPS.

Overseas demand recovery and non-auto demand would be the next big

growth drivers



Risks

Currency fluctuations: The rising proportion of exports (both to the US and Europe) in total revenue would raise currency fluctuation risks. The movement of the rupee against the US dollar and the euro would play an important role.

Execution risk: Given the nature of new greenfield projects involved, there remains an execution risk.

Inability to turn around subsidiaries: Most of BFL’s acquisitions were bankrupt companies. Therefore, there is an inherent risk that it may not be able to turn them around or sustain the operations at improved levels



Beneficiary of demand improvement Domestic auto demand is expected to follow a steady growth trend, while overseas markets, too, are showing signs of improvement. Given that Bharat Forge is a market leader in India and that it earns around ~60% of revenue from overseas, we expect it to be a major beneficiary of the industry’s growth ahead, both domestically and internationally.

The recovery in CV demand and good PV demand has resulted in BFL’s consolidated revenue growing 50.2% yoy and 11.2% qoq in 3QFY11. Production tonnage has improved – from a low 18,246 in 4QFY09 to ~35,000 in 3QFY10 and now to ~48,000 tons.

BFL’s FY11 performance reflects the steady recovery in the global auto industry and strong performance in the domestic M&H CV sector. The move towards greater non-auto share in production is also paying good dividends for Bharat Forge.

Fig 7 – India’s CV volumes and Bharat Forge’s domestic standalone sales

70,000

90,000

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150,000

170,000

190,000

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Total CV sales Standalone domestic revenues (RHS)

(Nos.) (`m)

Source: Company, SIAM

Fig 8 – M&HCV sales and impact on Bharat Forge’s EBITDA margin

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M&HCV sales EBITDA margin (RHS)

(units) (%)

Source: Company, SIAM

Exports contribute ~40% of BFL’s revenue (standalone), with overseas sales (including those of overseas subsidiaries) bringing in around ~60% of its (consolidated) revenue. The overseas subsidiaries have borne the brunt of the global slump in automobile demand, with their sales falling



45-75% in FY10. The steady improvement in demand overseas has benefited Bharat Forge’s overseas revenues as well, with the growth expected to be sustained ahead.

Fig 9 – Decline and recovery in Bharat Forge’s standalone exports

1,000

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In FY09, Bharat Forge’s exports to the US were `4,359m, dropping from `4,855m the year prior. As a result, Europe overtook the US as the major importer of the company’s products. However, with US demand expected to recover strongly on the back of the oldest fleet of trucks in recent history, demand recovery there is expected to be extremely robust.

Fig 10 – Bharat Forge’s consolidated region-wise revenue breakup

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FY09 FY10

(%)

Source: Company

Fig 11 – Bharat Forge’s consolidated segment-wise revenue breakup

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Vehi

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Source: Company



We expect the domestic CV sector to sustain good growth ahead, at a CAGR of 13.1% over FY11-13e. The global automobile market recovery ahead, after bottoming out in 2009-2010, is an added positive. As a significant proportion of its revenue derives from overseas and because of its leading position in India, Bharat Forge would be the prime beneficiary of an FY12 recovery.

Fig 12 – Bharat Forge: Rise in revenue (FY06-FY12e)

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CV demand in the US and Europe to be robust

Recent data released by FTR Associates (a leading North American transportation forecaster) on truck sales, indicates that Class 8 (heavy commercial vehicle) truck orders for major North American OEMs have shown consistent high percentage-point increases in the last five months. January Class 8 truck net orders were 27,009 units for major North American OEMs, a modest 1% mom increase but 324% yoy. These order levels were also the highest since May ’06.

Fig 13 – North America Class 8 and 4-7 production (‘000)

Source: FTR Associates

Ahead, FTR expects orders to show a normal seasonal increase to a level of between 22,000-25,000 units a month. Since the orders for class 8 trucks are showing exceedingly high growth rates, we expect the positive spillover effect to impact M&HCV (class 4-7 trucks) segment as well. All these point to the fact that truckers are willing to start ordering equipment, indicating a recovery for the truck-equipment market in North America. We think that most of these orders would come from leasing companies



and large fleets; small and medium-sized companies would also participate in this recovery.

Fig 14 – U.S. truck freight-ton miles

2.782.85

2.89 2.90

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As per ACEA (European Automobile Manufacturers Association) data, the European CV market is also in a recovery phase. In Dec ’10, demand for new commercial vehicles continued to soar (+12.5% yoy) in all sub-segments, except buses and coaches (-1.4% yoy). In CY10, EU markets for vans and trucks expanded while registrations of buses and coaches fell, leading to an overall 8% growth in Europe. As a result, European truck manufacturers have substantially increased production levels, indicating restocking by vendors on improved demand.

Fig 15 – Western Europe medium and heavy truck production GVW>6t (000)

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JVs, non-auto demand add to revenues We expect Bharat Forge’s four non-auto JVs to be operational by around FY13-end. These address power sector requirements, have good revenue growth and profitability potential and would add significantly to BFL’s revenues and profitability in the long run.

Non-automotive segment – a growth driver

The non-automotive business, which comes from the industrial and oil & gas industries, currently accounts for 19% of BFL’s consolidated and ~38% of its standalone sales. Due to the ongoing capex in the Indian economy and large-scale global oil & gas exploration, BFL’s expects strong growth in this segment. Forgings have varied industrial applications – in turbines for power plants, in parts of aircraft, in machined parts for the steel and cement industries, and in rigs for oil exploration.

The greater share of revenue from the non-auto segment would increasingly de-risk BFL’s business model, and result in a diversified product range. The sharper focus on the non-automotive business would see the higher proportion of CVs in the global revenue mix declining a little. The non-automotive business remains a lucrative segment for BFL.

Fig 16 – Bharat Forge’s non-automotive capacity Plant Capacity Baramati An 80-metre counterblow hammer for production of heavy forgings for large diesel engines

and aerospace applications, and a machining line for heavy-duty and medium-duty crankshafts. Commenced operations in Mar ’09.

Baramati Completed installation of a ring-rolling mill capable of rolling rings up to 4.5 metres in diameter and 50mm in height, along with its blanking press. Operational in Jun ’09. Secured orders from wind-turbine and large gearbox manufacturers from global OEMs.

Mundhwa A 4,000-ton open-die forgings press, commissioned in Aug ’08 and now fully operational. Source: Company

Fig 17 – Bharat Forge: Growth in share of non-automotive revenue (FY05-12e)

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Source: Company, Anand Rathi research

Entry into the non-automotive space would further de-risk BFL’s business model and this segment is expected to contribute up to 40% of global revenues by FY12 (17% in FY07, and 20% in FY10e).



JVs

Through its joint ventures with Alstom and NTPC, Bharat Forge would be tapping growth in segments where demand is high and supply is constrained.

Fig 18 – Details of Bharat Forge’s new JVs JVs Description

BF-NTPC Energy Systems (BFL 51%) - aimed at the power sector, in the balance-of-plant space. High-pressure piping, pumps, valves, related forgings and castings. A business plan would be developed on the appointment of a consultant. To manufacture sub-critical and super-critical turbines and generators at a port in India. Aims at further exploring possibilities for manufacturing turbines and generators for gas and nuclear power plants.

BF-Alstom

Plants of these companies are expected to be ready by 2012. BF-Alstom 1 (BF 49%)

To manufacture 5000 MW of turbines and generators of 300-800 MW+ range annually for coal-based power plants.

BF-Alstom 1 (BF 51%)

To manufacture sub-critical and super-critical turbines and generators at a port-based location in India. To manufacture a range of heat exchangers, condensers, de-aerators, and other auxiliaries for these power plants. To build a plant for heavy forgings in India. Would meet requirements of the indigenous power-generation sector.

BF - Areva Exploring locations, JV would have a state-of-the-art 14,000-ton open-die forgings press with associated equipment and an integrated steel-making facility.

Source: Company



Continued robust operating performance Successive sales increases, strong growth in exports, higher non- automotive revenues, capacity increases, efforts to lower breakeven point and sustained efforts to reduce costs have helped Bharat Forge regain its past normalised EBITDA margin of ~24% for standalone operations and ~18% for consolidated operations.

Bharat Forge has seen a consistent increase in sales for the past seven quarters, driven by strong growth in exports (driven by new products and customers in US and Europe), higher revenues from the non-automotive business, improved market share and program ramp-up (in both non-automotive and automotive). These, along with the company’s efforts to lower its breakeven point, sustained efforts to reduce costs, better capacity utilization and improved performance of subsidiaries, have helped it regain its past normalised EBITDA margin of ~24% for its standalone operations and ~18% for its consolidated operations.

The recovery in CV demand and good PV demand has resulted in BFL’s consolidated revenue growing 50.2% yoy and 11.2% qoq in 3QFY11. Production tonnage has improved – from a low 18,246 in 4QFY09 to ~35,000 in 3QFY10 and now to ~48,000 tons. In 3QFY11 volumes were up 4.3% qoq due to strong growth in exports and continued ramp-up of non-automotive capacities.

The 3QFY11 standalone EBITDA margin improved 90bps yoy and 10bps qoq to 24.3%, while EBITDA increased 58% yoy and 8% qoq. The yoy improvement in the EBITDA margin came mainly from the lower staff cost-to-sales ratio (60bps lower yoy and 10bps qoq), lower manufacturing cost-to-sales ratio (80bps lower yoy but qoq 40bps higher) and lower ‘other expenditure’ to sales (60bps qoq lower but 10 bps higher yoy). The 3QFY11 standalone adjusted PAT increased more than 2x yoy.

The share of the non-automotive business to sales increased to 37%, from 26% in 3QFY10, due to the ramp-up of new programmes at the new dedicated facilities, as well as to increase in market share with existing clients.

Consolidated performance

BFL’s 3QFY11 combined performance (India + overseas operations excl. China) marked the continuing qoq improvement as subsidiaries did well, driven by strong international operations due to a recovery in the European CV market. Revenue growth was 11.2% qoq and 50.2% yoy; the adjusted PAT increased 29.9% qoq to `787m.

There was an exceptional expense of `81m for a one-time cost incurred regarding concessions on labour union negotiations in Bharat Forge America as well as on business transfer expenses from Bharat Forge Scottish Stampings. The company said that the non-auto growth stemmed from new customer additions, higher value-addition of critical components and expanded product range. In CYFY11, it expects a better performance from subsidiaries post-restructuring, better capacity utilization and cost control.



Financials We expect a 22.4% CAGR in Bharat Forge’s consolidated revenues from FY11 to FY13e, with the EBITDA margin improving from 10.2% to 20.7% and an adjusted net profit CAGR of 49.1%.

We expect a 24.2% CAGR in Bharat Forge’s (standalone) revenue from FY11 to FY13e, but a 220bps EBITDA margin decline, and a 26% CAGR in the standalone adj. net profit.

We expect a 22.4% CAGR in (consolidated) revenue from FY11 to FY13e, backed by robust EBITDA margin improvement. The margin improvement in subsidiaries would be driven by higher capacity utilization, following mounting demand in the global auto market. We expect a 49.1% CAGR in the consolidated adj. net profit from FY11 to FY13e.

Fig 19 – Bharat Forge: Improvement in net profit (FY05-FY12e)

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Fig 20 – Bharat Forge: Improvement in EBITDA (FY05-FY12e)

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Fig 21 – Bharat Forge: Increase in capacity utilization (FY04-FY12e)

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Introducing FY13e

We introduce FY13 estimates; we expect sales of `72.2bn, EBITDA margin of 20.7% and EPS of `27.9 (40.9% yoy growth).



Fig 22 – Income statement Y/E MARCH FY09 FY10 FY11e FY12e FY13eNet Sales 46,730 32,616 47,477 59,084 71,290Change (%) 2.4 -30.2 45.6 24.4 20.7Operating Other Income 1,011 660 726 799 878Total Income 47,740 33,276 48,203 59,882 72,168Expenditure 42,176 29,891 39,382 48,239 57,232EBITDA 5,565 3,385 8,820 11,643 14,936 Change (%) -21.0 -39.2 160.6 32.0 28.3 % of Net Sales 11.7 10.2 18.3 19.4 20.7Depreciation 2,517 2,451 2,941 3,089 3,274Interest & Finance Charges 1,291 1,303 1,694 1,779 1,779Other Income 687 511 537 590 649Exceptional Expenses 1,336 787 123 0 0Non-recurring Income 0 0 0 0 0PBT 1,107 -645 4,599 7,367 10,533Tax 696 119 1,610 2,505 3,687Effective Rate (%) 62.9 -18.4 35.0 34.0 35.0PAT 411 -764 2,989 4,862 6,847 Change (%) -85.9 -286.0 -491.0 62.6 40.8Adj. PAT 1,518 153 3,070 4,844 6,827 Change (%) -47.1 -89.9 1,906.5 57.8 40.9


Fig 23 – Balance sheet Y/E MARCH FY09 FY10 FY11e FY12e FY13eSources of Funds Share Capital 445 445 466 466 466Equity Capital 445 445 466 466 466Reserves 16,223 14,185 19,461 23,830 30,114Net Worth 16,669 14,630 19,927 24,296 30,580Minority interest 954 783 783 783 783Loans 21,908 22,527 18,510 18,510 18,510Capital Employed 41,140 38,911 40,191 44,560 50,844Application of Funds Gross Fixed Assets 40,271 41,340 42,840 45,340 47,840Less: Depreciation 15,594 17,267 20,208 23,297 26,571Net Fixed Assets 24,676 24,073 22,632 22,043 21,269Capital WIP 3,219 1,987 0 0 0Investments 2 2,737 2,737 3,737 5,737Curr.Assets, L & Adv. 25,316 24,171 27,415 32,962 39,692Inventory 7,916 6,575 8,065 9,712 11,719Sundry Debtors 5,313 5,044 6,504 8,094 9,766Cash & Bank Balances 4,883 5,977 5,270 6,580 8,631Loans & Advances 5,784 5,204 6,204 7,204 8,204Others 1,420 1,372 1,372 1,372 1,372Current Liab. & Prov. 12,081 14,062 12,597 14,187 15,859Current Liabilities 8,538 11,164 9,932 11,522 13,194Net Current Assets 13,236 10,109 14,817 18,775 23,833Miscellaneous Expenditures 0 0 0 0 0Application of Funds 41,140 38,911 40,191 44,560 50,844




Fig 24 – Ratios @`319 Y/E MARCH FY09 FY10 FY11e FY12e FY13e

Basic (`)

EPS Consolidated 2.6 -2.8 12.8 20.8 29.3

Diluted EPS Cons. 6.2 0.6 12.5 19.8 27.9

Cons. EPS growth (%) -47.1 -89.9 1,906.5 57.8 40.9

Cash EPS 13.1 7.6 25.5 34.1 43.5

Book Value per Share 74.8 65.7 85.6 104.3 131.3

DPS 1.0 1.0 1.5 1.8 2.0

Payout % 63.4 -35.5 13.6 9.8 7.9

Valuation (x)

P/E Consolidated (Diluted) 51.4 509.8 25.4 16.1 11.4

Cash P/E 24.2 42.1 12.5 9.3 7.3

EV/EBITDA 15.8 25.0 9.6 7.1 5.2

EV/Sales 1.9 2.6 1.8 1.4 1.1

Price to Book Value 4.3 4.9 3.7 3.1 2.4

Dividend Yield (%) 0.3 0.3 0.5 0.5 0.6

Profitability Ratios (%)

RoE 2.5 -5.2 15.0 20.0 22.4

RoCE 9.1 3.7 16.0 20.5 24.2

Turnover Ratios

Asset Turnover (x) 1.1 0.8 1.2 1.3 1.4

Leverage Ratio

Debt/Equity (x) 1.3 1.5 0.9 0.8 0.6


Fig 25 – Cash flow statement Y/E MARCH FY09 FY10 FY11e FY12e FY13e

OP/(Loss) before Tax 3,047 934 5,879 8,555 11,662

Interest/Div. Received 687 511 537 590 649

Depreciation & Amort. 2,517 2,451 2,941 3,089 3,274

Direct Taxes Paid -29 -1,003 -1,610 -2,505 -3,687

(Inc)/Dec in Wkg. Capital -3,172 4,220 -5,415 -2,648 -3,007

Other Items 22 79 0 0 0

CF from Op. Activity 3,072 7,192 2,333 7,081 8,892

Extra-ordinary Items -1,336 -787 -123 0 0

CF after EO Items 1,736 6,405 2,210 7,081 8,892

(Inc)/Dec in FA+CWIP -6,812 -619 487 -2,500 -2,500

(Pur)/Sale of Invest. 2,986 -2,735 0 -1,000 -2,000

CF from Inv. Activity -3,826 -3,353 487 -3,500 -4,500

Inc./(Dec) in Networth -23 -1,003 2,715 -18 -19

Inc/(Dec) in Debt 5,364 618 -4,017 0 0

Interest Paid -1,291 -1,303 -1,694 -1,779 -1,779

Dividends Paid -260 -271 -407 -475 -543

CF from Fin. Activity 3,790 -1,959 -3,403 -2,272 -2,341

Inc/(Dec) in Cash 1,700 1,093 -706 1,310 2,051

Add: Beginning Balance 3,183 4,883 5,977 5,270 6,580

Closing Balance 4,883 5,976 5,270 6,580 8,631



India I Equities

Key financials


Sales (`m) 33,929 37,940 44,974 58,739 69,706

Net profit (`m) 3,207 5,229 6,006 7,270 8,580

Diluted EPS (`) 3.8 6.2 7.1 8.6 10.1

Growth (%) 39.0 63.0 14.9 21.0 18.0

PE (x) 34.6 21.2 18.5 15.3 12.9

PBV (x) 8.3 5.0 4.0 3.3 2.7

RoE (%) 25.7 23.6 21.8 21.7 21.1

RoCE (%) 33.4 33.9 29.1 30.1 30.5

Dividend yield (%) 0.5 0.8 1.0 1.1 1.3

Net gearing (%) 33.9 20.8 17.7 18.7 11.5


Auto Components

Update

22 February 2011

Exide Industries

Industrial slowdown impact; maintain Hold

Its industry dominance and backward integration measures are long-running positives for Exide. However, slowdown in industrial demand and hence lower pricing power, short-term capacity constraints and fair valuations lead us to re-iterate our Hold rating.

4Q to be subdued. Capacity commissioning for Exide’s auto segment in Apr ’11 would help it address replacement demand, which is now inadequately serviced. However in 4Q, weaker demand from the industrial segment and continuing capacity constraints in the auto segment are likely to temper Exide’s sales growth and profitability.

Industrial segment slowdown. The slowdown in user segments, power, telecoms and railways, led to sluggish demand. Poor demand has lowered Exide’s pricing power in the industrial-battery segment, where it had been able to pass on price increases.

Change in estimates. We reduce our FY12e EBITDA margin for Exide, by 3%, partially set off by higher other income, thereby lowering our FY12e standalone EPS, by 3.8%.

Valuation and risks. We value the standalone business at one-year forward PE of 16x. We value Exide’s stake in ING Vysya Life Insurance at `12. Our target price is `149 (from `128). We retain our Hold. Risks: Upside: recovery in industrial demand, lower lead prices. Downside: auto demand slowdown, delayed capex, industrial demand and pricing power being further lowered.

Rating: Hold Target Price: `149 Share Price: `130

Key data EXID IN/EXID.BO

52-week high/low `180/`105Sensex/Nifty 18212 / 54593-m average volume US$6.8m Market cap `107.9bn/US$2.5bnShares outstanding 850mFree float 54.0%Promoters 46.0%Foreign Institutions 15.5%Domestic Institutions 16.4%Public 22.1%


EXID

Sensex

100110120130140150160170180

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10

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Source: Bloomberg


22 February 2011 Exide Industries – Industrial slowdown impact; maintain Hold


Quick Glance – Financials and Valuations Fig 1 – Income statement (`m)

Year end 31 March FY09 FY10 FY11e FY12e FY13eNet sales 33,929 37,940 44,974 58,739 69,706Sales growth (%) 19.3 11.8 18.5 30.6 18.7 - Op. expenses 27,939 29,231 36,596 48,153 56,746EBIDTA 5,990 8,709 8,378 10,586 12,960EBITDA margins (%) 17.7 23.0 18.6 18.0 18.6 - Interest 479 139 54 54 54 - Depreciation 679 807 818 937 1,025 + Other income 65 121 892 903 925 - Tax 1,510 2,735 2,583 3,228 4,226Reported PAT 2,843 5,371 6,392 7,270 8,580Adjusted PAT 3,207 5,229 6,006 7,270 8,580Adj. PAT growth (%) 39.0 63.0 14.9 21.0 18.0FDEPS (Rs/share) 3.8 6.2 7.1 8.6 10.1CEPS (Rs/share) 4.9 7.1 8.0 9.7 11.3DPS (Rs/share) 0.6 1.0 1.3 1.5 1.8Source: Company, Anand Rathi Research


Year to 31 March FY09 FY10 FY11e FY12e FY13eShare capital 800 850 850 850 850Reserves & surplus 11,704 21,348 26,677 32,672 39,765Shareholders’ fund 12,504 22,198 27,527 33,522 40,615Debt 3,172 900 900 900 900Deferred tax / others 412 590 590 590 590Capital employed 16,087 23,688 29,017 35,012 42,105 Fixed assets 6,853 7,144 10,077 11,640 11,615Investments 6,682 13,354 14,354 16,854 19,354Working capital 2,215 3,161 3,981 6,332 7,714Cash 337 29 605 186 3,421Capital deployed 16,087 23,688 29,017 35,012 42,105No. of shares (m) 800 850 850 850 850Net Debt/Equity (%) 22.7 3.9 1.1 2.1 -6.2W C turn (days) 36 41 41 46 46Source: Company, Anand Rathi Research


Year end 31 March FY09 FY10e FY11e FY12e FY13eReported PAT 3,734 5,346 4,978 6,421 7,709 + Depreciation 679 807 818 937 1,025 Cash profit 4,413 6,152 5,795 7,358 8,734 - Incr/(Decr) in WC -808 945 821 2,351 1,382 Operating cash flow 5,221 5,207 4,975 5,007 7,352 - Capex 1,515 1,098 3,750 2,500 1,000 Free cash flow 3,706 4,109 1,225 2,507 6,352 - Dividend 480 850 1,063 1,275 1,488 + Equity raised 0 50 0 0 0 + Debt raised -326 -2,272 0 0 0 - Investments 1,499 6,672 1,000 2,500 2,500 - Misc. items 1,081 -5,327 -1,414 -849 -871 Net cash flow 320 -308 576 -419 3,235 + Opening cash 17 337 29 605 186 Closing cash 337 29 605 186 3,421Source: Company, Anand Rathi Research

Fig 4 – PE Band

Exide Industries

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Fig 5 – Price-to-Book Band

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Fig 6 – Exide vs BSE Auto

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Investment Argument and Valuation Its industry dominance and backward integration measures are long-running positives for Exide Industries. However, the slowdown in industrial demand and hence lower pricing power, short-term capacity constraints and fair valuations lead us to re-iterate our Hold rating.

4QFY11 to be subdued

Exide is expected to temper the rise in lead prices by increased in-house sourcing of the raw material from its lead smelters. The commissioning of its automobile-battery capacities, in Apr ’11, would help it address replacement demand, which is now inadequately serviced. However, in 4Q, weaker demand for industrial batteries and continuing capacity constraints in its automobile-battery division are likely to temper Exide’s sales growth and profitability.

Moreover, delayed recovery in industrial demand would lead to further lowering of our FY12 estimates.

Industrial-batteries division slowdown

The industrials segment, encompassing power, telecoms, railways, is seeing sluggish demand due to a slowdown in user segments. Additionally, poor demand has lessened Exide’s pricing power in a segment where, in the past, it had been able to pass on price increases.

The slowdown, which commenced in telecoms, has been more widespread in 3Q, as it affected demand for power inverters.

Replacement demand, key trigger in the automobile-battery division

The automobile OEM sector would register lower growth ahead, but the good 14% CAGR in auto volumes from FY02 to FY11 has generated high potential for replacement demand. Moreover, the high-volume Nano is a potential trigger when production accelerates. The completion of Exide’s capex in 1QFY12 would address replacement demand, which is now inadequately serviced due to higher demand from OEMs.

Valuations

We value Exide’s standalone business at one-year forward standalone PE of 16x (average of the past two years’ one-year-forward PE; the past six years average is 15x). We value Exide’s stake in ING Vysya Life Insurance at `12. Our new target price is `149 (from `128). We retain our Hold rating.

Upside risks

A faster-than-anticipated recovery in demand in Exide’s industrial-battery division.

Lower lead prices.

Downside risks

A lower economic interest in the insurance business would lower Exide’s target price to that extent.

Imports are a significant threat to Indian battery manufacturers. Exide has strong brand equity and products at various prices. Hence, its OEM-segment share is unlikely to be hit. However, imports could



impact its replacement-market sales.

Delayed capex.

Industrial demand and pricing power being further lowered.



4QFY11 to be subdued In 4Q, weaker demand in Exide’s industrial-battery division and continuing capacity constraints in its automobile-battery division are likely to temper its sales growth and profitability. Moreover, recovery in industrial demand, if delayed, would lead to a lowering of FY12 estimates.

3Q performance reflected industrial slowdown and lower replacement demand

Exide’s 3QFY11 sales rose only 15% yoy to `10.5bn, due to capacity constraints in its automobile-battery division and weaker performance in its industrial-battery division. Its EBITDA margin slid 800bps yoy to 14.7%. The company says this was chiefly due to: i) more OEM sales, diverting capacity from the replacement segment; ii) lack of buoyancy in the industrials segment; iii) high commodity prices – lead prices rose 18.4% qoq and 4% yoy; and iv) cautiousness in passing on costs in the replacement market.

Exide’s adjusted profit declined 1.5% yoy to `1.2bn; this was lower than its EBITDA decline owing to considerably low interest costs and significantly higher other income.

Demand not being serviced

OE demand is buoyant and Exide is a strong player with OE relationships built over the years; this could also have a reverse effect. In 3QFY11, Exide looked to supply more to OEMs in order to maintain this relationship.

Hence, the OE to replacement (& trade) ratio has been adverse in 3QFY11. For the past four or five years, the replacement-OE ratio was 1.4:1 or 1.45:1. In the downturn, when OE sales crashed, the ratio went to 1.6:1. In FY10, it was 1.61:1; the FY11 target was 1.65:1. In 1QFY11, this went to 1.32:1, while in 3QFY11, this was further lower at 1.17:1. Although the ratio has grown increasingly adverse, the two-year target is 1.75:1.

Exide is expected to temper the rise in lead prices by increased in-house sourcing of the raw material from its lead smelters. Its commissioning of capacities in its automobile-battery division, in Apr ’11, would help it address replacement demand, which is now inadequately serviced. However, in 4Q, weaker demand for industrial batteries and continuing capacity constraints in its automobile-battery division are likely to temper its sales growth and profitability. Moreover, recovery in industrial demand, if delayed, would lead to a lowering of FY12 estimates.



Fig 7 – Exide: EBITDA margin trend

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Industrial segment slowdown The industrials segment, encompassing power, telecoms, railways, is seeing sluggish demand due to a slowdown in user segments. Additionally, poor demand has lessened Exide’s pricing power in a segment where, in the past, it had been able to pass on price increases.

Exide is strongly represented in industrial batteries, with a 55% market share. This division (batteries for industry) brings in about 35-40% of its revenue.

The industrial division, manufacturing batteries for power equipment, telecoms, the railways, etc., has seen lower demand due to sluggish telecom demand, higher power generation leading to lower requirement of inverters, and lower pricing power due to the lower demand.

Unlike in the OEM battery segment, Exide has higher pricing power in the industrial-battery segment. It would frequently hike prices of batteries for the industrial segment, particularly for inverters and UPS. Its pricing power in this segment helped it sustain profitability even when other auto-parts companies started feeling their profitability pinch. In the present context, though, this is no longer true. Hence, the scope for greater profitability stands substantially reduced.

Commodity price risk escalates

The cost of lead comprises 70% of raw material cost for batteries. Lead prices corrected off their peak of US$3,800 a ton in 3QFY08 to less than half that, at US$1,500 in 1QFY10. Subsequently, it has steadily risen to ~US$2,500 a ton. Weak industrial demand raises concerns since Exide would not be able to pass on lead price increases.

Fig 8 – Lead prices (Apr ’06-Feb ’11)

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Fig 9 – Exide: Raw material costs-to-sales trend

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Replacement-demand recovery, the key The good 14% CAGR in automobile volumes from FY02 to FY11 has generated high potential for replacement demand. Completion of Exide’s capex in 1QFY12 would help it address replacement demand, which is now inadequately serviced due to higher supply pressure from OEMs.

Exide dominates the car-battery market, with a ~50% share, and is the leader in the organised sector for replacement batteries. Being a market leader, it is ensured steady volume growth, offsetting lower margins in OEM sales through greater economies of scale. Further, its well-established connection with OEMs helps brand-building and goodwill, boosting replacement-market sales and offering greater pricing power than the competition. Implementation of the more stringent norms pertaining to recycling of used batteries is another positive trigger. This would reduce the number of unorganised players in the replacement market.

The auto OEM segment would register relatively lower growth ahead, but the good 14% CAGR in auto volumes from FY02 to FY11 has generated great potential in replacement demand. Moreover, the high-volume Nano is a potential trigger ahead when production accelerates. Completion of Exide’s capex in 1QFY12 would help it address the replacement demand, which is now inadequately serviced due to higher supply pressure from OEMs.

Further, Exide would benefit from the 13.7% CAGR expected in auto OEM sales growth over FY11-13e.

Fig 10 – Auto OEM growth expected

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Financials We expect a 24.5% CAGR in Exide’s revenue from FY11 to FY13e, with a steady EBITDA margin of 18.6% and a 19.5% CAGR in adjusted net profit.

We expect a 24.5% CAGR in Exide’s revenue, based on assumptions of timely completion of capex and better industrial demand in the next 2-3 years (than in 2HFY11).

However, we lower our estimates to factor in more pressure from a further rise in the price of lead, short-term reduced supply to the auto replacement segment and lower demand and pricing power in the industrial-battery division.

We also factor in higher other income on the back of an increase in dividend from subsidiaries (Leadage Alloys and Chloride Metals). Our revised EBITDA margin expectation is 18% for FY12e (3% lower). The net impact on our FY12e standalone EPS estimate is 3.8% lower.

The expected volatility in commodity prices would only be partially neutralized by Exide’s backward integration step of purchasing lead smelters. We expect a 19.5% CAGR in adjusted net profit (standalone) from FY11 to FY13e.

Fig 11 – Change in estimates Previous estimate Revised estimate Change (%)

(`m) FY11e FY12e FY11e FY12e FY11e FY12e

Income 47,746 58,794 44,974 58,739 -5.8 -0.1

EBITDA 9,892 12,352 8,378 10,586 -15.3 -14.3

EBITDA Margin (%) 20.7 21.0 18.6 18.0

Adjusted PAT 6,011 7,560 6,006 7,270 -0.1 -3.8

EPS (`) 7.1 8.9 7.1 8.6 -0.1 -3.8

Source: Anand Rathi Research



Fig 12 – Income statement (`m) Y/E MARCH FY09 FY10 FY11e FY12e FY13eNet Sales 33,929 37,940 44,974 58,739 69,706 Change (%) 19.3 11.8 18.5 30.6 18.7Expenditure 27,939 29,231 36,596 48,153 56,746EBITDA 5,990 8,709 8,378 10,586 12,960 Change (%) 36.0 45.4 -3.8 26.4 22.4 % of Net Sales 17.7 23.0 18.6 18.0 18.6Depreciation 679 807 818 937 1,025 EBIT 5,311 7,903 7,560 9,649 11,935Interest & Finance Charges 479 139 54 54 54Other Income 65 121 892 903 925Non-recurring Expense 543 5 - - -Non-recurring Income - 226 576 - -PBT 4,353 8,106 8,974 10,498 12,806Tax 1,510 2,735 2,583 3,228 4,226 Effective Rate (%) 34.7 33.7 28.8 30.8 33.0Adj. PAT (bef. Extra) 3,207 5,229 6,006 7,270 8,580 Change (%) 39.0 63.0 14.9 21.0 18.0 % of Net Sales 9.5 13.8 13.4 12.4 12.3Rep. PAT 2,843 5,371 6,392 7,270 8,580 Change (%) 13.6 88.9 19.0 13.7 18.0


Fig 13 – Balance sheet Y/E MARCH FY09 FY10 FY11e FY12e FY13eShare Capital 800 850 850 850 850Reserves 11,704 21,348 26,677 32,672 39,765Net Worth 12,504 22,198 27,527 33,522 40,615Loans 3,172 900 900 900 900Deferred Tax Liability 412 590 590 590 590 Capital Employed 16,087 23,688 29,017 35,012 42,105Gross Fixed Assets 12,567 13,365 17,492 19,992 20,992Less: Depreciation 5,887 6,598 7,416 8,353 9,377Net Fixed Assets 6,680 6,767 10,077 11,640 11,615Capital WIP 173 378 - - -Investments 6,682 13,354 14,354 16,854 19,354Curr.Assets, L & Adv. 7,419 9,118 11,308 14,502 20,321Inventory 4,385 6,068 7,270 9,978 11,840Sundry Debtors 2,310 2,546 2,957 3,862 4,583Cash & Bank Balances 337 29 605 186 3,421Loans & Advances 387 476 476 476 476Current Liab. & Prov. 4,866 5,929 6,721 7,984 9,185Sundry Creditors 3,343 4,382 5,175 6,437 7,639Other Liabilities 465 561 561 561 561Provisions 1,059 985 985 985 985Net Current Assets 2,552 3,190 4,587 6,518 11,136Application of Funds 16,087 23,688 29,017 35,012 42,105




Fig 14 – Ratio @`130 Y/E MARCH FY09 FY10 FY11e FY12e FY13eBasic (`) Standalone Diluted EPS 3.8 6.2 7.1 8.6 10.1

Consol. EPS 2.7 5.8 7.3 8.9 10.7

Cash EPS 4.9 7.1 8.0 9.7 11.3

EPS Growth (%) 39.0 63.0 14.9 21.0 18.0


DPS 0.6 1.0 1.3 1.5 1.8

Payout (Incl. Div. Tax) % 15.0 16.3 17.7 17.5 17.3

Valuation (x)

P/E 34.6 21.2 18.5 15.3 12.9Consol. P/E 48.7 22.5 18.0 14.6 12.2Cash P/E 26.9 18.4 16.2 13.5 11.5EV/EBITDA 16.8 11.3 11.6 8.9 6.9EV/Sales 3.0 2.6 2.2 1.6 1.3Price to Book Value 8.3 5.0 4.0 3.3 2.7Dividend Yield (%) 0.5 0.8 1.0 1.1 1.3


RoE 25.7 23.6 21.8 21.7 21.1

RoCE 33.4 33.9 29.1 30.1 30.5

Turnover Ratios

Asset Turnover (x) 2.1 1.6 1.5 1.7 1.7

Leverage Ratio

Debt/Equity (x) 0.25 0.04 0.03 0.03 0.02


Fig 15 – Cash flow statement Y/E MARCH FY09 FY10 FY11e FY12e FY13eOP/(Loss) before Tax 5,311 7,903 7,560 9,649 11,935Depreciation & Amortisation 679 807 818 937 1,025Direct Taxes Paid -1,577 -2,557 -2,583 -3,228 -4,226(Inc)/Dec in Working Capital 808 -945 -821 -2,351 -1,382Other Items -123 5,123 0 0 0CF from Oper. Activity 5,098 10,330 4,975 5,007 7,352Extra-ordinary Items -543 221 576 0 0CF after EO Items 4,555 10,551 5,551 5,007 7,352(Inc)/Dec in FA+CWIP -1,515 -1,098 -3,750 -2,500 -1,000(Pur)/Sale of Invest. -1,499 -6,672 -1,000 -2,500 -2,500CF from Inv. Activity -3,014 -7,770 -4,750 -5,000 -3,500Issue of Shares 0 50 0 0 0Inc/(Dec) in Debt -326 -2,272 0 0 0Interest Rec./(Paid) -414 -18 838 849 871Dividends Paid -480 -850 -1,063 -1,275 -1,488CF from Fin. Activity -1,221 -3,089 -224 -426 -617Inc/(Dec) in Cash 320 -308 577 -419 3,235Add: Beginning Balance 17 337 29 605 186Closing Balance 337 29 605 186 3,421



India I Equities

Key financials Year end 31 March FY09 FY10 FY11e FY12e FY13e

Sales (`m) 33,211 35,429 45,187 55,972 66,722

Net profit (`m) 1,238 2,480 3,719 4,604 5,686

Diluted EPS (`) 5.3 10.5 15.8 19.6 24.2

Growth (%) -66.1 100.4 50.0 23.8 23.5

PE (x) 22.3 11.1 7.4 6.0 4.9

PBV (x) 0.5 0.5 0.5 0.4 0.4

RoE (%) 3.8 5.4 7.4 8.3 9.2

RoCE (%) 5.1 7.0 9.6 11.1 12.7

Dividend yield (%) 0.5 1.0 0.8 0.9 1.1

Net gearing (%) 48.5 38.9 36.7 34.3 32.4


Auto Components

Update

22 February 2011

Amtek Auto

Better times ahead; maintain Buy

We expect Amtek Auto to benefit from sustained auto demand locally and the nascent global recovery, along with market-share gains overseas. Its completed organizational restructuring and near completion of its non-auto capex are added positives. We trim our target price from `254 to `225, while maintaining a Buy.

Improvement in demand. Domestic auto demand has entered a steady growth mode, which would continue to provide a firm base for Amtek’s future operations. As demand in overseas auto markets recovers, Amtek’s sales volumes would further improve due to new orders, raising its market-share. Better operating leverage in its overseas subsidiaries would boost its profitability.

Non-auto capex nearing completion. Amtek Auto’s non-auto capex is nearing completion, thereby significantly raising its revenue potential. Further, on the successful completion of the open offer, Amtek India is now close to being a subsidiary. This has led to all forgings and castings units being brought under the ‘Amtek Auto’ umbrella. We expect this to result in better integrated operations, clearer efficiencies in sourcing and negotiations, and greater transparency in operations.

Valuation and risks. We cut our target price from `254 to `225 (10x FY12e EPS, and `29 as value of 38% stake in Amtek India). Risks: slower-than-expected demand ramp-up in Europe, unfavourable currency fluctuations and commodity-cost increases.


Key data AMTK IN/AMTK.BO

52-week high/low `201/`106Sensex/Nifty 18211 / 54593-m average volume US$4.7m Market cap `25.4bn/US$0.56bn



AMTK

Sensex

100120140160180200220240

Feb-

10

Apr-1

0

Jun-

10

Aug-

10

Oct

-10

Dec

-10

Feb-

11

Source: Bloomberg


22 February 2011 Amtek Auto – Better times ahead; maintain Buy


Quick Glance – Financials and Valuations Fig 1 – Income statement (`m) Year end 31 March FY09 FY10 FY11e FY12e FY13e

Net sales 33,211 35,429 45,187 55,972 66,722Sales growth (%) -26.1 6.7 27.5 23.9 19.2 - Op. expenses 27,381 27,719 34,749 43,182 51,309EBIDTA 5,830 7,710 10,439 12,790 15,413EBITDA margins (%) 17.6 21.8 23.1 22.9 23.1 - Interest 1,523 2,051 2,478 2,984 2,884 - Depreciation 2,728 3,102 3,370 3,622 4,215 + Other income 685 1,480 1,517 1,555 1,594 - Tax 849 1,216 1,832 2,322 2,972Rep PAT before MI 1,414 2,783 4,275 5,417 6,935Adjusted PAT 1,238 2,480 3,719 4,604 5,686Adj. PAT growth (%) -66.1 100.4 50.0 23.8 23.5FDEPS (`/share) 5.3 10.5 15.8 19.6 24.2CEPS (`/share) 32.9 41.2 54.2 64.1 79.1DPS (`/share) 0.6 1.2 1.0 1.0 1.3Source: Company, Anand Rathi Research

Fig 2 – Balance sheet (`m) Year to 31 March FY09 FY10 FY11e FY12e FY13e

Share capital 282 403 418 418 418Reserves & surplus 32,204 45,749 49,821 55,021 61,678Shareholders’ fund 32,486 46,152 50,239 55,439 62,097Debt 41,207 40,506 38,786 40,786 38,786Deferred tax / others 0 -1 -1 -1 -1Capital employed 73,693 86,657 89,024 96,224 100,882 Fixed assets 53,024 58,312 60,353 62,251 63,665Investments 491 2,814 4,814 6,814 8,814Working capital 12,197 17,284 13,856 14,391 16,158Cash 7,981 8,247 10,002 12,769 12,245Capital deployed 73,693 86,657 89,024 96,224 100,882No. of shares (m) 141 202 209 209 209Net Debt/Equity (%) 102.3 69.9 57.3 50.5 42.7W C turn (days) 87 125 70 60 60Source: Company, Anand Rathi Research

Fig 3 – Cash flow statement (`m) Year end 31 March FY09 FY10 FY11e FY12e FY13e

Reported PAT 2,252 3,391 5,236 6,846 8,225 + Depreciation 2,728 3,102 3,370 3,622 4,215 Cash profit 4,980 6,493 8,606 10,468 12,441 - Incr/(Decr) in WC 3,405 5,088 -3,428 535 1,767 Operating cash flow 1,575 1,406 12,035 9,933 10,674 - Capex 13,956 8,390 5,411 5,520 5,630 Free cash flow -12,381 -6,985 6,623 4,414 5,044 - Dividend 101 271 234 249 319 + Equity raised 0 121 15 0 0 + Debt raised 9,820 -701 -1,720 2,000 -2,000 - Investments 125 -2,323 -2,000 -2,000 -2,000 - Misc. items -395 -5,777 4,931 5,397 5,249 Net cash flow -2,391 265 1,754 2,767 -524 + Opening cash 10,373 7,981 8,247 10,002 12,769 Closing cash 7,982 8,247 10,001 12,769 12,245Source: Company, Anand Rathi Research

Fig 4 – PE Band

Amtek Auto

10x

14x

18x

22x

26x

30x

0

100

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Fig 6 – Amtek Auto vs. BSE Auto

AMTK

BSE Auto

100

120

140

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280

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10

Apr-1

0

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10

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11

Source: Bloomberg



Investment Argument and Valuation We expect Amtek Auto to benefit from sustained auto demand locally and the nascent global recovery, along with market-share gains overseas. It’s completed organizational restructuring and near completion of its non-auto capex are added positives. We trim our target price to `225 and re-iterate our Buy on the stock.

Improvement in demand

Amtek is the only Indian company, and one of the select few globally, to have integrated component-manufacturing facilities in forgings, iron castings, aluminium castings, machining and sub-assemblies of auto and non-auto components. Domestic demand for automobiles has entered a secular growth mode, which would continue to provide a firm base for Amtek’s operations. In the next 2-3 years, as demand in overseas auto markets recovers, Amtek’s sales volumes would further improve due to its market-share gains.

Operating leverage at overseas subsidiaries

Amtek’s overseas subsidiaries are now recovering, benefiting from improved auto demand in Europe, new orders from OEMs there and ‘job work’ to boost revenues, especially in the German subsidiary. Improved operating leverage in its overseas subsidiaries would further boost Amtek’s profitability and help counter raw material cost increases. Non-auto capex, restructuring nearing completion

Amtek’s non-auto capex is nearly complete, thereby significantly increasing its revenue potential. This would enable it to compete for wagon demand (from Oct ’11), expected to be strong in India. Additional avenues being targeted are demand from Defence, aerospace, specialty vehicles, etc.

Further, on the successful completion of the open offer, Amtek India is now close to becoming a subsidiary. This has resulted in bringing all the forgings and castings units of all group companies under the ‘Amtek Auto’ umbrella. We expect this to lead to better integration of operations, clearer efficiencies in sourcing and negotiations, and greater transparency in operations.

Valuation

We cut our target price from `254 to `225 (10x FY12e EPS, and `29 as the value of 38% stake in Amtek India). We value Amtek Auto at 10x FY12e earnings, a 50% discount to the target PE multiple for Bharat Forge. Our current EPS estimate excludes Amtek India and takes into account the recent dilution and change in estimates. At the current market price, the stock trades at attractive valuations of 6x FY12e EPS.

Mounting demand would raise capacity utilization and prove the

key to Amtek’s operating performance improvement



Risks

Slower-than-expected demand ramp-up in Europe and unfavourable currency fluctuations

Commodity cost increases

Corporate governance issues in the past.



Improvement in demand Domestic auto demand has entered a secular growth mode, which would continue to provide a firm base for operations. In the next 2-3 years, as demand in overseas auto markets recovers, Amtek’s sales volumes would further improve due to its market-share gains

Amtek Auto is the only Indian company, and among a select few globally, to have integrated component-manufacturing facilities in forgings, iron castings, aluminium castings, machining and sub-assemblies of auto and non-auto components. Given its wide reach, at home and overseas, Amtek would benefit from economic growth in India as well as from the global recovery.

Steady growth ahead

The domestic automobile industry is on a good growth trajectory. The global auto-components market is seeing qoq improvement after bottoming out in CY09-10. Exports, which used to bring in a significant 22% of Amtek’s standalone revenue, had dipped to a low of just 3-4% in 2HFY09. The steady recovery overseas has seen this increase to ~8% of revenue now (on the higher base of robust domestic demand).

Fig 7 – Trend in Amtek Auto’s standalone exports

0100

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Source : Company

Amtek would strongly benefit from this demand improvement, given its wide geographical reach. We expect a robust 37.9% CAGR (excl. the impact of the merger) in its (consolidated) profit over FY10-13. Similarly, its revenue growth would also be at a solid 23.5% CAGR over FY10-13e.



Fig 8 – Net sales trend (FY06-12e)

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Revenue breakup, region-wise

Europe: Amtek markets its products in Europe, exporting from the Indian parent and group companies, and through European subsidiaries. Products for Europe span the entire Amtek Auto and Amtek India range. Major customers are Jaguar, Land Rover, Ford, Audi, Mercedes, BMW, PSA and Renault.

US: Sales to the US used to be through a US subsidiary. The product range was relatively smaller: flexplates and ring-gear assemblies. To lower costs, production plants in the US were moved to India and now the entire product range is being manufactured in India.

India: The entire range of Amtek Auto and Amtek India products are marketed in India through the parent company and other group entities. Major customers are Maruti, M&M, Tata Motors, Chrysler and GM.

Fig 9 – Revenue breakup FY08 (segment-wise)

Passenger cars71% Commercial

Vehicles10%

2/3 wheelers8%

Tractors7%

Others4%

FY10 (segment-wise)

Passenger cars62%

Others11%

Tractors7%

2/3 wheelers9%

Commercial Vehicles

11%

FY09 (region-wise) US2%

Europe35%

India63%

FY10 (region-wise) US1% Europe

20%

India79%

Source: Company



Fig 10 – Global customer base Segment Customer Base

2/3 wheelers Hero Honda, HMSI, Musashi, M&M, Suzuki, TVS, Yamaha.

Passenger cars Aston Martin, Chrysler, Ford, Hyundai, Jaguar, LR, Maruti Suzuki, Nissan, Tata, BMW, Fiat, GM, HM, Lada, Mercedes Benz, Toyota, VW.

LCVs Ashok Leyland, Eicher, Swaraj Mazda, Tata.

HCVs Cummins, Detroit Diesel, Force-Man, Navistar, Tata.

Tractors CNH, Eicher, Escorts, JD, Kubota, Sonalika.

Railways Indian Railways, Diesel Locomotive Works, Diesel Loco Modernisation Works, GE Transportation.

Other non-auto Briggs & Stratton, JCB, Ingersoll Rand, Kawasaki, the Knorr-Bremse Group, LG, Tecumseh.

Source : Company

With its integrated facilities across India, Europe and North America, Amtek Auto is poised to benefit from improving demand. It has 43 manufacturing locations (38 domestic, five overseas).

Amtek has made the most of low-cost manufacturing sites, giving it an edge over its global peers. Further, its JVs with international manufacturers offer opportunities for accelerated growth, not just in terms of a broader product range, but also rising internal demand (as would be seen in its joint venture with American Railcar, Inc.).

Amtek’s growth potential is highlighted by the following projections:

Two-year growth CAGR (FY11-13) in India: PVs 13% and two-wheelers 13.7%. FY02-11 PV growth CAGR was 16.8%; two-wheelers, 13%.2.

Indian auto-components sub-segment expected to increase to US$29.1bn in FY13 from US$21.1bn in FY10 (11% growth CAGR). FY05-10 growth CAGR was 21.1%.

Indian auto-components exports sub-segment expected to increase to US$8.6bn in FY13 from US$4.7bn in FY10 (22.8% growth CAGR). FY05-10 growth CAGR was 23.7%.

No customer accounts for more than 15% of revenues



Overseas’ operating leverage Improved operating leverage in its overseas subsidiaries would further boost Amtek’s profitability and help offset raw material cost increases. Its average capacity utilization has risen through FY10 to 2QFY11.

Amtek’s overseas subsidiaries are now recovering, benefiting from rising automobile demand in Europe, fresh orders from OEMs there and taking up job work to boost revenues, especially in its German subsidiary, Amtek Deutschland. Improved operating leverage in its overseas subsidiaries would further boost profitability and help offset raw material cost increases.

Improved operating leverage

Its UK operations are showing the biggest sign of improvement as a result of increased volumes from Amtek’s largest customers. The robust increase in sales in the UK is being driven by the above-market performance of Amtek’s customers. Moreover, the restructuring of overseas operations has been completed and Amtek would benefit from sustained higher margins in these markets.

The European market lagged that of the UK; also, currency movements in Europe were unfavourable. Overall, the European operations have secured fresh orders in 1Q and are expected to see higher capacity utilisation in FY12.

Its US order book has been transferred to India, from where products are being exported to Amtek’s North American distribution centres, resulting in a significant increase in profitability.



Non-auto capex, restructuring nearing completion Amtek’s non-auto capex is nearly complete, thereby significantly increasing its revenue potential. Further, the open offer for Amtek India has been successfully completed. We expect this to lead to better integration of operations, clearer efficiencies in sourcing and negotiations, and greater transparency in operations.

Non-auto capex Amtek’s non-auto capex is nearing completion, thereby significantly increasing its revenue potential. This would enable it to compete for wagon demand, which is expected to be strong in India. Additional avenues being targeted are Defence, aerospace, specialty vehicles, etc.

Amtek is sharpening its focus on the non-auto segment, the share of which is targeted to be raised from 18% to 25% in the current upswing.

Amtek’s non-auto strategy includes:

Increase in Defence-related sales, focused on Defence markets in India and South Africa. (~US$30bn has been earmarked to upgrade the Indian army). Opportunities abound in ammunition shell forgings, armoured vehicles, and upgrading military tanks.

Railcars to significantly contribute, with increase in sales revenue. Wagon manufacturing would contribute US$400m to sales in the JV over four years (Amtek’s share is 50%). American Railcar would provide technical expertise. Targeting the Indian Railways and the Middle East markets.

Railcar-components business to grow significantly in the next four years.

New ventures of specialty vehicles to address increasing demand.

Aerospace to be developed in future.

Restructuring The open offer for Amtek India has been successfully completed. After the last stage of restructuring, Amtek India is likely to be made a subsidiary of Amtek Auto, by Mar ’11. This has resulted in bringing all the forgings and castings units under the ‘Amtek Auto’ umbrella. We expect this to lead to better integration of operations, clearer efficiencies in sourcing and negotiations, and greater transparency in operations.

Rationale for the Amtek India open offer:

Simplifying the group structure,

Achieving greater economies of scale,

Improving fund allocation across business units, and

Strengthening the balance sheet.



Financials We expect a 23.5% CAGR in Amtek’s revenues over FY10-13 (with the EBITDA margin improving from 21.8% to 23.1%) and a 31.9% CAGR in adjusted net profit.

We expect a 23.5% CAGR in Amtek’s revenue over FY10-13e, following a 130bps better EBITDA margin owing to lower raw material costs, a more favourable product mix (towards machined products), greater capacity utilization and a larger share of non-automotive products. We expect a 31.9% CAGR in adjusted net profit over FY10-13.

Its robust financial performance leads us to expect Amtek’s RoCE would improve, from a low 7% in FY10 to 12.7% three years later.

Fig 12 – AAL: standalone and consolidated EBITDA margins (FY04-12e)

12.0

17.0

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27.0

32.0

37.0

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

e

FY12

e

Standalone OPM Consolidated OPM

(%)


Fig 11 – EBITDA and net-profit margin EBITDA

10.9

19.220.6

22.6 22.523.6 23.1

22.2

15.3

19.8

8001,0001,2001,4001,6001,8002,0002,2002,4002,6002,800

1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q

FY09 FY10 FY11

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(`m) (%)

Net Profit

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1,000

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PAT As a % of Sales(RHS)

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Source: Company



Change in estimates We raise our estimates to factor in a faster-than-expected recovery in Amtek’s overseas business, reflected in better operating leverage, benefits of cost restructuring and new orders overseas. We raise our EBITDA margin estimate for FY12, by 290bps, and factor in higher depreciation, interest expense and minority interest. The net effect on our FY12 profit estimate is to raise it by 2.8%.


`m FY11e FY12e FY11e FY12e FY11e FY12e

Income 41,563 52,581 45,187 55,972 8.7 6.4

EBITDA 7,897 10,122 10,438 12,790 32.2 26.4

EBITDA Mrg (%) 19.0 19.3 23.1 22.9

Adjusted PAT 3,012 4,477 3,719 4,604 23.5 2.8


Fig 14 - Income statement (`m) Y/E JUNE FY09 FY10 FY11e FY12e FY13eNet Sales 33,211 35,429 45,187 55,972 66,722 Change (%) -26.1 6.7 27.5 23.9 19.2Expenditure 27,381 27,719 34,749 43,182 51,309EBITDA 5,830 7,709 10,438 12,790 15,413 Change (%) -27.1 32.2 35.4 22.5 20.5 % of Net Sales 17.6 21.8 23.1 22.9 23.1Depreciation 2,728 3,102 3,370 3,622 4,215EBIT 3,101 4,607 7,068 9,168 11,197Interest & Finance Charges 1,523 2,051 2,478 2,984 2,884Other Income 685 1,480 1,517 1,555 1,594Non-recurring Expense -490 112 0 0 0PBT 2,753 3,924 6,107 7,739 9,907Tax 849 1,216 1,832 2,322 2,972 Effective Rate (%) 30.9 31.0 30.0 30.0 30.0PAT 1,904 2,708 4,275 5,417 6,935Adj. PAT 1,414 2,783 4,275 5,417 6,935 Change (%) (64.9) 96.9 53.6 26.7 28.0 Minority Interest 176 303 556 813 1,248 PAT (After MI) 1,238 2,480 3,719 4,604 5,686 Change (%) (66.1) 100.4 50.0 23.8 23.5




Fig 15 – Balance sheet (`m) Y/E JUNE FY09 FY10 FY11e FY12e FY13eShare Capital 282 403 418 418 418Share warrants 499 2,154 2,154 2,154 2,154Reserves 31,706 43,595 47,667 52,867 59,524Net Worth 32,486 46,152 50,239 55,439 62,097Loans 41,207 40,506 38,786 40,786 38,786Minority Interest 2,226 2,419 2,419 2,419 2,419Capital Employed 73,693 86,658 89,025 96,225 100,882 Application of Funds Gross Fixed Assets 62,335 70,564 75,975 81,495 87,125Less: Depreciation 13,255 16,102 19,473 23,095 27,310Net Fixed Assets 49,080 54,462 56,503 58,400 59,815Goodwill 3,944 3,850 3,850 3,850 3,850Investments 491 2,814 4,814 6,814 8,814Curr.Assets, L & Adv. 30,929 33,557 35,640 40,420 43,135Inventory 7,554 8,122 8,047 9,201 10,968Sundry Debtors 5,220 6,405 6,809 7,667 9,140Cash & Bank Balances 7,981 8,247 10,002 12,769 12,245Loans & Advances 10,156 10,740 10,740 10,740 10,740Others 17 42 42 42 42Current Liab. & Prov. 10,751 8,025 11,782 13,260 14,732Sundry Creditors 4,884 2,433 6,190 7,667 9,140Other Liabilities 5,759 5,248 5,248 5,248 5,248Provisions 108 344 344 344 344Net Current Assets 20,178 25,532 23,858 27,160 28,403Miscellaneous Expenditures 0 1 1 1 1Application of Funds 73,693 86,658 89,025 96,225 100,882


Fig 16 – Ratios @`117 Y/E JUNE FY09 FY10 FY11e FY12e FY13eBasic (`) Diluted Cons EPS 5.3 10.5 15.8 19.6 24.2Cons. EPS (inc.Amtek India) 11.8 17.8 22.3 27.6EPS Growth (%) -66.1 100.4 50.0 23.8 23.5Cons. EPS Growth (%) n.m n.m 50.9 28.5 27.1Cash EPS 32.9 41.2 54.2 64.1 79.1Book Value per Share 230.4 228.8 240.3 265.1 297.0DPS 0.6 1.2 1.0 1.0 1.3Payout (Incl. Div. Tax) % 8.1 10.9 6.3 5.4 5.6Valuation (x) Cons P/E 22.3 11.1 7.4 6.0 4.9Cash P/E 3.6 2.8 2.2 1.8 1.5EV/EBITDA 8.5 6.9 4.6 3.6 2.7EV/Sales 1.5 1.5 1.1 0.8 0.6Price to Book Value 0.5 0.5 0.5 0.4 0.4Dividend Yield (%) 0.5 1.0 0.8 0.9 1.1Profitability Ratios (%) RoE 3.8 5.4 7.4 8.3 9.2RoCE 5.1 7.0 9.6 11.1 12.7Turnover Ratios Asset Turnover (x) 0.5 0.4 0.5 0.6 0.7Fixed Asset Turnover 0.7 0.7 0.8 1.0 1.1Leverage Ratio Debt/Equity (x) 1.3 0.9 0.8 0.7 0.6




Fig 17 – Cash flow statement (`m) Y/E JUNE FY09 FY10 FY11e FY12e FY13e

OP/(Loss) before Tax 3,101 4,607 7,068 9,168 11,197

Interest/Div. Received 685 1,480 1,517 1,555 1,594

Depreciation & Amort. 2,728 3,102 3,370 3,622 4,215

Direct Taxes Paid -849 -1,216 -1,832 -2,322 -2,972

(Inc)/Dec in Working Capital -3,405 -5,088 3,428 -535 -1,767

Other Items 493 11107 30 33 42

CF from Oper. Activity 2,753 13,992 13,582 11,521 12,309

(Inc)/Dec in FA+CWIP -13,956 -8,390 -5,411 -5,520 -5,630

(Pur)/Sale of Invest. 125 -2,323 -2,000 -2,000 -2,000

CF from Inv. Activity -13,831 -10,713 -7,411 -7,520 -7,630

Issue of Shares 0 121 15 0 0

Inc/(Dec) in Debt 9,820 -701 -1,720 2,000 -2,000

Interest Paid -1,523 -2,051 -2,478 -2,984 -2,884

Dividends Paid -101 -271 -234 -249 -319

CF from Fin. Activity 8,197 -2,901 -4,416 -1,233 -5,203

Inc/(Dec) in Cash -2,391 266 1,754 2,768 -524

Add: Beginning Balance 10,373 7,981 8,247 10,002 12,769

Closing Balance 7,981 8,247 10,002 12,769 12,245




Annexure 1 – Subsidiaries’ performance Fig 18 – Key subsidiaries’ performances Year end Jun (`m) FY09 FY10 FY11e FY12e FY13e

Ahmednagar Forgings

Revenue 5,176 6,653 9,562 12,008 14,189

Growth (%) -21.7 28.6 43.7 25.6 18.2

Net Profit 359 641 1,098 1,421 1,765

% growth -43.4 78.4 71.3 29.4 24.2

GWK (Amtek Investments, UK)

Revenue 7,928 3,813 4,194 4,823 5,787

Growth (%) -45.4 -51.9 10.0 15.0 20.0

Net Profit -349 -77 189 217 260

% growth -166.0 -77.9 -345.1 15.0 20.0

Smith Jones

Revenue 705 230 57 0 0

Growth (%) -14.8 -67.4 -75.0 -100.0 0.0

Net Profit -28 -33 -23 0 0

% growth -248.7 17.6 -31.3 -100.0 NA

Zelter

Revenue 4,834 3,389 3,050 3,507 4,033

Growth (%) -42.3 -29.9 -10.0 15.0 15.0

Net Profit 2 -145 -61 2 81

% growth -99.4 -9,780.0 -58.0 -102.9 4,500.0

Amtek Auto

Total Revenue 10,525 12,764 18,013 22,700 26,992

Growth (%) -17.9 21.3 41.1 26.0 18.9

Net Profit 1,032 1,509 2,216 2,782 3,661

% growth -55.6 46.2 46.9 25.5 31.6

Benda Amtek

Revenue 2,347 3,725 4,657 5,355 5,998

Growth (%) 2.3 58.8 25.0 15.0 12.0

Net Profit 175 427 419 482 540

% growth -29.7 143.3 -1.8 15.0 12.0

Amtek Siccardi

Revenue 3,115 4,461 4,907 5,643 6,320

Growth (%) 1.6 43.2 10.0 15.0 12.0

Net Profit 319 420 442 508 569

% growth 53.4 31.8 5.1 15.0 12.0

NPM 10.2 9.4 9.0 9.0 9.0




Fig 19 – Quarterly performance of subsidiaries Sales Contribution, company-wise (`m)

(`m) 1QFY10 2QFY10 3QFY10 4QFY10 1QFY11 2QFY11

Amtek Auto 2,674 3,022 3,404 3,664 4,091 4,319

% YoY growth -15.2 25.2 28.1 45.3 53.0 42.9

Ahmednagar Forgings 1,394 1,592 1,783 1,882 2,135 2,297

% YoY growth -7.4 39.1 42.4 49.2 53.2 44.3

GWK 831 1,068 997 917 1,010 1,102

% YoY growth -78.4 -55.1 -10.8 55.8 21.6 3.2

Zelter 1,007 838 766 778 700 848

% YoY growth -49.9 -23.9 -4.2 -16.0 -30.4 1.2

Smith Jones 87 61 56 26 10 0

% YoY growth -53.6 -71.5 -71.3 -76.3 -88.9 -100.0

Benda Amtek 728 867 978 1,153 1,147 1,172

% YoY growth 14.2 87.1 63.2 78.3 57.6 35.2

Amtek Siccardi 1,015 1,132 1,232 1,081 1,114 1,193

% YoY growth 47.7 123.0 63.2 -7.2 9.7 5.4

Others 108 99 107 61 155 165

% YoY growth -5.3 -1.9 201.1 -62.0 44.1 67.5

Total 7,842 8,678 9,323 9,562 10,362 11,097

% YoY growth -35.4 4.2 25.8 29.6 32.1 27.9

Company-Wise Ebitda Contribution (`m)

(`m) 1QFY10 2QFY10 3QFY10 4QFY10 1QFY11 2QFY11

Amtek Auto 676 804 936 1,017 1,148 1,207

EBITDA margin (%) 25.3 26.6 27.5 27.8 28.0 27.9

Ahmednagar Forgings 372 418 463 509 575 624

EBITDA margin (%) 26.7 26.3 26.0 27.1 26.9 27.1

GWK 6 23 95 68 156 144

EBITDA margin (%) 0.8 2.1 9.6 7.4 15.4 13.1

Zelter 37 44 38 77 31 29

EBITDA margin (%) 3.7 5.3 4.9 9.8 4.4 3.4

Smith Jones -5 -9 15 -10 -3 0

EBITDA margin (%) -5.9 -14.2 27.5 -39.1 -28.1 NA

Benda Amtek 199 246 283 266 255 265

EBITDA margin (%) 27.3 28.4 28.9 23.1 22.2 22.6

Amtek Siccardi 211 259 261 240 268 313

EBITDA margin (%) 20.8 22.9 21.1 22.2 24.1 26.2

Others 11 4 14 -11 12 -21

EBITDA margin (%) 10.5 4.1 13.2 -18.0 7.7 -12.5

Total 1,507 1,789 2,105 2,155 2,442 2,560

Cons EBITDA margin (%) 19.2 20.6 22.6 22.5 23.6 23.1




Fig 20 – Quarterly performance of subsidiaries Profit contribution, company wise (`m)

1QFY10 2QFY10 3QFY10 4QFY10 1QFY11 2QFY11

Amtek Auto 305 351 424 352 546 583

Net Profit margin (%) 11.4 11.6 12.5 9.6 13.3 13.5

Ahmednagar Forgings 114 145 181 198 255 280


GWK -81 -10 17 -2 72 50

Net Profit margin (%) -9.7 -1.0 1.7 -0.3 7.1 4.6

Zelter -39 -55 -20 -32 -26 -19

Net Profit margin (%) -3.8 -6.6 -2.6 -4.1 -3.7 -2.2

Smith Jones -13 -15 10 -15 -3 0

Net Profit margin (%) -14.7 -24.5 17.1 -58.2 -28.1

Benda Amtek 84 116 116 111 103 91


Amtek Siccardi 90 123 119 89 97 115


Others 2 -1 6 -13 -1 -32

Net Profit margin (%) 1.7 -1.4 6.0 -21.6 -0.8 -19.3

Profit bef. minority int. 462 652 852 687 1,041 1,067

Minority interest 57 69 85 93 124 136

Profit after MI 405 583 767 594 917 932


Fig 21 – Associate performance trend: Amtek India Income Statement

Year end Jun (`m) FY08 FY09 FY10 1QFY11 2QFY11

Net Sales 10,673 8,094 9,814 10,362 11,097

Change (%) 16.5 -24.2 21.2 32.1 27.9

Operating Other Income 0 0 0 0 0

Total Income 10,673 8,094 9,814 10,362 11,097

Expenditure 8,030 6,332 7,459 7,921 8,537

EBITDA 2,643 1,762 2,355 2,442 2,560

Change (%) 21.1 -33.3 33.6 62.0 43.1

% of Net Sales 24.8 21.8 24.0 23.6 23.1

Depreciation 540 706 962 825 810

EBIT 2,103 1,056 1,393 1,617 1,750

Deferred Revenue Exp. 0 0 0 0 0

Interest & Finance Charges 306 442 830 546 648

Other Income 361 216 551 366 387

Non-recurring Expense 66 0 0 0 0

Non-recurring Income 2,220 0 0 0 0

PBT 4,312 830 1,113 1,437 1,489

Tax 783 248 326 395 421

Effective Rate (%) 18.2 29.9 29.3 27.5 28.3

Rep. PAT 3,529 582 787 1,041 1,067

Change (%) 173.8 -83.5 35.2 125.4 63.7

Adj. PAT 1,374 582 787 NA NA

Change (%) 6.7 (57.6) 35.2 NA NA

Adj. PAT (After MI) 1,374 582 787 917 932

Change (%) 6.7 (57.6) 35.2 126.3 59.8



India I Equities

Key financials Year end 31 Mar FY09 FY10 FY11e FY12e FY13e

Sales (`m) 13,177 14,652 17,388 20,596 24,184

Net profit (`m) 947 1,590 1,470 1,793 2,213

Diluted EPS (`) 11.1 18.6 17.2 21.0 25.9

Growth (%) -33.1 67.8 -7.5 22.0 23.4

PE (x) 14.8 8.8 9.5 7.8 6.3

PBV (x) 3.5 2.6 2.1 1.7 1.4

RoE (%) 19.8 30.7 22.6 22.3 22.3

RoCE (%) 22.8 38.0 27.6 29.0 30.3

Dividend yield (%) 0.5 1.8 2.4 2.2 2.4

Net gearing (%) 40.8 23.7 23.6 24.4 18.0


Auto Components

Update

22 February 2011

Amara Raja Batteries

Short-term concerns, positive potential; maintain Buy

We expect the structural soundness of Amara Raja Batteries’ business to play out over the long term and, hence, help it out-perform its peers. Even though short-term concerns persist regarding the rise in commodity prices and lower industrial demand, we yet maintain our Buy recommendation.

Branding is key. Amara Raja is India’s second-largest battery maker in the regulated sector and has made its mark via branding, strong retail network and entry into the two-wheeler segment.

Healthy automotive demand. ARB operates in the auto replacement market and caters to some OEMs as well. With the strong automotive demand expected, a 13.7% CAGR over FY11-13e, we expect good growth in ARB’s automotive battery sales.

Industrials, a key segment. Notwithstanding the present industrial slowdown, we expect the segment to recover from the current lows in the medium to long term and drive demand in the long term. Being a significant revenue contributor for ARB, industrial demand recovery in FY12 would be a major positive.

Valuation and risks. We value ARB at 10x FY12e EPS (a 40% discount to the target multiple for market leader Exide Industries). At the ruling market price, the stock trades at 9.5x FY11e and 7.8x FY12e earnings. Risks: Delayed industrial demand recovery, further increase in the price of lead.


Key data AMRJ IN/AMAR.BO

52-week high/low `228/`140Sensex/Nifty 18212 / 54593-m average volume US$0.7m Market cap `14.04bn/US$313m



AMRJ

Sensex

150160170180190200210220230

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22 February 2011 Amara Raja Batteries – Short-term concerns, positive potential; maintain Buy



Year end 31 March FY09 FY10 FY11e FY12e FY13eNet sales 13,177 14,652 17,388 20,596 24,184Sales growth (%) 21.6 11.2 18.7 18.5 17.4 - Op. expenses 11,291 11,779 14,807 17,488 20,413EBIDTA 1,886 2,873 2,581 3,109 3,771EBITDA margins (%) 14.3 19.6 14.8 15.1 15.6 - Interest 182 68 19 18 14 - Depreciation 346 429 422 471 511 + Other income 81 50 50 50 50 - Tax 422 876 728 876 1,082Reported PAT 805 1,670 1,486 1,793 2,213Adjusted PAT 947 1,590 1,470 1,793 2,213Adj. PAT growth (%) 0.4 67.8 -7.5 22.0 23.4FDEPS (`/share) 11.1 18.6 17.2 21.0 25.9CEPS (`/share) 13.5 24.6 22.3 26.5 31.9DPS (`/share) 0.8 2.9 4.0 3.5 3.9Source: Company, Anand Rathi Research


Year to 31 March FY09 FY10 FY11e FY12e FY13eShare capital 171 171 171 171 171Reserves & surplus 3,885 5,266 6,398 7,874 9,742Shareholders’ fund 4,056 5,436 6,569 8,045 9,913Debt 2,859 912 1,012 812 612Deferred tax / others 183 216 414 414 414Capital employed 7,097 6,565 7,995 9,271 10,939 Fixed assets 3,209 3,284 3,362 3,391 3,380Investments 471 161 461 761 1,061Working capital 2,714 2,495 3,539 4,880 5,814Cash 703 625 634 238 684Capital deployed 7,097 6,565 7,995 9,271 10,939No. of shares (m) 85 85 85 85 85Net Debt/Equity (%) 53.2 5.3 5.8 7.1 -0.7W C turn (days) 76 80 84 95 95Source: Company, Anand Rathi Research


Year end 31 March FY09 FY10 FY11e FY12e FY13eReported PAT 1,132 1,602 1,629 1,762 2,177 + Depreciation 346 429 422 471 511 Cash profit 1,478 2,031 2,051 2,233 2,688 - Incr/(Decr) in WC -730 -171 1,059 1,342 934 Operating cash flow 2,207 2,202 991 891 1,755 - Capex 1,009 504 500 500 500 Free cash flow 1,198 1,698 491 391 1,255 - Dividend 68 248 338 302 330 + Equity raised 57 0 0 0 0 + Debt raised -304 -1,947 100 -200 -200 - Investments 309 -310 300 300 300 - Misc. items 383 -108 -56 -16 -20 Net cash flow 191 -79 9 -395 445 + Opening cash 511 703 625 634 238 Closing cash 703 625 634 238 684Source: Company, Anand Rathi Research

Fig 4 – PE Band

Amara Raja Battries Ltd

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Fig 6 – BSE auto v/s Amara Raja

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Investment Argument and Valuation Even though short-term concerns regarding higher commodity prices and lower industrial demand persist, we expect the structural soundness of Amara Raja Batteries’ business to play out in the long term and result in it outperforming its peers. We maintain our Buy recommendation.

Branding, the key Amara Raja Batteries is India’s second-largest battery manufacturer in the regulated sector. It has made its mark through branding, a strong retail network and entry into the two-wheeler segment.

It has been steadily expanding its “after-sales” retail network, which now comprises more than 200 franchisees and over 18,000 active retailers. A wider retail network would assist in further penetration in the replacement market.

Good automotive demand Amara Raja largely operates in the auto-replacement market and caters to some OEMs. With good automotive demand expected (a 13% CAGR over FY10-13e), we expect good growth in ARB’s battery sales.

Further, the strong 9.3% CAGR in auto volumes over FY02-09 could generate high replacement demand. This would continue to fuel replacement demand.

Industrials, a key segment Notwithstanding the current industrial slowdown, we expect the segment to recover in the medium to long term and thereby drive demand over this period. Being a significant revenue contributor for ARB, industrial demand recovery in FY12 would be a major positive.

The segment is crucial as it accounts for 40% of sales, by value, of the Indian storage-battery market. This segment registered a 25% CAGR in the past four years. VRLA (valve-regulated lead-acid) batteries constitute 60% of the industrial storage-battery market in India. The medium-VRLA segment accounts for the biggest sub-segment, growing 30% historically. Highly fragmented, the industrial battery segment's biggest consumers consist of telecoms, IT and ITeS, BFSI and companies/organizations.

Valuation We value Amara Raja Batteries at 10x FY12e EPS (a 40% discount to the target multiple for market leader Exide Industries). At the ruling market price, the stock trades at 9.5x FY11e and 7.8x FY12e earnings.

Risks

The battery-replacement market in India has not yet matured to a situation where batteries are picked up off the shelf. Hence, the retail focus of ARB may see hurdles to growth.

A slower-than-anticipated growth in OEM production and lukewarm demand for the Nano would lessen demand potential from the automobile segment.

ARB has focussed on branding and retail network expansion



Imports constitute a significant threat to Indian battery manufacturers. Imports could whittle down sales in the replacement market.

Continuing lower demand from the industrial segment would be an added concern.

Higher lead prices even from current levels would threaten profitability.

Fig 7 – Lead prices (Apr ’06-Feb ’11)

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Expanding retail network Amara Raja Batteries is India’s second-largest battery manufacturer in the organised sector. It has made its mark through branding, a strong retail network and entry in the two-wheeler segment. A wider retail network would assist in further penetration into the replacement market.

ARB has been steadily expanding its “after-sales” retail network, which now comprises more than 200 franchisees and over 18,000 active retailers. A wider retail network would assist in deeper penetration into the replacement market.

To boost volumes and improve market share in the higher-margin replacement market, the company has conceptualized retail outlets called ‘PowerZones’, to be set up in rural and semi-urban areas.

Key initiatives by ARB in this respect

1. A network of 18,000 active retailers has given ARB a touch point in urban India at almost every 5km.

2. ARB has also pioneered the concept of Amaron Pitstop and PowerZone, of which it has ~150 and 700 outlets, respectively, to provide a unique shopping experience in urban and rural regions.

3. Another of its innovations is the introduction of unconventional distribution channels – small shopkeepers, telephone-booth operators, auto-mechanics and lube sellers.

4. ARB has widened its reach through the ‘70 Aqua’ distribution network, which caters to replacement demand in industrial batteries.

5. ARB’s batteries are now used by more than 10m consumers. There are 175,000 live battery banks, providing uninterrupted backup power for various critical applications.

Fig 8 – Installed capacity

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High auto-replacement potential ARB operates in the auto replacement market and caters to some OEMs. With good automotive demand expected (a 13.7% CAGR over FY11-13e), we anticipate good growth in ARB’s battery sales.

Further, the strong 14% CAGR in auto volumes over FY02-11 would generate high replacement demand. This would further fuel replacement demand.

Fig 10 – Auto OEM growth expected

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Although ARB’s OE market share is relatively lower, anticipated growth in this segment is a positive for it from the point of view of greater demand and increased replacement-demand potential.

Entry into the two-wheeler sub-segment

In May ’08, ARB launched VLRA batteries in the two-wheeler sub-segment. VLRA technology is normally used in luxury cars. The entry into the two-wheeler segment with a good product and adequate installed capacity could help penetration there. ARB manufactures VLRA batteries with technology from its JV partner Johnson Controls, Inc.

In addition to the traditional segments, the regulated replacement-battery market growth is fueled by the greater popularity of the high-end two-wheelers and new users of non-gear scooters from urban and semi-urban women. The increasing shift from kick-start to self-start bikes also increases the importance of battery technology.



Industrials, a key segment Notwithstanding the current industrial slowdown, we expect the segment to recover from the lows in the medium to long term and drive demand over this period. Being a significant revenue contributor for ARB, industrial demand recovery over FY12 would be a major positive.

The high exposure of ARB to the telecom batteries segment (~30% of revenues) and ~17-18% from the inverter segment make it vulnerable to the current slowdown in demand there. However, we expect the segment to recover from the recent lows and to grow at a good clip ahead. Fundamental factors would continue to drive growth in the industrials segment.

The segment is crucial as it accounts for 40% of sales, by value, of the Indian storage-battery market. This segment registered a 25% CAGR in the past four years. VRLA batteries constitutes 60% of the industrial storage-battery market in India. The medium VRLA segment accounts for the biggest sub-segment, growing 30% annually, historically. Highly fragmented, the industrial battery segment's biggest consumers comprise telecoms, IT and ITeS, BFSI and companies/organizations.

The key growth recovery factors are :

1. Replacement demand from telecoms-tower batteries

2. Entry of new players and introduction of new services (3G) in the telecoms sector

3. Increasing computerisation, especially among government agencies

4. Demand from IT, ITeS, and BFSI sectors

5. Rising automation across business enterprises

6. Power deficit, enhancing the need for back-up batteries in critical equipment and processes

7. Part of the telecoms capacity to be utilized to support the UPS business

ARB’s strength in the segment is that it is the preferred vendor among domestic utilities, government agencies, multi-nationals and domestic telecoms service providers. The company plans to strengthen its presence in high-growth sectors and create products for specific user segments.



Financials We expect a 17.9% CAGR in Amara Raja’s revenue over FY11-13–with the EBITDA margin improving from 14.8% to 15.6%–and a 22.7% CAGR in adjusted net profit.

From FY11 to FY13 we expect a 17.9% CAGR in ARB’s revenue, with the EBITDA margin improving from a low 14.8% to 15.6%. The expected volatility in commodity prices would be countered by ARB’s increasing presence in the industrials segment and greater “replacement”-market share. The volatility in lead price can impact ARB’s EBITDA margin either way, since it does not have the fall-back of backward integration like Exide Industries. We expect a 22.7% CAGR in adjusted net profit from FY11 to FY13e.

To support growth, ARB would aggressively expand its capacity: four-wheeler batteries from 4.2m to 6m, and two-wheeler batteries from 1.8m to 5m.

Fig 11 – Amara Raja’s sales and net profit growth (FY04-12)

0

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800

1,200

1,600

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(`m) (`m)


Despite the ongoing capex and the decline in profitability in FY11, ARB has maintained healthy return ratios of over 20%.

Fig 12 – Amara Raja’s RoE, RoCE and asset turnover (FY04-12e)

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(%) (x)




Change in estimates We lower our estimates to factor in the short-term concerns regarding commodity price increases and lower demand for industrial batteries. We trim our EBITDA margin estimate for FY12, by 300bps, and factor in higher raw material and employee costs. We also cut our FY12 profit estimates, by 12.9%.


`m FY11e FY12e FY11e FY12e FY11e FY12e

Income 17,547 20,965 17,388 20,596 -0.9 -1.8

EBITDA 3,344 3,786 2,581 3,109 -22.8 -17.9

EBITDA Mrg (%) 19.1 18.1 14.8 15.1

Adjusted PAT 1,787 2,059 1,470 1,793 -17.7 -12.9


Commodity prices, a concern

The cost of lead works out to 70% of raw material cost of batteries. The price of lead has corrected off its peak of US$3,850 a ton in 4QFY08 to less than half that, at US$1,500 in 1QFY10. Subsequently, though, it has bounced back to US$2,500 now, thereby eating into margins in FY11.

Fig 14 – EBITDA margin

7.7

14.213.0

18.0

23.422.5

19.6

16.113.9 14.5

15.6

200

300

400

500

600

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800

1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q

FY09 FY10 FY11

6

10

14

18

22

26

EBITDA As a % of Sales (RHS)

(`m) (%)

Source: Company

Fig 15 – Raw material costs

72.8

68.166.5

61.0

56.458.0

60.0

64.2

66.6

63.8 64.5

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1,500

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FY09 FY10 FY11

54

58

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66

70

74

Raw-material cost As a % of Sales (RHS)

(`m) (%)

Source: Company



Fig 16 – Income Statement Year end 31 Mar (`m) FY09 FY10 FY11e FY12e FY13e

Net Sales 13,177 14,652 17,388 20,596 24,184

Change (%) 21.6 11.2 18.7 18.5 17.4

Expenditure 11,291 11,779 14,807 17,488 20,413

EBITDA 1,886 2,873 2,581 3,109 3,771

Change (%) 19.6 52.3 -10.2 20.4 21.3

EBITDA Margin (%) 14.3 19.6 14.8 15.1 15.6

Depreciation 346 429 422 471 511

EBIT 1,541 2,444 2,159 2,637 3,260

Interest & Finance Charges 182 68 19 18 14

Other Income 81 50 50 50 50

Non-recurring Expense 212 0 2 0 0

Non-recurring Income 0 121 27 0 0

PBT 1,227 2,546 2,214 2,669 3,295

Tax 422 876 728 876 1,082

Effective Rate (%) 34.4 34.4 32.9 32.8 32.9

Rep. PAT 805 1,670 1,486 1,793 2,213

Change (%) -14.7 107.5 -11.0 20.7 23.4

Adj. PAT 947 1,590 1,470 1,793 2,213

Change (%) 0.4 67.8 -7.5 22.0 23.4


Fig 17 – Balance Sheet Year end 31 Mar (`m) FY09 FY10 FY11e FY12e FY13e

Sources of Funds

Share Capital 171 171 171 171 171

Reserves 3,885 5,266 6,398 7,874 9,742

Net Worth 4,056 5,436 6,569 8,045 9,913

Loans 2,859 912 1,012 812 612

Deferred Tax Liability 183 216 414 414 414

Capital Employed 7,097 6,565 7,995 9,271 10,939

Application of Funds

Gross Fixed Assets 4,271 4,911 5,638 6,138 6,638

Less: Depreciation 1,458 1,854 2,276 2,747 3,258

Net Fixed Assets 2,813 3,057 3,362 3,391 3,380

Capital WIP 396 227 0 0 0

Investments 471 161 461 761 1,061

Curr.Assets, L & Adv. 5,260 6,311 7,169 8,379 10,053

Inventory 1,608 2,176 2,573 3,386 3,975

Sundry Debtors 2,078 2,423 2,875 3,668 4,307

Cash & Bank Balances 703 625 634 238 684

Loans & Advances 870 1,087 1,087 1,087 1,087

Other Current Assets 0 0 0 0 0

Current Liab. & Prov. 1,843 3,191 2,997 3,260 3,555

Sundry Creditors 937 1,376 1,429 1,693 1,988

Other Liabilities 201 281 281 281 281

Provisions 705 1,534 1,287 1,287 1,287

Net Current Assets 3,417 3,120 4,172 5,119 6,498

Application of Funds 7,097 6,565 7,995 9,271 10,939




Fig 18 – Ratios @`165 Year end 31 Mar FY09 FY10 FY11e FY12e FY13e

Basic (`)

EPS 11.1 18.6 17.2 21.0 25.9

EPS Fully Diluted 11.1 18.6 17.2 21.0 25.9

Cash EPS 13.5 24.6 22.3 26.5 31.9

EPS Growth (%) -33.1 67.8 -7.5 22.0 23.4


DPS 0.8 2.9 4.0 3.5 3.9

Payout (Incl. Div. Tax) % 0.1 0.2 0.2 0.2 0.1

Valuation (x)

P/E 14.8 8.8 9.5 7.8 6.3

Cash P/E 12.2 6.7 7.3 6.2 5.1

EV/EBITDA 8.3 4.9 5.4 4.4 3.4

EV/Sales 1.2 1.0 0.8 0.7 0.5


Dividend Yield (%) 0.5 1.8 2.4 2.2 2.4


RoE 19.8 30.7 22.6 22.3 22.3

RoCE 22.8 38.0 27.6 29.0 30.3

Turnover Ratios

Asset Turnover (x) 1.9 2.2 2.2 2.2 2.2

Leverage Ratio

Debt/Equity (x) 0.7 0.2 0.2 0.1 0.1


Fig 19 – Cash flow statement Year end 31 Mar (`m) FY09 FY10 FY11e FY12e FY13e

OP/(Loss) before Tax 1,541 2,444 2,159 2,637 3,260

Interest/Dividends Received

Depreciation & Amortisation 346 429 422 471 511

Direct Taxes Paid -409 -842 -530 -876 -1,082

(Inc)/Dec in Working Capital 730 171 -1,059 -1,342 -934

Other Items -69 6 1 -15 -15

CF from Oper. Activity 2,138 2,208 993 876 1,740

Extra-ordinary Items -212 121 25 0 0

Other Items

CF after EO Items 1,926 2,328 1,017 876 1,740

(Inc)/Dec in FA+CWIP -1,009 -504 -500 -500 -500

(Pur)/Sale of Invest. -309 310 -300 -300 -300

CF from Inv. Activity -1,318 -194 -800 -800 -800

Issue of Shares 57 0 0 0 0

Inc/(Dec) in Debt -304 -1,947 100 -200 -200

Interest Rec./(Paid) -102 -18 30 31 35

Dividends Paid -68 -248 -338 -302 -330

CF from Fin. Activity -417 -2,213 -208 -471 -494

Inc/(Dec) in Cash 191 -78 9 -395 445

Add: Beginning Balance 511 703 625 634 238

Closing Balance 703 625 634 238 684



India I Equities

Key financials


Sales (`m) 12,523 13,870 19,435 23,015 27,171

Net profit (`m) 700 2,069 1,798 1,601 2,116

EPS (`) 7.2 21.3 18.5 16.5 21.8

Growth (%) -32.9 195.5 -13.1 -10.9 32.1

PE (x) 17.6 6.0 6.9 7.7 5.8

PBV (x) 2.6 1.9 1.5 1.3 1.1

RoE (%) 15.0 31.3 21.7 16.4 18.0

RoCE (%) 14.6 28.0 20.0 15.0 16.2

Dividend yield (%) 0.9 1.1 1.0 0.9 1.1

Net gearing (%) 54.6 47.4 47.2 52.4 52.5


Auto Components

Initiating Coverage

22 February 2011

Balkrishna Industries

Good business model, rubber concerns; initiate with Hold

Balkrishna Industries focuses on agricultural tyres and the off-road sub-segment overseas. It typically enjoys higher margins than domestic peers. However, short-term capacity constraints and rising rubber prices have dampened its short- to medium-term outlook. We initiate coverage on BIL with a Hold recommendation.

Robust business model. Balkrishna mainly caters to the higher-margin segments–off-road vehicles and agricultural tyres. As it supplies heavier tyres mainly for export, it enjoys higher-than-industry margins.

Rubber is a concern. The escalating price of rubber is a concern for the entire tyre industry. While Balkrishna’s forward contracts at lower prices insure it from higher rubber prices in FY11, the impact cannot be avoided in FY12.

Peaking capacity. While demand for tyres is robust, BIL’s peaking capacity utilisation indicates that its revenue growth would be constrained in FY12.

Valuations and risks. We value the stock at `144 (8.25x FY12e standalone EPS of `16.5 and `8 as value of its paper business). At the CMP, the upside is not too compelling. We initiate coverage with a Hold. Upside risks: decline in rubber prices, faster-than-expected ramp-up in new capacities, and more-than-expected price increases. Downside risk: unfavourable currency movement.

Rating: Hold Target Price: `144 Share Price: `127

Key data BIL In/BLKI.BO

52-week high/low `162/`104Sensex/Nifty 18211 / 54593-m average volume US$0.3m Market cap `12.36bn/US$274.7mShares outstanding 97.4mFree float 45.7%Promoters 54.4%Foreign Institutions 14.2%Domestic Institutions 16.2%Public 15.2%


BIL

Sensex

100110120130140150160170

Feb-

10

Apr-1

0

Jun-

10

Aug-

10

Oct

-10

Dec

-10

Feb-

11

Source: Bloomberg

22 February 2011 Balkrishna Industries – Good business model, rubber concerns; initiate with Hold




Net sales 12,523 13,870 19,435 23,015 27,171Sales growth (%) 26.3 10.8 40.1 18.4 18.1- Op. expenses 10,553 10,172 15,834 19,390 22,552EBIDTA 1,970 3,698 3,601 3,625 4,619EBITDA margins (%) 15.7 26.7 18.5 15.8 17.0- Interest 375 187 212 424 530- Depreciation 565 662 750 855 1,026+ Other income 49 264 40 44 49- Tax 379 1,048 883 789 996Reported PAT 703 2,087 1,806 1,601 2,116Adjusted PAT 700 2,069 1,798 1,601 2,116Adj. PAT growth (%) -32.9 195.5 -13.1 -10.9 32.1FDEPS (`/share) 7.2 21.3 18.5 16.5 21.8CEPS (`/share) 13.1 28.4 26.3 25.3 32.4DPS (`/share) 1.2 1.4 1.3 1.1 1.4Source: Company, Anand Rathi Research


Share capital 193 193 194 194 194Reserves & surplus 4,485 6,414 8,102 9,577 11,542Shareholders’ fund 4,678 6,608 8,296 9,771 11,736Debt 4,728 4,643 5,643 8,393 10,243Deferred tax / others 524 548 548 548 548Capital employed 9,930 11,799 14,488 18,713 22,527 Fixed assets 6,093 6,738 8,399 12,543 15,517Investments 322 807 807 807 807Working capital 3,404 4,212 5,232 5,329 6,181Cash 111 42 50 33 22Capital deployed 9,930 11,799 14,488 18,713 22,527No. of shares (m) 97 97 97 97 97Net Debt/Equity (%) 98.7 69.6 67.4 85.6 87.1W C turn (days) 82 94 87 75 75Source: Company, Anand Rathi Research


Reported PAT 703 2,087 1,806 1,601 2,116+ Depreciation 565 662 750 855 1,026Cash profit 1,268 2,749 2,556 2,457 3,142- Incr/(Decr) in WC -538 808 1,019 98 852Operating cash flow 1,806 1,941 1,537 2,359 2,290- Capex 1,667 1,327 3,000 5,000 4,000Free cash flow 139 615 -1,463 -2,641 -1,710- Dividend 116 135 122 110 132+ Equity raised 0 0 1 0 0+ Debt raised 620 85 -1,000 -2,750 -1,850- Investments -19 485 0 0 0- Misc. items 638 148 -2,592 -5,484 -3,680Net cash flow 24 -69 8 -17 -11+ Opening cash 87 111 42 50 33Closing cash 111 42 50 33 22Source: Company, Anand Rathi Research

Fig 4 – PE Band

26x

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Fig 6 – BIL vs BSE Auto

BIL

BSE Auto

100

110

120

130

140

150

160

170

Feb-

10

Apr-1

0

Jun-

10

Aug-

10

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-10

Dec

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11

Source: Bloomberg



Investment Argument and Valuation Focussed on the agricultural-tyre and off-road sub-segments in the overseas market, Balkrishna Industries typically enjoys margins higher than its peers. However, short-term capacity constraints and rising rubber prices have dampened its short- to medium-term outlook. We initiate coverage on BIL with a Hold recommendation.

Robust business model

Balkrishna Industries mainly addresses the higher-margin tyre segments – off-road vehicles and agricultural tyres. As it supplies heavier tyres mainly for export, it enjoys higher-than-industry margins.

Fig 7 – Comparative EBITDA margins of tyre companies

0

5

10

15

20

25

30

FY05

FY06

FY07

FY08

FY09

FY10

FY11

e

BIL Apollo Tyres Ceat MRF

(%)

Source: Company, Anand Rathi Research.

Rubber is a concern

The escalating price of rubber is a concern for the entire tyre industry, Balkrishna included. While its forward contracts at lower prices insure it against higher rubber prices in FY11, the impact cannot be avoided in FY12.

High rubber prices are a function of a rise in international prices of rubber (due to abnormal weather conditions), a surge in demand backed by robust auto demand, an increase in the price of crude oil, and plateauing production at plantations.

Peaking capacity

While demand for tyres is robust, BIL’s peaking capacity utilisation indicates that its revenue growth would be constrained in FY12. For immediate additional capacity, it is undertaking de-bottlenecking. By Oct ’11, de-bottlenecking of 10,000 tons, at `2bn, would be complete. Of this, `600m-700m has already been incurred. By Mar ’11, an additional `200m-300m would have been incurred.

This de-bottlenecking involves adding equipment, increasing radial capacity, mixing capacity at Waluj, building a raw-material and finished-goods warehouse, and adding a press. The greenfield complex being set up at Bhuj would be completed only by 4QFY13.

Focus on exports; supply to the off-road & agricultural-tyre sub-

segments and successful hedging policy have helped Balkrishna register better-than-industry EBITDA

margins



Valuations not too compelling

We value the stock at `144 (8.25x FY12e standalone EPS of `16.5 and `8 as the value of the paper business). Our target PE multiple is at a 15% discount to the five-year average PE multiple of 9.75x. We attribute this discount to escalating rubber prices. At the current market price, the upside is not too compelling. We initiate coverage on the stock, with a Hold rating.

Fig 8 – BIL EV/EBITDA Band

0

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16

20

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07

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11

Source: Company

Risks

Upside: Decline in rubber prices, faster-than-expected ramp-up in fresh capacities, and more-than-expected price increases.

Downside: Currency fluctuations.



Robust business model Balkrishna Industries mainly addresses the higher-margin tyre segments—off-road vehicles and agricultural tyres. As it supplies heavier tyres mainly for export, it enjoys margins higher-than-industry peers.

Off-road, exports, key sub-segments

Balkrishna Industries is a leading manufacturer of a broad range of ‘off-road’ tyres in agriculture, construction, industrials, earthmovers and ATVs (all-terrain vehicles). It has three manufacturing plants and one die/tooling unit in Rajasthan and Maharashtra.

Products for which tyres are supplied vary from tractors, trailers and other farm equipment in agriculture to heavy earthmovers, compactors, graders, underground mining and backhoes in non-agriculture.

Demand drivers

Large farms in Europe have a high degree of mechanisation. Hence, agricultural-tyre requirement is higher, both from OEMs and in the replacement market.

Growth in the agricultural and mining sector in the Americas, coupled with the fast-growing South American economies.

Trend towards large farm equipment in America.

Growth in agriculture and infrastructure in Asia-Pacific and movement from traditional to larger equipment.

Growth in the off-road segment in India would be an additional demand driver. While India’s share of Balkrishna’s turnover is just 11%, on completion of its greenfield plant, Balkrishna would be in a position to further its penetration in India. To this end, it is tying up with new OEMs and establishing a distribution network.

Fig 9 – Revenue break-up by region

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pe

Amer

ica

Asia

Indi

a

RoW

FY06 FY10

(`m)

Source: Company

Balkrishna has benefited from this demand

With a wide product range of 1,900 stock-keeping units (SKUs), Balkrishna is India’s leading exporter of off-highway tyres, and addresses markets in more than 120 countries in Europe, America, Asia-Pacific, the Middle East, etc. To cater to more markets, it has taken aggressive steps in



the past five years:

Increasing achievable production capacity by ~2.5x from 48,750 tons to 120,000 tons, and setting up a third plant.

The markets being serviced increased from 75 to 120.

The number of distributors was increased from 120 to over 200.

The company has a range of over 1,800 types of tyres, from 5kg to 1,500kg. Thus, its product-mix is more versatile, but entails a longer turnaround time between products. Further, BIL’s product profile has 1,900 SKUs; daily, 1,200 SKUs are active. Also, typically, a mould is changed every three days; but this could go up to 30 days per mould. All sizes are manufactured at all plants.

User segments for BIL’s off-highway tyres:

Agriculture: Constituting ~70% of revenues, these include tyres for tractors, trailers, forestry, farm equipment, and specifically designed as per farm requirement. The agriculture segment also has more pricing power.

OTR: Constituting ~26% of revenues, these include industrial, construction, and earthmover tyres, for dump trucks, loaders, underground mines, and port applications.

Others: Constituting ~4% of revenues, these include tyres for sports and utility vehicles such as golf carts, lawn & garden tyres, and all-terrain-vehicle tyres.

Fig 10 – Sales breakup

Distributors75%

OEM15%

Off-take10%

Source: Company

Competitors

Global leaders like Bridgestone and Michelin manufacture off-highway tyres; off-road tyres comprise less than 5% of their revenues. However, their off-road tyre volumes are higher than BIL’s.

The Chinese are largely absent in the agri-segment, which has low volumes and great variety; hence, is not a volumes game. This is a positive for BIL.

BIL’s line of business is differentiated from other tyre manufacturers and is tough to replicate. BIL is the only Indian manufacturer that supplies off-road radials abroad.

In India, off-road tyre suppliers are local players such as Apollo Tyres. BIL does not supply extensively in the home market, but prefers to export. Capacity constraints do not allow it to tap the domestic market in the near term.



Rubber is a concern The escalating price of rubber is a concern for the entire tyre industry, Balkrishna included. While, its forward contracts at lower prices insure it against higher rubber prices in FY11, the impact cannot be avoided in FY12.

RM prices scaling a new peak

Natural rubber, a key input, has been scaling new peaks. This, in turn, has translated into higher raw material costs for most tyre companies.

High rubber prices are a function of a rise in international prices of rubber (due to abnormal weather conditions), a surge in demand (backed by robust auto demand), an increase in the price of crude and plateauing production at plantations.

Fig 11 – Trend in rubber prices

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Domestic Rubber price

(`/quintal)

Source: Rubber Board of India

BIL, a short-term exception to higher rubber prices

Balkrishna booked natural rubber (NR) contracts at US$3,400/ton and synthetic rubber (SR) contracts at US$2,700/ton. These contracts would run till Mar ’11. Spot prices of NR are US$5,200 in India and US$6,200 internationally. Approximately 60% of BIL’s operating costs are raw material costs. If NR increases 10%, the company would need to raise prices 1-1.5%.

Fig 12 – Key raw-material composition, by volume (%)

Natural rubber32%

Carbon black27%

Synthetic rubber16%

Chemicals16%

Fabric6%

Bead wire3%

Source: Company



In the past, imported rubber has been cheaper, by `20/kg, due to lower import duties. Recent trends in rubber prices, however, have been against the grain. The advance-license scheme availed of by BIL implies even lower costs. Advance licenses are given on export quantities; since 90% of BIL’s production is exported, the company benefits.

Transportation too constitutes a huge cost. Freight costs work out to 9-10% of revenue. Hence, the company has three-month contracts with shipping companies. In a month, it exports 900-1,000 containers. Imports comprise 40% of exports.

Benefits of the DEPB (duty-exempt passbook) scheme are received after exports; advance licenses are given before exporting. Though the net benefit in a stable raw-material price context is similar, in a fluctuating raw-material price context, the advance license proves beneficial.

A rubber plant takes seven years before it begins to produce rubber. In FY05-06, plantations saw an increase in the number of rubber saplings planted. The life of a rubber plant is 25 years. Supply constraints in natural rubber are expected to ease only by end-CY12.

Fig 13 – Comparative RM/sales and rubber price trend

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25,040

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(`/quintal) (%)


Fig 14 – Ratio of BIL's average rubber price to spot price

0.7

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1.1

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FY07

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e

(x)


On average, BIL’s contracting policies have been very astute



Peaking capacity While demand for tyres is robust, BIL’s peaking capacity utilisation indicates that its revenue growth would be constrained in FY12.

Greenfield capacity two years away

In the short term, Balkrishna would be faced with capacity constraints. Moreover, since various SKUs are involved in the production mix, 100% capacity utilisation is not possible.

While demand for tyres is robust, BIL’s peaking capacity utilisation indicates that its revenue growth would be constrained in FY12.

To gain some immediate additional capacity, the company is undertaking de-bottlenecking. By Oct ’11, de-bottlenecking of 10,000 tons, at `2bn, would be complete. Of this, `600m-700m has been incurred. By Mar ’11 an additional `200m-300m would have been incurred. The de-bottlenecking would improve achievable production capacity by 10,000 tons to 130,000 tons.

This de-bottlenecking involves adding equipment, increasing radial capacity, mixing capacity at Waluj, building a raw-material and finished-goods warehouse, and adding a press. Balkrishna is also setting up a greenfield complex at Bhuj, Gujarat. This would be ready only by 4QFY13, taking 16 months to ramp up to full capacity. It would have installed capacity of 120,000 tons and achievable capacity of 90,000 tons.

Fig 15 – Trend in BIL’s installed capacity

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250,000

300,000

FY06

FY10

FY12

e

FY14

e

Installed capacity Achievable capacity

(MT

Source: Company



Financials We expect BIL to register an 8.5% profit CAGR over FY11-13. We expect an 18.2% revenue CAGR (driven mainly by price hikes) and an EBITDA margin decline of 150bps.

Three major factors restricting Balkrishna’s revenue and profit expansion would be the surge in input costs, capacity constraints and the greenfield project at Bhuj, which would raise interest costs.

The de-bottlenecking is being carried out with internal accruals, while the greenfield project would be financed by external debt.

Balkrishna’s working capital cycle is 90 days. Its exports are on vanilla terms only. Debt drawal is in Jan ’11, but unlinked to project progress. The facility is available for six years, with a moratorium of three years. The rate would be LIBOR+3%. Considering the planned capex, the company does not plan to significantly increase dividend from the 10-15% current payout.

Under these assumptions, we expect BIL to register an 8.5% profit CAGR over FY11-13e. We expect an18.2% revenue CAGR (driven mainly by price hikes) and an EBITDA margin decline of 150bps.

Fig 16 – Revenue and profit trend – standalone

0

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Fig 17 – Income statement (`m) Year-end 31 March FY09 FY10 FY11e FY12e FY13eNet Sales 12,523 13,870 19,339 22,910 27,056Change (%) 26.3 10.8 39.4 18.5 18.1Operating Other Income 0 0 95 105 115Total Income 12,523 13,870 19,435 23,015 27,171Change (%) 26.3 10.8 40.1 18.4 18.1 Expenditure 10,553 10,172 15,834 19,390 22,552EBITDA 1,970 3,698 3,601 3,625 4,619 Change (%) -9.4 87.7 -2.6 0.7 27.4 % of Net Sales 15.7 26.7 18.5 15.8 17.0Depreciation 565 662 750 855 1,026EBIT 1,405 3,036 2,851 2,770 3,593Deferred Revenue Exp. 0 0 0 0 0Interest & Finance Charges 375 187 212 424 530Other Income 49 264 40 44 49Non-recurring Expense 3 2 61 0 0Non-recurring Income 6 24 71 0 0PBT 1,082 3,135 2,689 2,390 3,112Tax 379 1,048 883 789 996Effective Rate (%) 35.1 33.4 32.8 33.0 32.0Rep. PAT 703 2,087 1,806 1,601 2,116 Change (%) -33.4 196.9 -13.5 -11.3 32.1Adj. PAT 700 2,069 1,798 1,601 2,116 Change (%) (32.9) 195.5 (13.1) (10.9) 32.1


Fig 18 – Balance sheet (`m) Year-end 31 March FY09 FY10 FY11e FY12e FY13eSources of Funds Issued Equity Share Capital 193 193 194 194 194Reserves 4,485 6,414 8,102 9,577 11,542Net Worth 4,678 6,608 8,296 9,771 11,736Net Deferred Tax 524 548 548 548 548Total Loans 4,728 4,643 5,643 8,393 10,243 Capital Employed 9,930 11,799 14,488 18,713 22,527 Application of Funds Gross Fixed Assets 7,388 8,715 11,715 16,715 20,715Less: Depreciation 2,042 2,566 3,316 4,171 5,198Net Fixed Assets 5,346 6,149 8,399 12,543 15,517Capital WIP 747 589 0 0 0Total Net Fixed Assets 6,093 6,738 8,399 12,543 15,517 Investments 322 807 807 807 807 Curr.Assets, L & Adv. 6,309 8,173 9,681 10,320 11,502Inventory 1,223 2,031 2,755 3,138 3,706Sundry Debtors 2,191 2,403 3,179 3,452 4,077Cash & Bank Balances 111 42 50 33 22Loans & Advances 2,783 3,696 3,696 3,696 3,696Others 1 0 0 0 0Current Liab. & Prov. 2,793 3,918 4,399 4,958 5,299Sundry Creditors 611 843 1,325 1,883 2,224Other Liabilities 236 306 306 306 306Provisions 1,946 2,769 2,769 2,769 2,769Net Current Assets 3,515 4,254 5,282 5,362 6,203 Application of Funds 9,930 11,799 14,488 18,713 22,527




Fig 19 – Cash flow statement (`m) Year-end 31 March FY09 FY10 FY11e FY12e FY13eOP/(Loss) before Tax 1,405 3,036 2,851 2,770 3,593Interest/Div. Received 49 264 40 44 49Depreciation & Amort. 565 662 750 855 1,026Direct Taxes Paid -285 -1,024 -883 -789 -996(Inc)/Dec in Working Capital 538 -808 -1,019 -98 -852Other Items 0 0 21 0 0CF from Oper. Activity 2,272 2,130 1,760 2,782 2,820 Extra-ordinary Items 4 22 10 0 0Other Items 0 0 0 0 0CF after EO Items 2,276 2,152 1,770 2,782 2,820 (Inc)/Dec in FA+CWIP -1,139 -1,307 -2,411 -5,000 -4,000(Pur)/Sale of Invest. 19 -485 0 0 0CF from Inv. Activity -1,120 -1,792 -2,411 -5,000 -4,000 1,155 360 -641 -2,218 -1,180 Issue of Shares 0 0 1 0 0Inc/(Dec) in Debt -620 -85 1,000 2,750 1,850Interest Paid -375 -187 -212 -424 -530Dividends Paid -136 -158 -140 -126 -151CF from Fin. Activity -1,131 -429 649 2,200 1,169 Inc/(Dec) in Cash 24 -69 8 -17 -11Add: Beginning Balance 87 111 42 50 33Closing Balance 111 42 50 33 22


Fig 20 – Ratio analysis @ `127 Year-end 31 March FY09 FY10 FY11e FY12e FY13eBasic (`) Diluted EPS 7.2 21.3 18.5 16.5 21.8EPS Growth (%) -32.9 195.5 -13.1 -10.9 32.1Cash EPS 13.1 28.4 26.3 25.3 32.4Book Value per Share 48.4 68.4 85.5 100.7 121.0DPS 1.2 1.4 1.3 1.1 1.4Payout (Incl. Div. Tax) % 19.4 7.6 7.8 7.9 7.1 Valuation (x) P/E 17.6 6.0 6.9 7.7 5.8Cash P/E 9.7 4.5 4.8 5.0 3.9EV/EBITDA 8.4 4.4 4.8 5.5 4.7EV/Sales 1.3 1.2 0.9 0.9 0.8Price to Book Value 2.6 1.9 1.5 1.3 1.1Dividend Yield (%) 0.9 1.1 1.0 0.9 1.1 Turnover Ratios Asset Turnover (x) 1.3 1.2 1.3 1.2 1.2Fixed Asset Turnover (x) 1.7 1.6 1.7 1.4 1.3 Profitability Ratios (%) RoE 15.0 31.3 21.7 16.4 18.0RoCE 14.6 28.0 20.0 15.0 16.2 Leverage Ratio Debt/Equity (x) 1.0 0.7 0.7 0.9 0.9




Company Background & Management Balkrishna Industries is a leading manufacturer of a broad range of ‘off road’ tyres for agriculture, construction, industrials, earthmovers and ATVs (all-terrain vehicles). It has three manufacturing plants and one die/tooling unit in Rajasthan and Maharashtra.

Founded in 1988 to manufacture two- and three-wheeler tyres, Balkrishna shifted to the off-road tyre segment in 1993-94.

It focuses on producing off-highway tires for agriculture, industry, materials-handling, forestry, lawns and gardens, construction and earth-movers. It has a worldwide distribution network, ensuring extensive reach and penetration.

Balkrishna’s plants:

Aurangabad: bias at 85-88 tpd;

Bhiwadi: 80% radial and 20% bias; can go to 50-50 mix; 125 tpd;

Chopankhi: 115 tpd. 30 OTR radial, balance bias;

Dombivali: manufacturing own moulds;

The upcoming Bhuj plant.

Management

Aurag Poddar is VC & MD.

Rajeev Poddar is executive director.

B K Bansal is CFO.


India I Equities

Key financials - Consolidated


Sales (`m) 22,434 13,278 18,980 24,316 29,334

Net profit (`m) -771 -1,492 76 506 878

EPS (`) -8.4 -16.2 0.8 5.5 9.5

Growth (%) -290.6 93.6 -105.1 565.2 73.4

PE (x) - - 78.4 11.8 6.8

PBV (x) 0.6 0.7 0.8 0.7 0.6

RoE (%) - - 1.0 6.0 9.4

RoCE (%) 0.1 - 4.0 8.5 11.9

Dividend yield (%) 0.0 0.0 0.0 0.0 0.0

Net gearing (%) 55.6 46.7 45.1 44.0 40.8


Auto Components

Initiating Coverage

22 February 2011

Mahindra Forgings

Steady improvement; initiate with Buy

Mahindra Forgings is one of the leading forgings companies globally and is set to gain from the steady recovery in European auto demand. This would, in turn, drive a sustainable and profitable performance ahead. We initiate coverage on MFL with a Buy and a target price of `137.

Sound domestic demand. Domestic demand is good, especially in MFL’s key segments, PVs and tractors, thereby benefiting its India operations. The transfer of dies from Europe in FY11, while resulting in short-term pain, would help improve production standards and capture additional demand ahead.

Improved operations. Increased share of machined components at its India operations and greater operating leverage would lead to improved margins.

Overseas performance to see steady improvement. Given the scale of its European operations, ~80% of MFL’s revenue arises from outside India. Demand in the European auto market is expected to continue boosting steady recovery, which would benefit it both in terms of higher revenue and operating leverage.

Valuation and risks. We value MFL at `137 (25x FY12e EPS of `5.5). Future re-rating is likely on: i) proven ability to sustain consolidated profitability and ii) likely restructuring of MFL as part of Mahindra Systech. We initiate coverage with a Buy. Risks: decline in domestic or overseas auto sales; currency fluctuations.

Rating: Buy Target Price: `137

Share Price: `65

Key data MFOL In/MAFR.BO



MFOL

Sensex

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10

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11

Source: Bloomberg

22 February 2011 Mahindra Forgings - Steady improvement; initiate with Buy




Net sales 22,434 13,278 18,980 24,316 29,334Sales growth (%) -3.3 -40.8 42.9 28.1 20.6 - Op. expenses 21,148 13,362 17,317 21,884 26,176EBIDTA 1,286 -84 1,663 2,431 3,158EBITDA margins (%) 5.7 -0.6 8.8 10.0 10.8 - Interest 704 606 424 488 561 - Depreciation 1,494 1,371 1,303 1,498 1,723 + Other income 223 65 130 117 129 - Tax 80 -504 -10 56 125Reported PAT -1,153 -1,845 76 506 878Adjusted PAT -771 -1,492 76 506 878Adj. PAT growth (%) -290.6 93.6 -105.1 565.2 73.4FDEPS (`/share) -8.4 -16.2 0.8 5.5 9.5CEPS (`/share) 10.6 -1.4 15.0 21.8 28.2DPS (`/share) 0.0 0.0 0.0 0.0 0.0Source: Company, Anand Rathi Research


Share capital 686 879 922 922 922Reserves & surplus 6,762 7,064 6,993 7,499 8,378Shareholders’ fund 7,448 7,943 7,915 8,421 9,299Debt 8,740 6,536 4,936 4,536 4,336Deferred tax / others -80 -539 -539 -539 -539Capital employed 16,107 13,940 12,312 12,418 13,096 Fixed assets 14,004 12,355 11,570 10,872 10,549Investments 23 294 294 294 294Working capital 1,733 1,005 318 1,109 1,755Cash 348 287 130 144 498Capital deployed 16,107 13,940 12,312 12,418 13,096No. of shares (m) 69 88 92 92 92Net Debt/Equity (%) 112.7 78.7 60.7 52.2 41.3W C turn (days) 61.2 83.2 45.0 47.0 47.0Source: Company, Anand Rathi Research


Reported PAT -1,153 -1,845 76 506 878 + Depreciation 1,494 1,371 1,303 1,498 1,723 Cash profit 341 -474 1,379 2,004 2,601 - Incr/(Decr) in WC -1,057 -1,032 -1,056 435 278 Operating cash flow 1,398 558 2,434 1,570 2,322 - Capex 1,126 -278 517 800 1,400 Free cash flow 272 836 1,917 770 922 - Dividend 0 0 0 0 0 + Equity raised 0 193 43 0 0 + Debt raised 626 -2,204 -1,600 -400 -200 - Investments 3 271 0 0 0 - Misc. items 983 -1,384 516 356 368 Net cash flow -88 -61 -156 14 354 + Opening cash 437 348 287 130 144 Closing cash 348 287 131 144 498Source: Company, Anand Rathi Research

Fig 4 – Consolidated Price-to-Book Band

Mahindra Forgings

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Fig 5 – Standalone Price-to-Book Band

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Fig 6 – Mahindra Forgings vs. BSE Auto

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Source: Bloomberg



Investment Argument and Valuation One of the leading forgings companies globally, MFL would benefit from the steady recovery in European auto demand. This would, in turn, drive a sustainable and profitable performance. We initiate coverage on MFL with a Buy recommendation and a target price of `137.

Sound domestic demand

Domestic demand is sound, particularly in MFL’s key segments of PVs and tractors. We expect the auto industry in India to see a 13.7% volume CAGR over FY11-13e. Auto volume growth in FY11 has been robust at 25.1% yoy, while the FY02-11 CAGR was 14%. Hence, MFL’s domestic operations would benefit from the secular growth expected in PVs and tractors.

Transfer of dies from Europe in FY11, while leading to short-term pain, would help improve production standards and capture additional demand ahead.

Improved efficiencies

Higher operating leverage, benefits of cost-reduction measures, completion of business restructuring and a greater proportion of machined forgings would drive MFL’s EBITDA margin higher from FY12.

Moreover, measures at its overseas operations to conserve cash, reduce costs and improve productivity, while helping in surviving the downturn, would also augur well for enhanced profitability ahead.

Direct exports comprise a negligible proportion of MFL’s consolidated revenue, but the scale of the European operations means that ~80% of revenue arises from outside India. Demand in the European auto market is expected to steadily recover from FY11, after bottoming out over CY08-10, thereby benefiting MFL.

Turnaround

With a host of global majors setting up car manufacturing plants in India, adequate capacity is a prime requisite for business growth. New machining and forgings lines being set up would help address this growing demand.

We expect MFL to turn around its operations and register a profit CAGR of 239.6% over FY11-13e (from a very low base), together with a revenue CAGR of 24.3% and an EBITDA margin improvement of 200bps.

Valuation

Since listing, MFL’s price performance has been hampered by organizational restructuring, operational restructuring and the impact of the demand downturn. Hence, past valuations are not too meaningful.

Future re-rating is likely on two counts: proven ability to sustain profitability and benefits of re-organization with Mahindra Systech. We value MFL at `137 (25x FY12e EPS of `5.5). We initiate coverage on MFL with a Buy rating.



Risks

Decline in auto demand

Double-dip recession in Europe

Currency fluctuations

Delay in ramp-up in India machining capacity.



Sound domestic growth Domestic demand is sound, particularly in MFL’s key segments of PVs and tractors. Domestic operations would benefit from the secular growth expected in these segments.

In India, the key sources of revenues for MFL are the PV (both cars and UVs) and tractor segments. Other segments constitute a much smaller share of MFL’s annual revenue.

Domestically, MFL derives 41.5% of its revenue from passenger cars, 23.4% from MUVs, 12.8% from tractors, 9.5% from LCVs, 2.8% from HCVs and 9.9% from the non-auto segment. Non-M&M business accounts for more than 70% of MFL’s sales.

Fig 7 - Mahindra Forgings India: Revenue breakup, segment-wise

Passenger cars41%

Non-auto10%

HCV3%

LCV10%

Tractors13%

MUVs23%

Source: Company

India turning into a small car manufacturing hub, new capacities from global OEMs being set up in India, ramp-up in capacity of the Nano and increasing preference for UVs as a lifestyle product would lead to PVs seeing 13% volume CAGR over FY11-13e.

On the other hand, the tractor segment would be more volatile, with seasonal vagaries of weather having a glaring influence on annual demand.

PVs and tractors to continue doing well

After two years of breakneck growth, the Indian auto sector has entered the secular growth phase in the current cycle. We expect an industry volume CAGR of 13.7% over FY11-13e, providing firm support to the sector.

PVs – India has emerged as a small car manufacturing hub as global giants General Motors (plant of 225,000-unit capacity annually set up at Talegaon near Pune), Volkswagen (plant at Pune), Nissan (upcoming plant at Chennai), and Renault (in partnership with Nissan) have joined the existing India old hands such as Suzuki and Hyundai. These companies not only cater to domestic demand but would also use India as an export base in the medium term.

Tractors – The tractor segment would benefit from the agri-friendly policies of the government and increased penetration in non-traditional tractor markets. An additional factor would be the increase in usage in non-traditional areas such as transportation and infrastructure. Tractor demand growth is expected to see a 9% CAGR over FY11-13e, subject to monsoon cycles.



Fig 8 – Industry: Volume growth expectation for PCs

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Fig 9 – Industry: Volume growth expectation for UVs

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Improved operations Increased share of machined components and greater operating leverage would lead to improved margins for MFL.

Higher operating leverage, benefits of cost reduction activities, completion of business restructuring and an increased proportion of machined forgings would drive MFL’s EBITDA margin higher, from FY12 onwards.

Moreover, measures at its overseas operations to conserve cash, reduce costs and improve productivity, while helping survive the downturn, would augur well for enhanced profitability ahead.

Operating efficiencies at India operations

Over FY09-10, MFL’s India operations were impacted by a combination of factors – adverse forex movement, breakdown of press, and auto demand slowdown.

Ahead, we expect Mahindra Forgings India (MFI) to put behind this phase, and register sustainable improvement in its EBITDA margin, owing to:

1. Increase in share of machined forgings in MFI’s product mix – MFI is setting up additional machining capacity. This would in turn do away with the need for MFI to outsource machining, or for OEMs to carry out machining in-house. As machining is a more value-added and hence profitable activity, an incremental share would drive up MFI’s profitability.

Fig 10 – Mahindra Forgings India: Increase in share of machined forgings

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Machined Forgings Non-machined forgings Source: Company, Anand Rathi Research

2. Operating leverage – As production activity picks up, MFI would benefit increasingly from higher operating leverage. Current capacity utilization is ~60% (of actual usable capacity), which is expected to be scaled up to >80% by FY13e.



Fig 11 – Mahindra Forgings India: Trend in capacity utilization

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on rated capacity on usable capacity Source: Company, Anand Rathi Research

3. Productivity and efficiency gains – MFI has been able to improve its operational productivity by ~20% from FY09 levels. Among other steps to improve profitability, improvement in yield is expected to contribute ~4% savings on its raw-material costs. Lastly, focus on reduction in rejections would help save costs significantly. Current level of rejections is ~5%, which is lower than that in FY09 (~8%). Even a reduction to the level at which Bharat Forge operates (~4%) would result in considerable savings. The target for MFI is 2% rejections, which would bring it on par with its European operations.

4. Transfer of dies from Europe carried out in FY11, while leading to short-term pain, would help improve production standards and capture additional demand.

Fig 12 – Mahindra Forgings India: Trend in EBITDA margin

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Steps taken to improve MFE profitability

With a significant downturn in the European CV market, Mahindra Forgings Europe (MFE) has trimmed expenditure and turned around its performance, owing to stringent steps including:

1. Reduction of personnel expenses – by 34% in FY10 vis-à-vis FY09. This included measures such as reduction of head count by 31% and up to 100% short-time-working.

2. Stock reduction – MFE has reduced WIP and finished goods worth €12m, while reducing raw-material inventory, by €8m, since Aug ’08.



Hence, due to exhaustion of channel inventories, a pick-up in demand would lead to greater capacity utilization.

3. Cost reduction – MFE has been successful in reducing its fixed costs by ~40%. To ensure that costs do not significantly spiral up, further capacity expansion has been kept at an absolute minimum, with the focus being on cash-flow generation. Closure of the Walsall, UK, plant is also a step in this direction.

Key for European operations is that except for the 3-5% annual maintenance capex, no further investments are required to accommodate future growth. The company’s co-development approach adopted with OEMs would continue to help forge long-term business relationships. Strong technological capabilities and an innovation culture would serve as a tool to garner incremental share of new business.

Fig 13 – Mahindra Forgings Europe: Profitability improvement

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Turnaround in financials We expect MFL to record a turnaround in its operations and register a profit CAGR of 239.6% over FY11-13e. We expect a revenue CAGR of 24.3% and an EBITDA margin improvement of 200bps.

Direct exports comprise a negligible proportion of MFL’s consolidated revenue, but the scale of European operations means that ~80% of revenue arises from outside India. Demand in the European auto market is expected to steadily recover from FY11, after bottoming out over CY08-10, thereby benefiting MFL.

Anecdotal evidence suggests that European CV demand has slid ~60% in FY10 from FY09. We expect a 24.9% revenue CAGR over FY11-13e for MFE. This is after a compounded annual 36.4% decline in revenue over FY08-10. Ahead, growth would be driven by improvement in demand as well as commencement of supply for new orders. Increase in low-cost sourcing from India and diversification into non-autos and marines would open long-term growth avenues for MFL.

With a host of global majors setting up car manufacturing plants in India, adequate capacity is a prime requisite for business growth. New machining and forgings lines being set up would help address this growing demand.

We expect MFL to record a turnaround in its operations and register a profit CAGR of 239.6% over FY11-13e. We expect a revenue CAGR of 24.3% and an EBITDA margin improvement of 200bps.

Fig 14 - Trend in MFL standalone revenues and profitability

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Fig 15 - Trend in MFL’s consolidated revenues and profitability

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We expect 22.5% CAGR in MFL’s (standalone) revenue over FY11-13e, backed by EBITDA margin improvement to 14% in FY13e from 10% in FY11e. The margin improvement is expected to be facilitated by a better product mix favoring machined products, higher capacity utilization and operational efficiencies. We expect a movement to adjusted profit from a loss in FY11e.

We expect a 24.3% CAGR in (consolidated) revenue over FY11-13e, backed by an EBITDA margin improvement to 10.8% in FY13e from 8.8% in FY11e. In the past, MFL’s overseas subsidiaries have had a higher EBITDA margin than the standalone operations. We expect the trend to change in favor of India operations (MFI) from FY10. Margin improvement in subsidiaries would be driven by higher capacity utilization and cost restructuring & reduction. We expect a 239.6% CAGR in the (consolidated) adjusted net profit over FY11-13e.

Trend in India operations’ production tonnage

Production tonnage growth CAGR in India operations is expected to be high for MFL due to:

1. Higher visibility of revenue growth since 78.1% of revenue is from the fast-growing PV and tractor segments; and

2. Increased machining potential.

Reduction in debt

MFL would steadily lower its debt over a period of time. The debt-equity ratio would be reduced to 0.5x in FY12e from 0.8x in FY10 and 1.2x in FY09. This would gradually lower the interest expense for MFL.



Fig 16 - Income statement (`m) Y/E MARCH FY09 FY10 FY11e FY12e FY13eTotal Income 22,434 13,278 18,980 24,316 29,334Change (%) -3.3 -40.8 42.9 28.1 20.6Expenditure 21,148 13,362 17,317 21,884 26,176EBITDA 1,286 -84 1,663 2,431 3,158Change (%) -34.6 -106.5 -2,077.1 46.2 29.9 % of Net Sales 5.7 -0.6 8.8 10.0 10.8Depreciation 1,494 1,371 1,303 1,498 1,723 Goodwill amortization - - - - -EBIT -209 -1,455 360 934 1,436Provision for contingency 0 0 0 0 0Interest & Fin. Charges 704 606 424 488 561Other Income 223 65 130 117 129Non-recurring Expense 383 353 - - -Non-recurring Income - - - - -PBT -1,073 -2,349 66 563 1,003PBT margin (%) -4.8 -17.7 0.3 2.3 3.4Tax 80 (504) (10) 56 125 Effective Rate (%) -7.5 21.5 -15.0 10.0 12.5Rep. PAT -1,153 -1,845 76 506 878Change (%) -800.9 60.0 -104.1 565.2 73.4Adj. PAT -771 -1,492 76 506 878Change (%) -290.6 93.6 -105.1 565.2 73.4


Fig 17 - Balance sheet (`m) Y/E MARCH FY09 FY10 FY11e FY12e FY13eSources of Funds Equity Share Capital 686 879 922 922 922 Reserves 6,730 7,024 6,953 7,459 8,337 ESOPs outstanding / Others 32 40 40 40 40 Net Worth 7,448 7,943 7,915 8,421 9,299 Loans 8,740 6,536 4,936 4,536 4,336 Secured Loans 7,742 5,677 4,277 3,877 3,677 Unsecured loans 998 859 659 659 659 Deferred Tax Liability (79) (539) (539) (539) (539)Minority Interest (1) - - - -Capital Employed 16,107 13,940 12,312 12,418 13,096 Application of Funds Gross Fixed Assets 28,048 25,748 26,748 27,548 28,948 Less: Depreciation 14,580 13,876 15,178 16,676 18,399 Net Fixed Assets 13,469 11,872 11,570 10,872 10,549 Capital WIP 535 483 - - -Investments 23 294 294 294 294 Curr.Assets, L & Adv. 6,748 5,114 5,105 6,434 8,025 Inventory 3,275 2,559 2,600 3,330 4,018 Sundry Debtors 1,955 1,974 2,080 2,664 3,214 Cash & Bank Balances 348 287 130 144 498 Loans & Advances 1,171 295 295 295 295 Current Liab. & Prov. 4,667 3,823 4,656 5,181 5,772 Sundry Creditors 1,469 1,507 2,340 2,864 3,455 Other Liabilities 2,087 979 979 979 979 Provisions 1,110 1,337 1,337 1,337 1,337 Net Current Assets 2,081 1,291 449 1,253 2,254 Application of Funds 16,107 13,940 12,312 12,418 13,096




Fig 18 - Cash flow statement (`m) Y/E MARCH FY09 FY10 FY11e FY12e FY13eOP/(Loss) before Tax -209 -1,455 360 934 1,436Interest/Dividends Received 223 65 130 117 129Depreciation & Amortisation 1,494 1,371 1,303 1,498 1,723Direct Taxes Paid -18 44 10 -56 -125(Inc)/Dec in Working Capital 834 967 926 -552 -407Other Items -1,045 1,843 -516 -356 -368CF from Oper. Activity 1,279 2,836 2,212 1,584 2,387 Extra-ordinary Items -383 -353 0 0 0Other Items CF after EO Items 897 2,483 2,212 1,584 2,387 (Inc)/Dec in FA+CWIP -1,126 278 -517 -800 -1,400(Pur)/Sale of Invest. -3 -271 0 0 0CF from Inv. Activity -1,129 7 -517 -800 -1,400 Issue of Shares 0 193 43 0 0Inc/(Dec) in Debt 626 -2,204 -1,600 -400 -200Interest Rec./(Paid) -481 -541 -294 -371 -432Dividends Paid 0 0 0 0 0CF from Fin. Activity 145 -2,552 -1,851 -771 -632 Inc/(Dec) in Cash -88 -62 -156 14 354Add: Beginning Balance 437 348 287 130 144Closing Balance 348 286 130 144 498


Fig 19 - Ratio analysis @ `65 Y/E MARCH FY09 FY10 FY11e FY12e FY13eBasic (`) EPS -11.2 -17.0 0.8 5.5 9.5EPS Fully Diluted -8.4 -16.2 0.8 5.5 9.5Cash EPS 10.6 -1.4 15.0 21.8 28.2EPS Growth (%) -290.6 93.6 -105.1 565.2 73.4Book Value per Share 108.6 90.4 85.9 91.4 100.9DPS 0.0 0.0 0.0 0.0 0.0Payout (Incl. Div. Tax) % 0.0 0.0 0.0 0.0 0.0Valuation (x) P/E - - 78.4 11.8 6.8Cash P/E 6.1 - 4.3 3.0 2.3EV/EBITDA 10.0 - 6.3 4.1 3.0EV/Sales 0.6 0.9 0.6 0.4 0.3Price to Book Value 0.6 0.7 0.8 0.7 0.6Dividend Yield (%) 0.0 0.0 0.0 0.0 0.0Profitability Ratios (%) RoE - - 1.0 6.0 9.4RoCE 0.1 - 4.0 8.5 11.9Turnover Ratios Asset Turnover (x) 1.4 1.0 1.5 2.0 2.2Leverage Ratio Debt/Equity (x) 1.2 0.8 0.6 0.5 0.5




Company Background & Management MFL is part of Mahindra Systech, which is the ‘Art to Part’ business arm of the M&M Group. MFL focuses on forgings, with operations in India and Europe. The company has a diversified revenue stream, with ~70% of European revenues arising from the truck segment; India operations focus more on PVs and tractors.

MFL is part of the Systech business of the Mahindra Group. Systech comprises various businesses, offering customers full services, from designing to delivery.

The Systech division is made up of three segments:

1. Contract sourcing – for sourcing of components at competitive prices;

2. Mahindra Engineering Services – for design solutions (revenue of US$34m); and

3. Auto-components business unit (ACBU) – the manufacturing and main revenue generating arm, which consists of plants manufacturing forgings, castings, stampings, gears, steel and composites.

Annualized revenue of the Systech division in FY09 stood at ~US$850m. Among all segments of the ACBU, the forgings segment is the biggest, with revenue of ~US$400m.

Fig 20 – Current Mahindra Systech: organisational chart

Mahindra & Mahindra & Mahindra

Mahindra Forgings Limited(Chakan)


MahindraForgings Europe


MahindraCastings

(Urse)

MahindraCastings

(Urse)

Mahindra Gears* (Rajkot )


PE1PE1 PE2PE2

MetalCastelloMetalCastello

53%

47%51%65%35%

India

Europe

53%

Mahindra & Mahindra & Mahindra





MahindraCastings

(Urse)

MahindraCastings

(Urse)



PE1PE1 PE2PE2

MetalCastelloMetalCastello

53%

47%51%65%35%

India

Europe

53%47%

Source: Company

Fig 21 – Mahindra Systech businesses

Key Businesses

Forgings

Mahindra Forgings (Listed)

One of the leading forgings company in the world*

Castings

Mahindra Hinoday(with PE partner)

HPDC, Induction Melting, Auto Pour, Computerized Sand Mixing

Gears

Mahindra Gears and Transmission Pvt. Ltd.

Metalcastello S.r.l.(with PE partner)

150,000 gears every month

Stampings & Steel

MUSCO (Listed)

Alloy steel and critical stamping parts required for auto & non-auto

Engineering Services

Mahindra Engineering Design and Development Co

Engines Engineering

Automotive (inc. motorcycles), aerospace & engineering

Composites

MahindraComposites (Listed)

Polymer compositesBrief Description

Mahindra Systech

Source: Company



Creation of a global forgings capacity

Mahindra Forgings is a leading manufacturer of forgings, with plants in three countries, India, Germany and the UK. Its product portfolio includes a range of forged components for cars, tractors, trucks as well as the non-auto segment.

In FY06-07, several acquisitions were made by M&M and group companies in the forgings business, to build its manufacturing capacity, product portfolio, technological abilities and add clients. Some acquisitions are:

1. Apr ’05 – 100% stake in Amforge, Chakan unit, India, subsequently renamed Mahindra Forgings

2. Jan ’06 – 99.5% stake in Stokes, UK

3. Nov ’06 – 67.9% stake in Jeco Holdings, Germany

4. Dec ’06 – 90.47% stake in Schoeneweiss, Germany

Consequent on these acquisitions, the European companies became subsidiaries of MFL during the subsequent restructuring. Post consolidation and restructuring, MFL is one of the biggest forgings companies globally, with forgings capacity comparable with that of Sumitomo and Hirschvogel.

Key management personnel:

Mr. Anand Mahindra - Chairman

Mr. Hemant Luthra: President - Systech Sector

Mr. Sanjay Joglekar: CFO - Systech Sector

Mr. Deepak Dheer – MD – Mahindra Forgings


India I Equities

Key financials

Year end Mar FY09 FY10 FY11e FY12e FY13e

Sales (`m) 2,968 3,568 4,797 6,135 7,900

Adj. Net profit (`m) 26 217 497 602 831

EPS (`) 0.3 2.2 5.1 6.2 8.6

Growth (%) -92.2 727.6 128.8 21.1 38.2

PE (x) 168.4 20.4 8.9 7.3 5.3

P/BV (x) 2.5 2.3 1.9 1.6 1.3

RoE (%) 1.4 11.8 23.4 23.4 26.8

RoCE (%) 6.2 15.0 27.3 27.6 32.2

Dividend yield (%) 1.8 2.2 2.6 3.2 3.8

Net gearing (%) 76.8 47.0 42.8 41.1 29.6


Auto Components

Initiating Coverage

22 February 2011

NRB Bearings

The leader in needle roller bearings; initiate at Buy

We initiate coverage on NRB, the leading manufacturer of needle bearings in India, with a Buy rating and a target of `68. The huge rise in number of vehicles in India, NRB’s sharper focus on exports and the replacement market, and its expansion are likely to lead to a 29% earnings CAGR over FY11-13e.

Market leader in needle bearings, with a ~10% share in the organised bearings sector. The bearings sector is split equally between organised and unorganised companies. NRB has a ~10% market share in the organised sector; in needle bearings it has a commanding 70% market share.

Sharper focus on exports and replacement market. As exports and replacement markets command higher margins, the company is increasing its focus on these markets. In the next three years exports would rise to 20% of sales.

Adding capacities to satisfy stable auto demand. As most of NRB’s revenue comes from the auto segment, robust demand for automobiles would benefit it. To cater to this roaring demand, NRB is investing `0.6bn to double its needle bearings capacity by Jul ’11.

Valuations and risks. At our target of `68, the stock would trade at 11x 12-month-forward earnings and an EV/EBITDA of 5.7x. Risks: fragmentation in the sector, spurious products in after-sales market, threat of cheap imports from China, increase in prices of raw materials.


Key data NRBBR IN / NBEA.BO

52-week high/low `65/`29Sensex/Nifty 18212 / 5459

3-m average volume US$0.1m Market cap `4.4bn/US$96mShares outstanding 97m

Free float 26.2%

Promoters 73.8%

Foreign Institutions 8.0%

Domestic Institutions 4.5%

Public 13.7%


NRBBR

Sensex

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Source: Bloomberg

22 February 2011 NRB Bearings – The leader in needle roller bearings; initiate at Buy



Year end 31 Mar FY09 FY10 FY11e FY012e FY13e

Net sales 2,968 3,568 4,797 6,135 7,900Sales growth (%) -11.0 20.2 34.4 27.9 28.8 - Op. expenses 2,585 2,962 3,736 4,871 6,271EBIDTA 383 607 1,062 1,264 1,629EBITDA margins (%) 12.9 17.0 22.1 20.6 20.6 - Interest 106 105 95 108 112 - Depreciation 202 206 240 270 288 + Other income 9 50 37 40 45 - Tax 55 128 266 326 442PAT 29 217 497 602 831PAT growth (%) -92.2 727.6 128.8 21.1 38.2Consolidated PAT 26 217 497 602 831FDEPS (`/share) 0.3 2.2 5.1 6.2 8.6CEPS (`/share) 2.4 4.4 7.6 9.0 11.5DPS (`/share) 0.8 1.0 1.2 1.4 1.7Source: Company, Anand Rathi Research

Fig 2 – Balance sheet (`m) Year end 31 Mar FY09 FY10 FY11e FY012e FY13e

Share capital 97 97 194 194 194Reserves & surplus 1,563 1,667 2,026 2,462 3,095Shareholders’ fund 1,785 1,891 2,349 2,787 3,423Debt 1,416 943 1,143 1,243 1,193Minority interests -14 -14 -14 -14 -14Capital employed 3,187 2,821 3,478 4,017 4,602 Fixed assets 1,775 1,690 1,836 1,966 1,879Investments 1 1 1 1 1Working capital 1,366 1,075 1,504 1,952 2,542Cash 45 55 138 98 181Capital deployed 3,187 2,821 3,478 4,017 4,602No. of shares (m) 96.9 96.9 96.9 96.9 96.9Net Debt/Equity (%) 76.8 47.0 42.8 41.1 29.6W C turn (days) 155.7 124.9 98.1 102.8 103.8Source: Company, Anand Rathi Research

Fig 3 – Cash flow statement (`m) Year end 31 Mar FY09 FY10 FY11e FY012e FY13e

Consolidated PAT 26 217 497 602 831 + Depreciation 202 206 240 270 288 Cash profit 235 426 739 873 1,121 - Incr/(Decr) in WC 200 (291) 428 448 590 Operating cash flow 35 716 310 425 531 - Capex 279 121 386 400 200 Free cash flow (244) 596 (76) 25 331 - Dividend 91 113 136 163 196 + Equity raised 0 0 0 0 0 + Debt raised 325 (473) 200 100 (50)- Investments 0 0 0 0 0 - Misc. items 9 0 (95) 2 2 Net cash flow (16) 10 83 (40) 83 + Opening cash 62 45 55 138 98 Closing cash 45 55 138 98 181 Source: Company, Anand Rathi Research

Fig 4 – PE Band

NRB

5x

8x

11x

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Fig 5 – P/BV Band

NRB

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c


Fig 6 – NRB V/s Auto Index

NRBBR

BSE Auto

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Source: Bloomberg



Investment Argument and Valuation We initiate coverage on NRB, a leader in needle roller bearings, with a Buy rating and a target price of `68. Its dominance in needle roller bearings, the vast rise in vehicle volumes, the sharper focus on exports and replacements, and its expansion are likely to lead to a 29% earnings CAGR over FY11-13e.

Market leader in needle bearings, with a ~10% overall share in the organised bearings sector

The bearings sector is split equally between organised and unorganised companies. In the organised space, the company has a ~10% market share; it leads in needle bearings, with a commanding 70% market share. The Indian bearings industry was worth `120bn-130bn in 2010, and has seen a healthy growth rate. The domestic industry satisfies 75% of that demand, the balance 25% is met through imports. A number of global bearings manufacturers have established units in India through joint ventures or 100% ownership.

Fig 7 – Structure of the bearings industry

Organised, 37.50%

Unorganised, 37.50%

Imported, 25%


Sharper focus on exports and the replacement market

NRB plans to leverage its leading position in needle roller bearings by concentrating on furthering exports. It aims at a consistent 20-25% growth pa in the next five years, largely from mounting exports. We expect the exports share in sales to rise from 8% in FY10 to 20% in FY13e.

Adding capacities, to satisfy stable automobile demand

As a huge 93% of demand for NRB’s bearings in India arises from the automobile segment (both OEM and replacement), stable demand prospects in this segment are a positive for the company. As many of NRB’s products are in the R&D stage, and with new product launches planned for OEMs, we expect healthy volume off-take for NRB.

The fourth largest in the bearings segment, dominated by SKF, FAG and NEC (unlisted), NRB’s market share has stagnated at around 10% since FY04. For growth, NRB has chalked out a capacity expansion plan, at its present plant at Waluj where it has sufficient land. It has already ordered machinery. It is doubling its needle roller bearings capacity by Jul ’11 (the benefits would show from 2HFY12). When this expansion goes on stream, its market share would improve to ~13-14%.



Outlook and Valuation

We expect the domestic automobile industry to grow 13.7% over FY11-13e, boosting demand for bearings. Hence the domestic bearings sector would see a 15-20% CAGR over FY11-13e. NRB would benefit from this emerging domestic demand and increased export opportunity.

On all valuation parameters—P/E, P/BV, MCap/sales—NRB is available at a discount to FAG and SKF. Also, both SKF India and FAG Bearings have trading revenues; NRB’s revenues arise only from its products.

The industry is characterized by high-end technology and the amount of capital required (raising entry barriers to others). Hence, organised domestic bearings companies, mainly global players, have a dominant share through their tie-ups. SKF India has a 37% market share, FAG 19%, NRB Bearings ~10%.

NRB’s enhanced capacity would help satisfy the booming demand and boost sales volumes. Its profitability would rise owing to its operating leverage, rising exports and after-sales share. Given the better long-term growth prospects for bearings, we expect healthy return ratios for NRB.

At our target price of `68, the stock would trade at 11x 12-month-forward earnings. NRB’s one-year-forward PBV in the past five years has ranged between 0.7x and 3.8x. At `46, NRB trades at PE of 8.9x and 7.3x FY11e and FY12e earnings, respectively, and EV/EBITDA of 4.8x and 4x.

Fig 8 – 12-month-forward P/BV – Mean and standard deviations

Mean

+1SD

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Risks to our valuation

Increase in prices of raw materials. Steel, constituting almost 35% of net sales, has a significant impact on margins. Any increase in steel prices would result in pricing and margin pressures if NRB is not able to pass on the higher costs.

Spurious products. Spurious products are a significant part of the Indian bearings market, mainly in the price-sensitive replacement market. This market uses inferior materials, which are relatively unsafe and unreliable.

Threats from imports. Customs duty on imported bearings was reduced from 30% in FY03 to nil. This has attracted more imports, catering mainly to the replacement market. Major imports of ball bearings are from China and have been rising.

We value NRB at 11x 12-month-forward earnings; target price: `68



Leading in needle roller bearings NRB Bearings manufactures almost all types of bearings: needle roller bearings, spherical roller bearings, cylindrical roller bearings, tapered roller bearings, ball bearings, crank pins and wide inner-ring bearings. It is a leader in the domestic needle roller bearings markets, with a commanding 70% market share. Its strength lies in customising bearings to meet the needs of its clients.

NRB has well-established relationships with some major OEMs. Its top-five customers are Tata Motors, Hero Honda, Ashok Leyland, Mahindra & Mahindra, and Bajaj Auto, bringing in 35-40% of its revenues. But no single customer accounts for >10%, resulting in a suitably diversified client portfolio. Its global clientele isare Daimler, Volvo and Volkswagen. Its non-automobile clients are TAFE, Siemens, ABB, Lucas and LMW.

Fig 9 – NRB's client-wise percentage sales break-up (FY09 and FY10) Company FY09 FY10

Tata Motors 7.8 9.9

Hero Honda 7.1 6.5

Ashok Leyland 4.2 5

M&M 4.6 5.5

Bajaj 5 5

HMSI 2.1 2

Maruti 2 1.5

Source: Company

The roaring prospects in the automobile sector augur well for demand for bearings, and we expect all segments of the automobile industry to report robust growth in coming years. We expect the bearings sector to continue seeing good times, riding on the auto sector boom and export growth.

However, we expect NRB, the market leader in needle roller bearings to report a better performance in the next two years, as demand growth in key user industries is expected to rise sharply. The automobile industry, which is the primary client of NRB Bearings (93% of its sales go to auto companies) grew 25% yoy in FY10 and registered 28% yoy growth till Jan ’11.

The Indian bearings industry is estimated at `120bn-130bn. Domestic manufacturers address almost 75% of that demand. Imports cater to the rest of that demand (25%), essentially for industrial applications and special purpose.

Fig 10 – Bearings industry structure Bearing Industry(~ 120bn-130bn)`

Organised~37.5%

Unorganised~37.5%

Imported~25%

OEM(Auto, Rail & Industrial)

Replacement Special Purpose Bearing




Demand for bearings is derived from demand in two key user segments, automobiles and industrial sector growth. The automobile industry is the largest growth driver as it accounts for almost 47% of the bearings market. The industrial sector makes up the rest.

Since the bearings industry is technology-intensive, most Indian manufacturers have collaborated as joint-venture partners with other more established global players. The largest user segments of bearings in India are the auto industry, the industrial OEM segment, and the replacement market. Leaders in this market are SKF in ball bearings (with a 41% market share), FAG in spherical roller bearings (60%), NBC in tapered roller bearings (23%) and NRB in needle roller bearings (70%).

Fig 11 – User-segment demand for bearings

Auto47%Industrial

53%




Capacity expansion, a growth driver In order to cater to mounting demand in the auto segment, NRB has chalked out an expansion programme. This would help it raise its market share.

On account of slowdown in the auto industry in FY09, NRB had not increased its capacity for ball and roller bearings in FY09, but its utilization levels fell considerably, from 76% in FY08 to 60% in FY09. In FY10, on the revival in the automobile industry, NRB’s production improved 40%, utilization levels improved to 76% on 10% higher capacities. At present, NRB’s average utilization levels are 80-85%. In order to grow at more than 20%, it has been undertaking regular capacity expansions at its main plants at Waluj and Jalna, by 20-25% in course of time. A further ramp-up in capacity would take place as and when demand from its customers increases.

Demand from the automobile sector makes up 47% of demand for bearings. Over FY05-10, bearings have seen an 8-10% CAGR. If the industry has to grow at 20% pa, with greater preference for branded products, there is need for capacity ramp-ups and product development to meet the new-age user requirements.

In order to grow, NRB has chalked out a capacity expansion plan. It is doubling its needle roller bearings capacity by Jul ’11, and such benefits would be reflected from 2HFY12. Its market share has stagnated at around 10% since FY04, and when this expansion goes on stream its market share would rise to 13-14%. The expansion would take place at its present plant at Waluj, where it has enough land. It has already ordered machinery. The rationale behind establishing this plant (involving capital outlay of `0.6bn) is to cater to the swelling demand from auto companies and from exports.

The Thailand subsidiary formed at an investment of `200m would cater to the ASEAN and SAARC markets, 70% would be exported and 30% sold in the Thai market. Manufacturing at this subsidiary is likely to go on stream from Q4FY11. It would have capacity to produce 32m pieces yearly. According to us, a key trigger for NRB would be the execution of its capacity expansion plans as that would place it in an ideal situation to gain market share.

Expansion in needle bearings in 2QFY12 would drive growth.

The full impact of the enhanced capacity would be seen in FY12

Auto industry to drive demand



Focus on exports and replacements NRB plans to leverage its leading position in needle roller bearings by focusing on furthering exports. It aims at a consistent 20-25% growth pa in the next five years, chiefly from rising exports. We expect the exports share in sales to rise from 8% in FY10 to 20% in FY13.

Since exports and the replacement market command higher margins, the company is increasing its focus in these segments. Its exports, which were 8% of its sales, would rise to 20% in the next three years. NRB focuses on non-commoditised bearings, i.e., it customises bearings for important clients. It has come a long way from manufacturing only needle-roller bearings. Today, it has diversified into cylindrical, tapered, roller, spherical and ball bearings, and is making a concentrated effort to boost exports by focusing on its research and development centre. This centre has churned out 1,500 products so far. NRB has old customers in Renault, Volvo and the UK-based ZF Group.

This is a technology-intensive industry and there is a significant difference in the quality of products manufactured by others. This works in India's favour. Dumping by Chinese companies (selling in India under fake brand names) is common. As the Indian auto components industry is doing well, this has a direct effect on demand for bearings of quality. These are certainly good times for many Indian manufacturers. Ahead, there will not be adequate capacity to satisfy the vast and growing demand.

NRB is hence looking at widening its global footprint and proposes to focus on exports. In the next three years, we estimate the share of exports to sales would increase from 8% now to 20%. The company has sensed outsourcing opportunities and has initiated the process to produce a range of bearings to meet the requirements of the parent or of other global customers.

NRB has already entered into talks with some major OEMs. It is also exploring the possibility of tapping replacement markets in Asia and Europe. It plans to develop new products to satisfy the requirements of the international market. Technical collaboration with Nadella, France, would prove significant in achieving export targets.

Fig 12 – Trend in exports over the years

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Also, the sharper and greater focus on the replacement market would help safeguard NRB in a slowdown, which could lead to lower growth in the OEM segment and higher growth in replacement demand. NRB has been concentrating on improving its share in the replacement market, and is set to garner a higher share there.

In order to deepen its penetration into the replacement market it is focusing on developing the market. It is also widening its dealer network in the lucrative semi-urban and rural markets. This initiative would help it penetrate further into such lucrative areas. Margins in the replacement market being higher would translate into higher overall margins.



Financials Roaring demand in the auto sector coupled with NRB’s capacity expansion to satisfy this demand offers assurance of revenue for the next two years. We expect NRB to register CAGRs of 28% in revenue and 29% in net profit over FY11-13e.

A 28% CAGR in revenue expected over FY11-13e

Following expansion in needle bearings capacity on the increase in demand, we expect a robust revenue performance from NRB. Capex planned for FY11-12 is `0.8bn. We expect a 28% CAGR in revenue from FY11 to FY13. We believe the share of exports as well as of the after-sales market would rise in the next two years.

Fig 13 – Revenue and revenue growth

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Margins to be stable

We expect the EBITDA margin over FY11-13 to be around 20-21%. This strong EBITDA performance would stem from the healthy growth in export and replacement sales.

Fig 14 – EBITDA and EBITDA margin

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1,800

FY09

FY10

FY11

e

FY12

e

FY13

e

11

13

15

17

19

21

23

EBIDTA EBITDA margins (RHS)

(`m) (%)


We expect a 28% CAGR in revenue from FY11 to FY13

We expect the EBITDA margin over FY11-13 to be around

20-21%



A 29% CAGR in net profit expected over FY11-13

We expect NRB to post a 29% CAGR in net profit over FY11-13. The growth in net profit would be reflected in expanded return ratios. Over FY11-13, we expect the RoE to rise from 23.4% to 26.8% and the RoCE from 27.3% to 32.2%.

Comfortable balance sheet

The FY10 net debt-equity ratio holds at a manageable 0.5x and falls within the industry range of 0.2x to 2x. We expect it to gradually slip to around 0.3x in FY13. Working capital days are also at manageable levels of around 98 days. Over FY11-13, this is expected to be maintained around FY11 levels.

The company has capex plans for the next two years, of ` 0.8bn, which would be met by internal accruals and debt. Its FY10 debt-equity ratio is 0.5x. This implies that it is in a comfortable position to raise debt, if required.

Fig 17 – Working capital days

0

40

80

120

160

FY09

FY10

FY11

e

FY12

e

FY13

e

(Days)


Fig 18 – Debt and Net-debt-to-equity ratio

0

200

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600

800

1,000

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1,600

FY09

FY10

FY11

e

FY12

e

FY13

e

25

32

39

46

53

60

67

74

81

Debt Net Debt/Equity (RHS)

(`m) (%)


Fig 15 – Net profit and Net-profit margin

0

100

200

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800

900

FY09

FY10

FY11

e

FY12

e

FY13

e

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PAT PAT margin (RHS)

(`m) (%)


Fig 16 – Return ratios

0

5

10

15

20

25

30

35

FY09

FY10

FY11

e

FY12

e

FY13

e

RoE RoCE

(%)


We expect NRB to post a 29% CAGR in net profit over

FY11-13



Fig 19 - Income statement (`m) Year end 31 March FY09 FY10 FY11e FY12e FY13e Gross sales 3,311 3,843 5,240 6,703 8,641-Excise duty 343 274 443 567 740Net sales 2,968 3,568 4,797 6,135 7,900-COGS 1,278 1,551 2,099 2,788 3,584Gross profit 1,690 2,018 2,699 3,347 4,317-Operating costs 1,307 1,411 1,637 2,083 2,687Operating profit 383 607 1,062 1,264 1,629+Other recurring income 9 50 37 40 45EBITDA 392 657 1,098 1,305 1,674-Depreciation/Amortisation 202 206 240 270 288EBIT 190 450 858 1,035 1,386-Interest expense 106 105 95 108 112PBT 84 345 763 927 1,274-Tax 55 128 266 326 442PAT 29 217 497 602 831+Share of profits in associates 0 0 0 0 0-Minority interests 3 0 0 0 0 PAT 26 217 497 602 831+Extra-ordinary income/(expense) 0 0 0 0 0Net profit 26 217 497 602 831-Preference dividend 0 0 0 0 0-Dividend paid 78 97 116 140 167-Dividend tax 13 16 20 24 28Transferred to reserves -65 104 361 438 636


Fig 20 - Balance sheet (`m) Year end 31 March FY09 FY10 FY11e FY12e FY13e Equity 97 97 194 194 194 Reserves 1,563 1,667 2,026 2,462 3,095 Deferred tax liability 126 128 130 132 134 -Miscellaneous expenses - - - - -Networth 1,785 1,891 2,349 2,787 3,423 Working capital loans 966 435 - - -Long term debt 451 508 1,143 1,243 1,193 Preference equity - - - - -Total debt 1,416 943 1,143 1,243 1,193 Minority interests (14) (14) (14) (14) (14)Capital employed 3,187 2,821 3,478 4,017 4,602 - - - - -Gross block 3,707 3,826 4,226 4,626 4,826 -Accumulated depreciation 1,947 2,150 2,390 2,659 2,947 Net block 1,760 1,676 1,836 1,966 1,879 +CWIP 15 14 - - -Fixed assets 1,775 1,690 1,836 1,966 1,879 Financial investments 1 1 1 1 1 Investments 1 1 1 1 1 Debtors 743 746 1,026 1,331 1,738 Inventory 956 866 1,169 1,481 1,888 Loans & advances 157 200 215 230 245 Other current assets - - - - --Creditors 348 545 715 899 1,137 -Provisions 125 167 167 167 167 -Other curent liabilities 16 25 25 25 25 Working capital 1,366 1,075 1,504 1,952 2,542 +Cash & cash equivalents 45 55 138 98 181 Net current assets 1,411 1,130 1,642 2,050 2,723 Capital deployed 3,187 2,821 3,478 4,017 4,602




Fig 21 - Cash flow statement (`m) Year end 31 March FY09 FY10 FY11e FY12e FY13e

PAT 26 217 497 602 831

+Depreciation 202 206 240 270 288

+Deferred tax 7 2 2 2 2

Cash profit 235 426 739 873 1,121

-Increase/(Decrease) in WC 200 (291) 428 448 590

Operating cash flow 35 716 310 425 531

-Capex 279 121 386 400 200

Free cash flow (244) 596 (76) 25 331

-Dividend 91 113 136 163 196

+Equity raised - - 0 - -

+Debt raised 325 (473) 200 100 (50)

+Minority interests 3 0 - - -

-Investments - - - - -

-Miscellaneous items 9 - (95) 2 2

Net cash flow (16) 10 83 (40) 83

+Opening cash 62 45 55 138 98

Closing cash 45 55 138 98 181


Fig 22 - Ratio analysis @ `46 Year end 31 March FY09 FY10 FY11e FY12e FY13e

Basic (`)


Cash EPS 2.4 4.4 7.6 9.0 11.5

EPS Growth (%) (92.2) 727.6 128.8 21.1 38.2


DPS 0.8 1.0 1.2 1.4 1.7

Valuation (x)

P/E 168.4 20.4 8.9 7.3 5.3

Cash P/E 19.4 10.4 6.0 5.1 3.9

EV/EBITDA 13.5 8.0 4.8 4.0 3.2

EV/Sales 1.8 1.5 1.1 0.9 0.7


Dividend Yield (%) 1.8 2.2 2.6 3.2 3.8


RoE 1.4 11.8 23.4 23.4 26.8

RoCE 6.2 15.0 27.3 27.6 32.2

Turnover Ratios

Debtors (Days) 99.1 76.1 67.4 70.1 70.9

Inventory (Days) 112.4 93.2 77.4 78.8 77.8

Creditors (Days) 52.8 45.7 47.9 48.0 47.0

Working Capital (Days) 155.7 124.9 98.1 102.8 103.8

Asset Turnover (x) 1.2 1.0 0.8 0.8 0.7

Leverage Ratio

Debt/Equity (x) 0.8 0.5 0.5 0.4 0.3




Company Background & Management NRB manufactures ball and roller bearings and is the only one in India to make all types of bearings: ball, needle, cylindrical, spherical, tapered, thrust, roller. It is a market leader (70% share) in needle roller bearings, which bring in ~55% of its revenues, and has a notable 16% market share in cylindrical roller bearings. Besides, it has also taken up manufacturing ball and tapered roller bearings. Over FY05-10, NRB had a 9% revenue CAGR.

Brief history and business

Incorporated in 1966, The Needle Roller Bearing Co. a joint venture with Nadella, France, was the first in India to manufacture needle roller bearings. In view of its diversified range and types of bearings, it was renamed NRB Bearings. It manufactures over 600 types of bearings at its plants at Thane, Jalna, Waluj and Pantnagar. It has two subsidiaries, the profitable SNL Bearings in Ranchi (in which it holds a 69% equity stake) and the loss-making 100% subsidiary in Thailand. NRB supplies all types of bearings and is dominant in needle roller bearings. It also supplies light-weight bearings where the load is low, as in automobiles: for gears, clutches and brakes.

Fig 23 – Key management Key Person Designation Background

Trilochan Singh Sahney

Executive Chairman

M.A.; CEO. Executive chairman since 1 Oct ’10; till then, managing director; member, Governing Council, and VP, Indo-French Chamber of Commerce & Industry. Was non-executive director, Punjab Tractors.

P D Ojha

Director B.A (Econ) M.A (Advanced Econ), Ph.D (Economics) 56 years experience; retired as Deputy Governor of The Reserve Bank of India

Kala S Pant

Director B.Sc., M.Sc. (Stats.) for Economics and Industry. Doctoral research work in quantitative methods in banking and transport. 42 years experience in management and research methodologies; research in the problems of transport, ports, infrastructure cost-benefit analysis, both macro and micro

Harshbeena S Zaveri

Managing Director

23 years in industry, in planning, purchase & imports, and marketing. Since January, responsible for entire operations Is also on the Board of SNL Bearings.

Devesh S Sahney

Director 16 years’ experience. B.A. (Business Administration & Economics), Richmond College, London, and MBA (general management), Asian Institute of Management (Philippines)

K M Elavia

Director B.Com (Hons), FCA; 39 years post-qualification experience. Former partner, Kalyaniwalla & Mistry; on the Boards of many listed and unlisted Indian companies

Anand N Desai

Additional Director

LL.B., Bombay University, LLM (International Law), University of Edinburgh, Scotland. Managing partner, DSK Legal. Has extensive experience in banking and financial services law, intellectual property rights, among others

Source: Company


India I Equities

Key financials

Year end Mar FY09 FY10 FY11e FY12e FY13e

Sales (`m) 2,320 2,559 3,230 4,169 4,912Net profit (`m) 160 143 264 357 442EPS (`) 9.1 8.1 15.0 20.2 25.0Growth (%) 17.6 -10.4 84.4 35.3 23.6PE (x) 12.9 14.4 7.8 5.8 4.7PBV (x) 3.5 3.0 2.2 1.7 1.3RoE (%) 30.4 22.2 32.6 33.1 30.9RoCE (%) 18.0 17.2 23.3 25.0 24.8Dividend yield (%) 1.1 1.3 1.5 1.8 2.2Net gearing (%) 192.8 164.9 123.8 105.4 81.0Source: Company, Anand Rathi Research Prices as on 18 February 2011

Auto Components

Initiating Coverage

22 February 2011

Setco Automotive

M&HCV clutch leader; initiate with a Buy

We initiate coverage on Setco Automotive, the leader in M&HCV clutches, with a Buy and a target of `182. Setco’s unique business model, expansion and upswing in vehicle volumes would lead to 29% earnings CAGR over FY11-13e.

Domestic leader in M&HCV clutches. While Setco is one of the top-five clutch manufacturers globally, it is the largest in India. It caters to the OEM and replacement markets, meeting ~75% of the M&HCV OEM clutch demand in the country.

Unique business model. Setco is one of the largest clutch suppliers to the after-sales segment via the distribution networks of Tata Motors, Ashok Leyland and Eicher. Its after-market sales saw a 29% CAGR over FY03-10, and growth even during the economic downturn.

Expansion to cater to the growing demand. Setco caters to the strong sustainable demand from the clutch replacement and OEM markets that we believe would continue. The company plans setting up a unit in an SEZ to cater to rising exports; the unit would be completed by FY12-13.

Valuation and risks. At our target price, the stock would trade at 9x 12-month forward earnings and EV/EBITDA of 5.1x. The target PE is in line with the three-year average. Key risks: low volume offtake from OEMs and rising raw material prices.


Key data SETC IN / SETC.BO

52-week high/low `143/`77Sensex/Nifty 18212 / 54593-m average volume US$0.1m Market cap `2.1bn/US$46mShares outstanding 17.64mFree float 36.4%Promoters 63.6%Foreign Institutions 18.6%Domestic Institutions 0%Public 17.8%


SETC

Sensex

80

90

100

110

120

130

140

Feb-

10

Apr-1

0

Jun-

10

Aug-

10

Oct

-10

Dec

-10

Feb-

11

Source: Bloomberg

22 February 2011 Setco Automotive – M&HCV clutch leader; initiate with a Buy



YE 31 March FY09 FY10 FY11e FY12e FY13e

Net sales 2,320 2,559 3,230 4,169 4,912Sales growth (%) 10.4 10.3 26.2 29.1 17.8- Op. expenses 2,005 2,187 2,682 3,458 4,059EBIDTA 315 371 548 711 853EBITDA margins (%) 13.6 14.5 17.0 17.1 17.4- Interest 91 114 121 138 150- Depreciation 44 84 98 123 142+ Other income 12 24 23 26 28- Tax 33 54 87 119 147PAT 160 143 264 357 442PAT growth (%) 17.6 -10.4 84.4 35.3 23.6Consolidated PAT 160 143 264 357 442FDEPS (`/share) 9.1 8.1 15.0 20.2 25.0CEPS (`/share) 11.5 12.9 20.5 27.2 33.1DPS (`/share) 1.3 1.5 1.8 2.2 2.6Source: Company, Anand Rathi Research

Fig 2 – Balance sheet (`m) YE 31 March FY09 FY10 FY11e FY12e FY13e

Share capital 88 88 176 176 176Reserves & surplus 485 579 717 1,030 1,418Shareholders’ fund 594 696 922 1,236 1,623Debt 1,157 1,171 1,271 1,471 1,621Minority interests 0 0 0 0 0Capital employed 1,751 1,866 2,193 2,706 3,244 Fixed assets 935 938 939 1,066 1,174Investments 0 10 10 10 10Working capital 804 896 1,115 1,462 1,755Cash 12 23 129 169 305Capital deployed 1,751 1,866 2,193 2,706 3,244No. of shares (m) 18 18 18 18 18Net Debt/Equity (%) 193 165 124 105 81W C turn (days) 117 121 114 113 119Source: Company, Anand Rathi Research

Fig 3 – Cash flow statement (`m) YE 31 March FY09 FY10 FY11e FY12e FY13e

Consolidated PAT 160 143 264 357 442 + Depreciation 44 84 98 123 142 Cash profit 216 233 362 480 584 - Incr/(Decr) in WC 118 91 220 346 293 Operating cash flow 98 142 143 134 291 - Capex 278 87 100 250 250 Free cash flow (180) 55 43 (116) 41 - Dividend 26 31 37 45 54 + Equity raised 0 0 0 0 0 + Debt raised 214 14 100 200 150 - Investments (3) 10 0 0 0 - Misc. items 9 17 0 0 0 Net cash flow 1 11 106 39 137 + Opening cash 11 12 23 129 169 Closing cash 12 23 129 169 305 Source: Company, Anand Rathi Research

Fig 4 – PE Band

Setco

5x

7x

9x

11x

30

50

70

90

110

130

150

170

190

210

Aug-

06

Nov

-06

Feb-

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Nov

-09

Feb-

10

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-10

Aug-

10

Nov

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Feb-

11

( )


Fig 5 – P/BV Band

1.0x

1.5x

2.0x

2.5x

0

20

40

60

80

100

120

140

160

180

Aug-

06

Nov

-06

Feb-

07

May

-07

Aug-

07

Nov

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08

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08

Nov

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Feb-

09

May

-09

Aug-

09

Nov

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Feb-

10

May

-10

Aug-

10

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-10

Feb-


Fig 6 – Setco vs. Auto sector index

SETC

BSE Auto

80

90

100

110

120

130

140

Feb-

10

Apr-1

0

Jun-

10

Aug-

10

Oct

-10

Dec

-10

Feb-

11

Source: Bloomberg



Investment Argument and Valuation We initiate coverage on Setco, the leader in M&HCV clutches, with a Buy recommendation and a target price of `182. The company’s unique business model, expansions to cater to exports and healthy growth in the automobile sector would lead to 29% earnings CAGR over FY11-13e, in our view.

Domestic leader in M&HCV clutches

Setco meets 75% of India’s M&HCV OEM clutch demand and is among the top-five (in volumes) globally. Eaton is #1 internationally (but does not operate in India), followed by Fisher & Facs, a part of the ZF Group. LUK is #3 and is part of the Scaefller Group. Valeo, which caters to the car and LCV clutch segments in India, is #4.

Setco commands a 40% share of the domestic industry and saw 26% revenue CAGR through FY06-10. It expects a similar growth rate in the next five years.

Setco is the largest supplier of M&HCV clutches to Tata Motors, Ashok Leyland, Eicher and Asia Motor Works. Also, it is an approved source for Daimler India. Robust growth in the M&HCV business and the shift to higher value-added new-generation CVs would boost its growth. Its strength in the after-sales market and the recognition of its LIPE brand give it added penetration.

Unique business model

Setco is one of the largest suppliers of clutches to the after-sales market, through the distribution networks of Tata Motors, Ashok Leyland and Eicher Motors. Its after-market sales have seen a 29% CAGR through FY03-10. Even in the severe economic downturn, it saw growth. It has tie-ups with OEMs for their distribution networks to cater to the replacement markets (where Setco supplies ~56% of its products).

Expansion to cater to the growing domestic and export demand

Setco caters to the clutch replacement market (clutches need replacement every 2-2.5 years on average) and to OEMs. The strong demand growth in OEMs and in the replacement market would continue. To cater to rising exports, Setco plans to set up a `0.7bn unit in an SEZ, to be complete by FY13 and to be funded via debt and internal accruals. Access to international CV players through acquisitions in the US and UK has enhanced its customer portfolio. The lower cost of production in India would continue to help it gain international clients. At present, its plants run on two shifts, and can be increased to three if demand increases.

Outlook and valuations

The domestic automobile industry grew a strong 14% through FY02-11. We expect the growth to continue, boosting demand for clutches in the OEM and replacement markets. Consequently, we estimate that domestic clutch volumes would see a 20-25% CAGR over FY10-13e. Setco would benefit from the emerging domestic demand and increased export opportunity.

We believe that the stock would be re-rated owing to Setco’s leading position, strong OEM clients, unique business model and a breakeven in its international business operations. We expect the enhanced capacity to



cater to the growing demand and to boost sales volumes. Profitability would improve on account of the operating leverage, rising exports and after-sales contribution.

At the current market price, the stock trades at FY11e and FY12e EPS of 7.8x and 5.8x respectively. At present valuations, it appears inexpensive. We initiate coverage on Setco with a Buy rating and a target price of `182. The stock would trade at 9x 12-month-forward earnings and an EV/EBITDA of 5.1x. The target PE is in line with the three-year average.

Fig 7 – Twelve-month forward PE: Mean and standard deviations

Mean

+1SD

+2SD

-1SD

0

2

4

6

8

10

12

14

16

Aug-

06

Dec

-06

Apr-0

7

Aug-

07

Dec

-07

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8

Aug-

08

Dec

-08

Apr-0

9

Aug-

09

Dec

-09

Apr-1

0

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10

Dec

-10

Source: Bloomberg

Risks

OEM risk. The replacement market comprises 56% of Setco’s sales; OEMs constitute nearly 37%. Low volume growth in OEMs would directly affect the company’s revenue.

Interest-rate risk. Many vehicles are purchased through auto finance. Higher interest rates would raise the cost of auto loans and curb volume growth of auto players, thereby affecting Setco’s growth.

High raw-material prices. Raw material costs, as high as 55% of sales, affect pricing and margins. Steel, aluminium and ceramic buttons are key raw materials. Any rise in prices would erode margins.

Risk of economic slowdown. A slowdown in the economy would affect demand for M&HCVs, curtailing Setco’s revenue.

We value Setco at 9x FY12e earnings, with a target price of `182



Domestic leader in M&HCV clutches Setco is leveraging its strong brand, market leadership and marquee clientele to ride on the strong auto demand.

The prevailing macro-economic scenario is benefiting the auto sector and, in turn, the auto clutch segment. Setco manufactures new-technology clutches under the LIPE brand, with over 90% of its sales coming from clutches. It is a market leader in the OEM segment (sales to OEMs constitute ~37% of sales) and one of the largest suppliers of clutches to the after-sales segment (56% of sales).

Fig 8 – Plant details Plant Year of

commencement Area (acres)

Facility Comment

Kalol, Gujarat 1984 24 Integrated unit: press shop, heat treatment, machining, assembly and R&D

Capacity utilization: 75-80%

Sitarganj, Uttarakhand

2008 1.5 Assembly Capacity utilization: ~65%

UK subsidiary 2006 1 Clutch assembly and R&D Clients added to Setco: Daimler, BMC and after-sales market

USA subsidiary 2007 44 Clutch assembly, hydraulics Clients added to Setco: Caterpillar, Terex and after-sales market

Source: Company

The company’s domestic unit at Kalol, Gujarat, manufactures all clutches for original-equipment-manufacturer (OEM) sales. The export-oriented unit (EOU) at Kalol caters to international demand. Setco has set up a new press shop at the Kalol unit, at ~`320m. Commercial production commenced in FY10.

In FY08, Setco set up a new assembly line at Sitarganj, Uttarakhand (for its tax incentives, entailing exponential growth potential), especially for the replacement market, for ~`80m. The Sitarganj unit, which mainly caters to the after-sales market, has the flexibility to meet increasing demand. Setco also has the option to purchase components and assemble them, since it can set up an additional assembly line quickly, without high capital costs.

Setco is a manufacturer of new-technology clutches, which it markets globally under the ‘LIPE’ brand. It is a pioneer in cera-metallic friction technology clutches in India and a tier-I supplier to Tata Motors, its largest customer. MCV clutches supplied to Tata Motors average `4,000 and HCV clutches range from `6,000 to `11,000.

Strong in the OEM market

Healthy growth in CVs and its business strategy have helped Setco establish itself as a strong player. This trend is expected to continue. We expect M&HCV demand to see an 11.5% CAGR through FY11-13e. Setco enjoys a strong clientele, including major OEMs Tata Motors, Ashok Leyland and Eicher Motors in India and others in Europe and the US. Setco meets ~80% of Tata Motors’ M&HCV clutch requirement, 100% of Eicher Motors’ and 65% of Ashok Leyland’s. It has added global clients Caterpillar, General Motors, Daimler-Benz, Chrysler and Hitachi to its elite client list. Also, Setco is the approved vendor for some global OEMs which have entered India; this would help it service such global markets. It boasts of a loyal client base, attributable to timely delivery, robust and simple clutch designs and an effective cost structure.



Fig 9 – Domestic business opportunities

M&HCV opportunity5.5bn-6bn p.a.`

OEM1.1bn`

Setco’s 75% share790m`

Replacement~ 4.5bn-4.9bn`

Setco’s 30% share1.3bn`

2m vehicles added inthe last 10 years.

1m clutches replaced every year @ 4,400 each`


We believe Setco would cater to clutches for new-age trucks. These have higher realizations for their higher value addition. Its R&D facility in the UK is continually improvising clutch designs. Future demand for higher capacity trucks also augurs well for Setco’s growth potential.

Fig 10 – Demand drivers for clutches

Increasing Freight Capacity

Huge replacement

demand

Massive investment in road sector

Ban on Overloading


Fig 11 – Factors affecting clutch life

Condition of roads

Distance Travelled

Application

Driver

Overloading




Unique business model Setco is one of the largest suppliers of clutches to the after-market sales, through the distribution networks of Tata Motors, Ashok Leyland and Eicher Motors. Its after-market sales has thus seen a 29% revenue CAGR through FY03-10. Hence, the cyclical effect in the automobile sector is mitigated by the strong after- market sales, as even during the severe downturn in the CV cycle, Setco continued to grow.

In the Indian market, Setco supplies to OEMs and original equipment suppliers (OESs), who cater to the M&HCV segment. Others such as Clutch Auto cater to the MCV, LCV and passenger-car segments, marketing products through OEMs, OESs and the after-market sales. Exide India (erstwhile Ceekay Daikin) supplies only to LCVs and passenger cars via OEMs, OESs and the after-sales market. There are two others, LUK Clutch and Amalgamations Valeo Clutch, in the organised space. Amalgamations Valeo competes with Clutch Auto in the segments it operates in, while LUK caters to the farm-equipment segment only.

On account of its customer profile and nature of the segment (M&HCVs) it caters to, Setco would always have a high replacement market. Also, realizations and margins for Setco’s clutches are very high. The company caters to the replacement market mainly via OEMs’ spare-parts divisions (i.e., OES), which contribute ~56% to its turnover. We believe Setco is well placed to cater to the rising demand as it is the largest manufacturer of M&HCV clutches in India, where it enjoys a ~40% market share. Setco’s clutch realization per piece is much higher than that of its peers (Fig 12-13) on account of its thrust into higher value-added products.

With the increasing number of new-generation CVs on Indian roads, the market for branded clutches is rising. Setco deals in OE as well the after-sales market, giving it a hedge in any downturn in the automobile industry and providing a steady sales pipeline. Clutches need frequent replacement owing to wear & tear in M&HCVs. With more advanced and costly M&HCVs nowadays, demand for clutches being used by OEMs has increased in the after-sales market as well.

Fig 12 – Average realization, clutch cover assembly

0

1,000

2,000

3,000

4,000

5,000

FY05

FY06

FY07

FY08

FY09

FY10

Setco Clutch auto Exedy India

(`/unit)

Source: Company

Fig 13 – Average realization, clutch plate/disc

0

500

1,000

1,500

2,000

2,500

FY05

FY06

FY07

FY08

FY09

FY10

Setco Clutch auto Exedy India

(`/unit)

Source: Company



In addition to India, Setco caters to the US, Europe, the Middle East, South Asia and African markets. It plans to expand its client base in the after-sales segment in the aforementioned markets, especially West Africa and Iran. The typical validation period for a clutch, with major OEMs, is 2-3 years. Setco follows the cost-plus pricing formula with customers, thereby largely insulating itself from the change in base prices as well as exchange-rate risks.

Growth in after-market sales is expected to translate into a higher profit margin, since margins in this market are higher than those in OE products. We believe that the size of the Indian M&HCV clutch segment is `5.5bn-6bn, where the organized sector caters to OEM demand and the unorganized sector serves the replacement market only.

Wear and tear requires replacement of a clutch every two years or after 200,000km for M&HCVs. The cover assembly needs to be replaced every 4-5 years. Demand in the replacement market is largely catered to by unorganized manufacturers. Owing to quality and technology issues, the trend is slowly reversing. OEM measures to promote genuine products, customer awareness programmes and tie-ups with local mechanics have helped the organised sector. There has been healthy volume growth in OEMs in the past decade, leading to more vehicles on the road, stimulating replacement demand for clutches.

Setco’s cost-efficient business model enables clients (OEMs) to offer quality spares to end-users and create a sustainable source of revenue. Hence, it has clocked growth through FY09, the worst year for the auto sector. Superior new-age trucks are coming into the market, shifting to organised manufacturers offering premium, branded clutches. M&HCVs produced in the past decade use Setco-manufactured, new-technology clutches.

Fig 14 – Sales trend: segment-wise

60 5750

2936

32 35 43

6356

8 8 7 8 8

0

25

50

75

100

FY06

FY07

FY08

FY09

FY10

OEM Aftermarket Export

(%)

Source: Company

At present, there are +6m CVs in India. In the past decade, more than 2m M&HCVs were produced. Higher growth rates are expected in future. The after-sales market for clutches, which command a higher margin, has significant potential. We expect sales during FY11-13e (in terms of replacement demand for clutches) to grow 25-30%. Also, exports, which command a higher margin, contribute 8% to the company’s revenue and are expected to increase to 15% by FY12e.



Expansion to meet rising demand In order to meet the increasing demand, Setco has chalked out an expansion strategy, which would help it increase market share. It is also aggressively looking at exports.

Setco caters to the clutch replacement market and OEMs, where demand drivers are strong. Strong demand revival from OEMs and the replacement market would continue. The company has tie-ups with OEMs for their distribution networks to cater to the replacement markets (where Setco supplies ~56% of its products). Its strength in the after-sales market and high LIPE-brand recognition provide high penetration.

Growing demand

Strong demand revival from OEMs and the replacement market would continue through FY12-13. With these markets booming, Setco is set to see further gains. Access to international CV players through acquisitions in the US and UK has enhanced the company’s customer portfolio. The lower cost of production in India would help the company gain international clients. Robust growth in M&HCVs and the shift to higher value-added new generation CVs would boost growth. The company’s strength in the after-sales segment and brand recognition through its LIPE brand provide high penetration.

Expansion plans

Utilization at Setco’s plants is high. To capitalise on expected growth, the company plans to set up capacity at its Kalol SEZ, at `0.7bn, to cater to rising exports. The unit would be complete by FY13 and funded through debt and internal accruals. Setco also plans to set up an SEZ and R&D centre. These expansion projects would support additional demand and assure a strong revenue stream in future.

Ahead, Setco is looking at increasing its global footprint and plans sharpening its focus on exports. In the next two years, we estimate exports’ share in sales to increase, from 8% at present to 15% by FY13. The company has doubled capacity in the past two years, and continues to increase it, to meet the growing demand for clutches.

Product and research capabilities.

Setco has the ability to produce new-generation ceramic clutches. It acquired two companies to add to its abilities and obtain technology, brands and access to the US and European markets. It has dedicated R&D centres, which help improve customization for export markets

In Jan ’06, Setco acquired the LIPE clutch division from Dana Corporation, UK, along with the latter’s manufacturing and R&D centre. The facility is now known as Setco Automotive, UK. The company has an agreement since CY00 to use the LIPE brand and has been paying royalty to Dana Corp. In addition, it acquired the engineering designing capabilities as well as technical competencies and intellectual property of LIPE to develop new products for India and international markets.

In FY07 Setco acquired the manufacturing plants of Haldex in Paris, USA, in an asset-purchase deal. It became the sole owner of the LIPE brand globally. The acquisition aimed to add important OE customers, especially in the US. Setco has already added Caterpillar and Terex in the US for hydraulics sale.



Exports

As exports are a high-margin business, we expect Setco to increase them, from 8% of sales at present to 15% by FY13e. Manufacturing costs in India are 25-30% lower than in the West. The expected entry of major global auto companies Navistar, Mann and Daimler into India, to set up low-cost manufacturing bases would open up fresh opportunities. Supplying the Indian arm of global majors would throw up opportunities to tap demand from other areas for auto components.

Other opportunities

The company has the ability to manufacture clutches for LCVs. It proposes to enter the segment early next fiscal. Technological advances such as hydraulics manufacturing being introduced from the US to India would help gain more international clients. Strong products, R&D capital and the ability to provide a low-cost base for international markets are key ingredients in tapping the vast export opportunities.



Financials Robust demand in the auto sector coupled with Setco’s capacity expansion to cater to such demand gives assurance of revenue for the next two years. We expect CAGRs of 23% in revenue and 29% in net profit over FY11-13. We believe that the company would see increased volumes along with better margins.

23% revenue CAGR expected over FY11-13e

With increased demand, we expect a robust revenue performance from Setco. We expect a 23% revenue CAGR over FY11-13. We believe the contribution from exports as well as from the after-sales market would rise in the next two years. The company has seen a 19% revenue CAGR in the past three years despite a recession in the auto industry.


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On account of mounting demand, OEM sales (as percent of total sales) increased in FY10. Exports (as percent of sales) decreased, but are expected to rise in future.

We expect a 23% CAGR in revenue during FY11-13

Fig 16 – Revenue breakdown (FY09)

OEM29%

Aftermarket63%

Export8%

Source: Company

Fig 17 – Revenue breakdown (FY10)

OEM37%

Aftermarket57%

Export6%

Source: Company



Increase in margins due to operating leverage

We expect Setco’s EBITDA margin to increase to 17.4% in FY13, mainly on account of the healthy margin in the India operations and improvement in the foreign subsidiaries. In the past few quarters, the company has improved its profit margin. PAT margin has improved from 7.9% in 9MFY10 to 10.2% in 9MFY11. The EBIDTA margin rose from 18.6% to 19.4% in the same period.

9MFY11 performance

Revenue stood at `1,925m (34.8% yoy growth); EBITDA was `373m (40.4% yoy growth) and PAT was `19.6m (73.7% yoy growth).


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29% CAGR in net profit expected over FY11-13e

We expect Setco to see a 29% CAGR in net profit over FY11-13e. The growth in net profit would be reflected in expanded return ratios. Over FY11-13, we expect the RoE to be 32.6% in FY11e and 30.9% in FY13e, and the RoCE to increase from 23.3.2% to 24.8%.

Fig 19 – Net profit and net-profit margin

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Balance sheet improving

Setco’s FY10 net debt-equity ratio was 1.65x and would fall to 0.9x in FY13e. Its working capital days would remain in the 120-day range from FY11-13.


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Fig 23 - Income statement (`m) Year end 31 March FY09 FY10 FY11e FY12e FY13e Gross sales 2,446 2,704 3,372 4,358 5,138-Excise duty 126 145 143 189 226Net sales 2,320 2,559 3,230 4,169 4,912-COGS 1,492 1,708 2,174 2,823 3,321Gross profit 828 851 1,056 1,346 1,591-Operating costs 513 480 508 635 738Operating profit 315 371 548 711 853+Other recurring income 12 24 23 26 28EBITDA 328 395 571 737 881-Depreciation/Amortisation 44 84 98 123 142EBIT 284 311 473 613 738-Interest expense 91 114 121 138 150PBT 192 197 351 476 589-Tax 33 54 87 119 147PAT 160 143 264 357 442+Share of profits in associates 0 0 0 0 0-Minority interests 0 0 0 0 0 PAT 160 143 264 357 442+Extra-ordinary income/(expense) -27 0 0 0 0Net profit 133 143 264 357 442-Preference dividend 0 0 0 0 0-Dividend paid 22 26 32 38 46-Dividend tax 4 4 5 6 8Transferred to reserves 107 112 227 313 388


Fig 24 - Balance sheet (`m) Year end 31 March FY09 FY10 FY11e FY12e FY13e Equity 88 88 176 176 176 Reserves 485 579 717 1,030 1,418 Deferred tax liability 25 31 31 31 31 -Miscellaneous expenses 5 2 2 2 2 Networth 594 696 922 1,236 1,623 Working capital loans 550 682 - - -Long term debt 607 489 1,271 1,471 1,621 Preference equity - - - - -Total debt 1,157 1,171 1,271 1,471 1,621 Minority interests - - - - -Capital employed 1,751 1,866 2,193 2,706 3,244 Gross block 839 1,193 1,293 1,543 1,793 -Accumulated depreciation 181 256 354 477 620 Net block 658 938 939 1,066 1,174 +CWIP 277 - - - -Fixed assets 935 938 939 1,066 1,174 Subsidiary - - - - -Strategic investments 0 10 10 10 10 Financial investments - - - - -Investments 0 10 10 10 10 Debtors 347 363 459 592 698 Inventory 537 600 758 978 1,152 Loans & advances 151 188 188 188 188 Other current assets - - - - --Creditors 173 188 221 228 215 -Provisions 39 49 49 49 49 -Other curent liabilities 19 19 19 19 19 Working capital 804 896 1,115 1,462 1,755 +Cash & cash equivalents 12 23 129 169 306 Net current assets 816 919 1,244 1,630 2,060 Capital deployed 1,751 1,866 2,193 2,706 3,244





PAT 160 143 264 357 442

+Depreciation 44 84 98 123 142

+Deferred tax 12 6 0 0 0

Cash profit 216 233 362 480 584

-Increase/(Decrease) in WC 118 91 220 346 293


-Capex 278 87 100 250 250

Free cash flow (180) 55 43 (116) 41

-Dividend 26 31 37 45 54

+Equity raised - - - - -

+Debt raised 214 14 100 200 150

+Minority interests - - - - -

-Investments (3) 10 - - -

-Miscellaneous items 9 17 - - -

Net cash flow 1 11 106 39 137

+Opening cash 11 12 23 129 169

Closing cash 12 23 129 169 306


Fig 26 - Ratio analysis @ `117 Year-end 31 Mar FY09 FY10 FY11e FY12e FY13e

Basic (`)


Cash EPS 11.5 12.9 20.5 27.2 33.1

EPS Growth (%) 17.6 (10.4) 84.4 35.3 23.6


DPS 1 2 2 2 3

Valuation (x)

P/E 12.9 14.4 7.8 5.8 4.7

Cash P/E 10.1 9.1 5.7 4.3 3.5

EV/EBITDA 7.9 6.5 4.5 3.5 2.9

EV/Sales 1.1 1.0 0.8 0.6 0.5


Dividend Yield (%) 1.1 1.3 1.5 1.8 2.2


RoE 30.4 22.2 32.6 33.1 30.9

RoCE 18.0 17.2 23.3 25.0 24.8

Turnover Ratios

Debtors (Days) 54.6 50.7 46.5 46.0 47.9

Inventory (Days) 83.6 81.1 76.7 76.0 79.1

Creditors (Days) 31.7 25.8 23.1 19.7 16.5


Asset Turnover (x) 0.8 0.8 0.7 0.7 0.7

Leverage Ratio

Debt/Equity (x) 1.9 1.7 1.4 1.2 1.0



India I Equities

Key standalone financials


Sales (`m) 2,928 4,131 4,592 5,647 6,759

Net profit (`m) 415 786 642 820 1,026

EPS (`) 5.8 11.0 9.0 11.5 14.3

Growth (%) -4.2 89.6 -18.3 27.8 25.1

PE (x) 12.3 6.5 7.9 6.2 5.0

PBV (x) 3.0 2.2 1.8 1.5 1.2

RoE (%) 24.5 34.0 22.7 23.5 23.5

RoCE (%) 27.0 29.9 21.5 23.2 24.4

Dividend yield (%) 2.1 2.8 2.2 2.5 2.7

Net gearing (%) 13.4 35.1 35.1 34.4 24.6


Auto Components

Initiating Coverage

22 February 2011

Banco Products, India

Temporary dip, bright prospects; initiate with Buy

Banco Products, India, is a leading manufacturer of radiators and primed to benefit from steady auto growth at home as well as better demand globally. Strong ties with OEMs, de-risked business and inexpensive valuations make the stock attractive. We initiate with a Buy and a target of `103.

Well placed in the auto segment. Being a leading manufacturer of automobile radiators in India, particularly in the heavy vehicle & equipment segment, Banco is set to benefit from the sustained automobile growth (a 13.7% demand CAGR over FY11-13e).

Diversification benefits. Besides benefiting from demand from OEMs, increased penetration in the non-auto space would de-risk revenue concentration in autos. The acquisition of NRF, Holland, would provide Banco better access to the European market.

Growth to recover. Despite a disappointing FY11, we expect Banco to see a strong recovery in FY12 and register standalone CAGRs of 21.3% in revenue and 26.4% in profit over FY11e-13e.

Valuation and risks. We value the stock at `103, based on 9x FY12e EPS of `11.5. It trades at an attractive 6.2x FY12e standalone PE. After a disappointing FY11, we expect the PE multiple to be re-rated, given stable growth ahead. We initiate with a Buy. Risks: decline in auto demand; negative surprises from a cement venture in Tanzania and rise in commodity prices.

Rating: Buy Target Price: `103

Share Price: `71

Key data BNCO IN/BNCO.BO



BNCO

Sensex

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22 February 2011 Banco Products (India) - Temporary dip, bright prospects; initiate with Buy


Quick Glance – Financials and Valuations Fig 1 – Standalone Income statement (`m)


Net sales 2,928 4,131 4,592 5,647 6,759Sales growth (%) -2.0 41.1 11.2 23.0 19.7 - Op. expenses 2,354 3,071 3,598 4,362 5,181EBIDTA 574 1,060 994 1,285 1,578EBITDA margins (%) 19.6 25.7 21.7 22.8 23.4 - Interest 26 22 97 145 160 - Depreciation 88 95 129 151 177 + Other income 19 42 33 37 40 - Tax 64 199 160 205 256Reported PAT 415 786 642 820 1,026Adjusted PAT 415 786 642 820 1,026Adj PAT growth (%) -4.2 89.6 -18.3 27.8 25.1FDEPS (`/share) 5.8 11.0 9.0 11.5 14.3CEPS (`/share) 7.0 12.3 10.8 13.6 16.8DPS (`/share) 1.5 2.0 1.6 1.8 1.9Source: Company, Anand Rathi Research

Fig 2 – Standalone Balance Sheet (`m) Year to 31 March FY09 FY10 FY11e FY12e FY13e

Share capital 143 143 143 143 143Reserves & surplus 1,550 2,168 2,678 3,353 4,219Shareholders’ fund 1,694 2,311 2,821 3,496 4,362Debt 93 964 1,264 1,464 1,464Deferred tax / others 86 90 90 90 90Capital employed 1,873 3,364 4,175 5,050 5,916 Fixed assets 798 859 981 1,130 1,253Investments 55 1,305 1,805 2,205 2,205Working capital 915 1,146 1,296 1,644 2,011Cash 106 55 92 71 448Capital deployed 1,873 3,364 4,175 5,050 5,916No. of shares (m) 72 72 72 72 72Net Debt/Equity (%) -0.7 39.3 41.5 39.8 23.3W C turn (days) 126 122 122 122 122Source: Company, Anand Rathi Research


PBT 486 965 866 1,133 1,401+ Depreciation 88 95 129 151 177Cash profit 574 1,060 994 1,285 1,578- Incr/(Decr) in WC -285 -203 -475 -278 -259Operating cash flow 859 1,263 1,469 1,563 1,838- Capex 221 149 251 300 300Free cash flow 638 1,114 1,218 1,263 1,538- Dividend 126 167 132 145 159+ Equity raised 1 0 0 0 0+ Debt raised -123 871 300 200 0- Investments -28 1,250 500 400 0- Misc. items 328 618 850 939 1,002Net cash flow 91 -50 37 -21 376+ Opening cash 15 106 55 92 71Closing cash 106 55 92 71 448Source: Company, Anand Rathi Research

Fig 4 – PE Band

Banco Products

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Fig 6 – Banco vs. Sensex

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Investment Argument and Valuation Banco is India’s leading manufacturer of radiators and is poised to benefit from the steady automobile growth at home as well as the better demand overseas. A less-regulated competition and strong ties with OEMs coupled with inexpensive valuations make the stock attractive. We initiate coverage on Banco with a Buy and a target price of `103.

Banco is a leading supplier of engine-cooling components and all types of gaskets in addition to radiators, intercoolers, oil-coolers, etc. Its products are used in the auto and non-auto segments: auto (55% of off-take), earthmoving equipment and construction (20%), industrial engines and others (30%).

In FY10, 78% of Banco revenue came from radiators, 22% from gaskets. Key customers for gaskets were Maruti Suzuki, Tata Motors, Hero Honda and TVS Motors; for radiators, Tata Motors, Ashok Leyland, M&M, BEML, TAFE and the Indian Railways were the main clients. The company’s operations are well-diversified: no customer contributes more than ~10-12% to revenue.

Well placed in the auto segment

Being a leading manufacturer of auto radiators, Banco would continue to benefit from the sustained auto growth ahead, especially as it caters to the heavier vehicle segment (India M&HCV CAGR expected at 11.5% and LCV CAGR at 14.4% over FY11-13e).

The automotive sector is a key customer, contributing ~55% to Banco’s sales. Of this, two-thirds arise at home, the balance from exports. In the CV segment, Banco has a significant 30-35% market share.

The engine-cooling segment is concentrated among the large regulated manufacturers. Stringent design and performance requirements of OEMs and a less active replacement market limit the scope for unregulated players of lower quality.

With the Indian automotive industry seeing robust growth (~25.1% in FY11, and expecting a 13.7% CAGR over FY11-13e), the domestic growth potential for Banco is upbeat. Higher off-take for the non-auto segment would help faster growth than in the auto industry. The share of exports slipped from 37% in FY08-09 to 33% in FY10, attributable to the robust domestic growth and relatively subdued overseas markets.

Diversification benefits

In addition to benefiting from demand from OEMs, increased penetration in the non-auto space would serve towards de-risking revenue. The share of non-auto radiators has risen to ~45-50% of Banco’s revenue (from 25-30% in the past few years).

Even after such fast growth, the industrial segment still has the potential to be a major growth driver, with user industries Railways and Power adding mass to the present business owing to huge spending. The Railways contribute 4-5% of domestic radiator sales; in view of the aggressive targeted capex by the Railways, its share has the potential to rise to 8-10% in the medium term (even on the expanded auto base).

Good presence in the automotive segment and increased presence in

the non-auto segment over the past few years augurs well for Banco’s

growth ahead



Acquisition gives access to overseas market

The acquisition of NRF, Holland, would give Banco better access to the European market. Further, it would help in product diversification into the non-auto segment, with NRF’s area of expertise being in the quick-supply business as well as in end-products utilised in industries (air-coolers and air-conditioners).

Recovery from the lows for the European auto market (EU regions being major customers) and continuing replacement demand on a further build-up in the automotive base would benefit Banco. (In exports, most of its sales are in the replacement market.)

Valuation

We value the stock at `103, based on 9x FY12e EPS of `11.5. At present, it trades at an attractive 6.2x FY12e standalone PE. After a disappointing FY11, we expect the PE multiple to be re-rated, given the stable growth expected. We initiate with a Buy.

Risks

Banco is looking at new business opportunities in Europe as well as new customers through its acquisition. It would target OEMs in the marine sub-segment. However, this would take at least two years to start contributing to revenue.

Upward trend in commodity prices.

Delay in ramp-up at the acquired company.

Domestic or international auto demand slowdown.

Cement venture in Tanzania may provide negative surprises.

With 33% of revenue from exports, Banco would be subject to a currency-fluctuation risk.



Well placed in the auto segment Being a leading manufacturer of auto radiators, particularly catering to the heavier vehicle sub-segment, Banco would continue to benefit from the sustained auto growth (13.7% demand CAGR over FY11-13e).

To benefit from auto industry growth

The automotive industry is a key customer, with ~55% of Banco’s sales going to this segment. Of this, two-thirds come from the home markets, the rest from exports.

With the Indian automotive industry in the midst of robust growth (~25.1% yoy growth in FY11e, and 13.7% demand CAGR expected in the next two years), the domestic growth potential for Banco is good. The share of exports has declined from 37% in FY08-09 to 33% in FY10, attributable to the robust domestic growth and relatively subdued overseas markets.

Most of the growth in FY10 net sales was driven by better volumes, introduction of value-added products and competitive pricing. With the rapid transition in technology norms and increase in efficiency standards in the automotive industry, the company has to cater to the much more complex and demanding gaskets and radiators sub-segments of Indian OEMs.

The engine-cooling segment is concentrated among large organised manufacturers. Stringent design and performance requirements of OEMs and a less active replacement market limit the scope for unorganised players of lower quality.

Four decades of experience have resulted in Banco’s better understanding of the business. The company is one of the largest in the organised radiator business, offering a wide range of products and innovative processes.

Tata Motors, M&M and Ashok Leyland are some of its major clients, the first two contributing ~11% each. Banco’s market share in the CV segment ranges from 30% to 35%.

Fig 7 – Comparison of BPIL’s revenue growth and auto industry growth

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Banco’s revenue growth trend till FY10 largely mirrored the

Indian CV sector’s. Ahead, we expect its increased non-auto

presence and higher exports to help de-risk operations



Diversification benefits Besides benefiting from demand from OEMs and exports, increased penetration in the non-auto space would effectively de-risk revenue.

Non-auto share has increased

The industrial segment would be a major growth driver, with user industries Railways and Power adding to the existing business owing to the vast expenditure expected in those sectors. The Railways contribute ~5-7% of domestic radiator sales; ahead, this could rise to 8-10% in the medium term.

Banco’s penetration in the OTR/construction engines sub-segment would boost growth, as these have high sensitivity to capex and infrastructure cycles. The slow and steady foray into the Railways and other heavy engines would be a key growth driver for high-value components and ensure that incremental revenue has a higher EBITDA margin.

In the next 2-3 years, Banco expects to benefit from NRF’s marine-components-supply business and diversify its Indian revenue streams through this vertical. It looks forward to monetize the technology and market access that it would gain through this acquisition.

Cement foray

More controversial in nature is Banco’s decision to venture into the African cement market via setting up a 500,000-ton plant in Tanzania. At present, this has not been factored into our estimates. Some highlights of the project are:

The project cost is US$70m. Of this, equity would be US$24m. Banco’s investment in the cement venture would be US$12.3m. The rest would be borrowed.

Banco would have a 51% stake in the venture; the balance would be with local companies.

The payback period is expected to be three years, with project breakeven predicted at 28% capacity utilisation.

On full production, this plant would cater to 10% of Tanzania’s demand. However, competition would include large players such as Lafarge.

Lake Cements would be run by professionals appointed from India, and would be financed by local banks in Tanzania.

As this is a venture into an unrelated field for the company, we reserve our judgement on the project while factoring in the execution risk as one that might impair financial performance ahead.



NRF gives access to global markets The acquisition of NRF, Holland, would give Banco better access to European markets through a local base. As NRF specializes in non-auto heat exchanges, this acquisition would help de-risk Banco’s operations.

Exports, overseas presence to increase

The acquisition of NRF, Holland, would give Banco better access to European markets through a local base. NRF has been operating in the business for more than 80 years. Though it specializes in the marine/shipbuilding industry, 50% of its revenue comes from the automotive segment, 25% from Marine and 25% from others. Replacement demand accounts for +50% of sales.

Banco acquired Nederlandse Radiateuren Fabriek B.V. (NRF), which was incorporated in the Netherlands and manufactures heat transfer products. NRF was owned by a US company, now undergoing Chapter 11 proceedings. Banco acquired NRF without any liabilities, for €17.70m, funded via debt and equity.

The European auto market recovering from its lows (EU regions being major customers) and the continuing replacement demand owing to a further build-up in the automotive base would benefit Banco. (In exports, most of its sales come from the replacement market.)

Banco is looking at new business opportunities in the European markets as well as new customers through this acquisition. NRF has subsidiaries all over Europe and a main warehouse in Holland. Banco aims to improve NRF’s product line and business, though 2-3 years would be required for that. Similarly, NRF would benefit from Banco’s cost-cutting measures, synergies, and management initiatives.



Financials Growth ahead would be driven by growth in user industries such as the automobile sector, marine requirements, the Railways, construction equipment and other industrials. The acquisition of NRF would contribute to growth by increasing operations in Europe, North America and other areas.

Most of Banco’s FY10 sales growth was driven by better volumes, new value-added products and competitive pricing. With the rapid transition in technology norms and the increase in efficiency standards in the automotive industry, Banco has to cater to the complex and demanding gaskets and radiator segments of Indian OEMs.

Banco now operates at ~70-75% utilization. Despite a disappointing FY11, we expect it to recover in FY12 and register standalone CAGRs of 21.3% in revenue and 26.4% in profit over FY11e-13e.

The continuing good performance of OEMs would augur well for Banco, in terms of sustained revenue growth. Growth opportunities from the Railways and Power have further potential for revenue.

Additional positives are Banco’s adapting to changes in technology via investing in R&D and following globally competitive pricing and timely delivery.

Fig 8 – Trend in revenue and profit growth

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Fig 10 – Income statement (`m) Year-end 31 March FY09 FY10 FY11e FY12e FY13eNet Sales 2,879 4,071 4,524 5,568 6,669Change (%) -3.7 41.4 11.1 23.1 19.8Expenditure 2,354 3,071 3,598 4,362 5,181EBITDA 574 1,060 994 1,285 1,578 Change (%) 3.6 84.7 -6.2 29.2 22.9 % of Net Sales 19.6 25.7 21.7 22.8 23.4Depreciation 88 95 129 151 177EBIT 486 965 866 1,133 1,401Deferred Revenue Exp. 0 0 0 0 0Interest & Finance Charges 26 22 97 145 160% of Debt 16.9 4.1 8.7 10.7 10.9Other Income 19 42 33 37 40Non-recurring Expense 0 0 0 0 0Non-recurring Income 0 0 0 0 0PBT 479 985 802 1,025 1,282Tax 64 199 160 205 256Effective Rate (%) 13.4 20.2 20.0 20.0 20.0Rep. PAT 415 786 642 820 1,026 Change (%) -4.2 89.6 -18.3 27.8 25.1 % of Net Sales 14.2 19.0 14.0 14.5 15.2 Adj. PAT 415 786 642 820 1,026 Change (%) (4.2) 89.6 (18.3) 27.8 25.1


Fig 11 – Balance sheet (`m) Year-end 31 March FY09 FY10 FY11e FY12e FY13eSources of Funds Share Capital 143 143 143 143 143Reserves 1,550 2,168 2,678 3,353 4,219Net Worth 1,694 2,311 2,821 3,496 4,362Net Deferred Tax 86 90 90 90 90Total Loans 93 964 1,264 1,464 1,464Capital Employed 1,873 3,364 4,175 5,050 5,916

Application of Funds Gross Fixed Assets 1,273 1,376 1,676 1,976 2,276Less: Depreciation 479 566 695 846 1,023Net Fixed Assets 795 810 981 1,130 1,253Capital WIP 3 49 0 0 0Total Net Fixed Assets 798 859 981 1,130 1,253Investments 55 1,305 1,805 2,205 2,205Curr.Assets, L & Adv. 1,442 1,796 2,015 2,414 3,233Inventory 552 759 844 1,038 1,244Sundry Debtors 646 879 977 1,202 1,440Cash & Bank Balances 106 55 92 71 448Loans & Advances 138 102 102 102 102Others 0 0 0 0 0Current Liab. & Prov. 421 595 626 699 775Sundry Creditors 204 282 314 386 462Other Liabilities 66 118 118 118 118Provisions 151 195 195 195 195Net Current Assets 1,021 1,201 1,388 1,715 2,458Application of Funds 1,873 3,364 4,175 5,050 5,916




Fig 12 – Cash flow statement (`m) Year-end 31 March FY09 FY10 FY11e FY12e FY13eOP/(Loss) before Tax 486 965 866 1,133 1,401Interest/Div. Received 19 42 33 37 40Depreciation & Amort. 88 95 129 151 177Direct Taxes Paid -45 -195 -160 -205 -256(Inc)/Dec in Working Capital -26 -231 -151 -348 -367Other Items 46 -2 0 0 0CF from Oper. Activity 568 674 717 769 996Extra-ordinary Items 0 0 0 0 0Other Items 0 0 0 0 0CF after EO Items 568 674 717 769 996(Inc)/Dec in FA+CWIP -231 -157 -251 -300 -300(Pur)/Sale of Invest. 28 -1,250 -500 -400 0CF from Inv. Activity -203 -1,407 -751 -700 -300Issue of Shares 1 0 0 0 0Inc/(Dec) in Debt -123 871 300 200 0Interest Paid -26 -22 -97 -145 -160Dividends Paid -126 -167 -132 -145 -159CF from Fin. Activity -274 682 72 -90 -319Inc/(Dec) in Cash 91 -51 37 -21 377Add: Beginning Balance 15 106 55 92 71Closing Balance 106 55 92 71 448


Fig 13 – Ratio analysis @ `71 Year-end 31 March FY09 FY10 FY11e FY12e FY13eBasic (`) Diluted EPS 5.8 11.0 9.0 11.5 14.3EPS Growth (%) -4.2 89.6 -18.3 27.8 25.1Cash EPS 7.0 12.3 10.8 13.6 16.8Book Value per Share 23.7 32.3 39.4 48.9 61.0DPS 1.5 2.0 1.6 1.8 1.9Payout (Incl. Div. Tax) % 30.3 21.2 20.5 17.7 15.5Valuation (x) P/E 12.3 6.5 7.9 6.2 5.0Cash P/E 10.1 5.8 6.6 5.2 4.2EV/EBITDA 8.7 4.4 4.5 3.3 2.5EV/Sales 1.7 1.2 1.0 0.8 0.6Price to Book Value 3.0 2.2 1.8 1.5 1.2Dividend Yield (%) 2.1 2.8 2.2 2.5 2.7Turnover Ratios Asset Turnover (x) 1.5 1.2 1.1 1.1 1.1Fixed Asset Turnover (x) 2.3 3.0 2.7 2.8 2.9Profitability Ratios (%) RoE 24.5 34.0 22.7 23.5 23.5RoCE 27.0 29.9 21.5 23.2 24.4Leverage Ratio Debt/Equity (x) 0.1 0.4 0.4 0.4 0.3




Company Background & Management Banco supplies engine-cooling components and all types of engine gaskets, besides radiators, inter-coolers, oil-coolers, etc. Its products are used across auto and non-auto segments.

Banco started in 1962. It has four modern manufacturing plants at Baroda, with state-of-the-art facilities. It collaborates with Elring Klinger, Germany and Japan Metal Gaskets for the Indian market. It has ~600 employees.

Promoter and chairman Vimal Patel has an M.Sc. (Economics) from the London School of Economics and wide experience in automotive components. Shailesh Thakker is the executive director and CFO. Co-promoter Mehul K Patel is a post graduate in engineering from England. The promoter holding in Banco is 69.5%.

Product range

1. Gaskets: The company manufactures and exports a wide range of gaskets for diesel engines (automotive and agriculture).

2. Radiator: It also manufactures and exports radiators for all sorts of applications (automotive, industry, agriculture). It supplies radiators and air coolers to all major OEMs in India and some leading companies in Europe. It also addresses the replacement market, with an extensive range covering popular German, French and Japanese cars.

3. Compressed Fibre Jointing Sheets (CFJS): It manufactures compressed jointing sheets using non-asbestos raw materials, exporting many varieties, covering a range of automotive and industrial applications world-wide.


India I Equities

Key financials


Sales (`m) 5,267 7,031 9,500 12,221 15,112

Net profit (`m) 56 240 282 407 566

EPS (`) 0.8 3.3 3.9 5.7 7.9

Growth (%) -26.7 329.1 17.2 44.6 39.1

PE (x) 54.2 12.6 10.8 7.5 5.4

PBV (x) 2.1 1.9 1.7 1.4 1.2

RoE (%) 3.9 15.7 16.3 20.6 24.1

RoCE (%) 8.3 16.7 15.4 20.2 23.1

Dividend yield (%) 1.7 2.0 2.4 2.9 3.5

Net gearing (%) 103.4 82.9 81.9 77.2 63.5


Auto Components

Initiating Coverage

22 February 2011

Gabriel India

A leading shock-absorber manufacturer; initiate with Buy

We initiate coverage on Gabriel, with a Buy recommendation and a target of `62. Gabriel is one of the leading manufacturers of shock absorbers and likely to see a 42% earnings CAGR over FY11-13e supported by a strong brand catering to stable demand, its location advantage and expansion.

Stable auto demand. India’s auto sector is likely to see a 13.7% volume CAGR over FY11-13e, boosted by two-wheelers and cars. The country is already one of the world’s largest two-wheeler markets and an established small-car global manufacturing hub. We expect the nascent recovery in export demand to gather steam as US/EU auto demand recovers in FY11 after hitting bottom in CY08/CY09.

Strategic plant location; timely delivery. Gabriel’s plants are strategically located, in proximity to original equipment manufacturers (OEMs). This results in timely delivery to clients at lower costs.

Adding capacities. The boom in the automobile industry has led to Gabriel investing `1.5bn-2bn in the next 3-4 years to enhance capacity to cater to the booming demand.

Valuation and risks. At our target price of `62, the stock would trade at 11x FY12e earnings and EV/EBITDA of 4.9x. The target PE is at a slight discount to the stock’s five-year average PE. Key risks: higher interest rates and rise in raw material prices


Key data GABR IN / GABR.BO

52-week high/low `74/`29Sensex/Nifty 18212 / 54593-m average volume US$0.1m Market cap `3.2bn/US$71mShares outstanding 71.8mFree float 45.4%Promoters 54.6%Foreign Institutions 6.0%Domestic Institutions 0.7%Public 38.7%


GABR

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Source: Bloomberg

22 February 2011 Gabriel – A leading shock-absorber manufacturer; initiate with Buy




Net sales 5,267 7,031 9,500 12,221 15,112Sales growth (%) 10.4 33.5 35.1 28.6 23.7- Op. expenses 4,978 6,385 8,778 11,215 13,833EBIDTA 290 647 722 1,006 1,279EBITDA margins (%) 5.5 9.2 7.6 8.2 8.5- Interest 171 160 127 197 219- Depreciation 153 202 216 251 281+ Other income 107 68 7 7 8- Tax 16 112 104 158 220PAT 56 240 282 407 566PAT growth (%) -26.7 328.5 17.2 44.6 39.1Consolidated PAT 56 240 282 407 566FDEPS (`/share) 0.8 3.3 3.9 5.7 7.9CEPS (`/share) 2.9 6.2 6.9 9.2 11.8DPS (`/share) 0.7 0.9 1.0 1.2 1.5Source: Company, Anand Rathi Research

Fig 2 – Balance sheet (`m) YE 31 March FY09 FY10 FY11e FY12e FY13e

Share capital 72 72 72 72 72Reserves & surplus 1,252 1,421 1,617 1,921 2,364Shareholders’ fund 1,430 1,633 1,829 2,134 2,577Debt 1,569 1,488 1,688 1,888 2,088Minority interests 0 0 0 0 0Capital employed 2,999 3,122 3,517 4,022 4,665 Fixed assets 1,896 1,965 2,127 2,377 2,596Investments 133 133 133 133 133Working capital 878 889 1,068 1,270 1,485Cash 91 134 189 242 451Capital deployed 2,999 3,122 3,517 4,022 4,665No. of shares (m) 71.9 71.8 71.8 71.8 71.8Net Debt/Equity (%) 103.4 82.9 81.9 77.2 63.5W C turn (days) 66.3 45.9 37.6 34.9 33.3Source: Company, Anand Rathi Research

Fig 3 – Cash flow statement (`m) YE 31 March FY09 FY10 FY11 FY12 FY13

Consolidated PAT 56 240 282 407 566 + Depreciation 153 202 216 251 281 Cash profit 211 477 498 658 848 - Incr/(Decr) in WC (156) 11 179 202 215 Operating cash flow 367 466 319 456 633 - Capex 456 271 379 500 500 Free cash flow (89) 196 (59) (44) 133 - Dividend 59 71 86 103 123 + Equity raised 0 (0) 0 0 0 + Debt raised 108 (81) 200 200 200 - Investments (10) 0 0 0 0 - Misc. items 0 0 0 0 0 Net cash flow (31) 43 55 53 209 + Opening cash 122 91 134 189 242 Closing cash 91 134 189 242 451 Source: Company, Anand Rathi Research

Fig 4 – PE Band

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Fig 5 – P/BV Band

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Fig 6 – Gabriel Vs Auto sector index

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Investment Argument and Valuation We initiate coverage on Gabriel India with a Buy and a target price of `62. Gabriel is one of the leading manufacturers of shock absorbers and likely to see a 42% earnings CAGR over FY11-13e on the back of a strong brand catering to the stable demand, locational advantage and expansion.

Stable auto demand – positive for Gabriel

Most of the domestic demand for shock absorbers comes from the OEM market; 80% stems from fresh demand in case of Gabriel. With the revival in the auto sector, prospects for the shock-absorber segment seem bright. India’s auto sector is likely to see a 13.7% volume CAGR over FY11-13e, boosted by two-wheelers and cars. Various launches in the past year have attracted a healthy response; with OEMs likely to see further launches, we expect healthy volume off-take for the company.

India is already one of the world’s largest two-wheeler markets and an established small-car global manufacturing hub. We expect the nascent recovery in export demand to gather steam as US/EU auto demand recovers in FY11 after hitting bottom in CY08/CY09.

Leveraging its strategic plant location for timely delivery

Gabriel’s largest plant, at Hasur (Tamil Nadu) supplies suspension products to OEMs Suzuki, Yamaha and TVS Motors. Its plant at Nashik supplies front forks and shock absorbers to Bajaj Auto and Yamaha. Maruti’s plant at Mansesar is being supplied shock absorbers by Gabriel’s Khandsa plant; similarly, Tata Motors, Bajaj Auto, Renault, Volkswagen and the Indian Railways are being served struts and shock absorbers from the company’s Chakan plant at Pune. Gabriel’s plants are strategically located, in proximity to OEMs. Hence, it boasts of timely delivery at lower costs.

Adding capacities

Gabriel plans to leverage its strong brand by targeting more exports. (‘Gabriel’ is India’s most recognized shock-absorber brand.) The company has, through its long experience in shock absorbers, built units to further strengthen its product range. It is #2 in shock absorbers (dominated by Munjal Showa, which primarily supplies Hero Honda), with a 30% share of the organized set-up and a past five-year CAGR of 11-12% (largely volume-driven). It aims at a consistent 25% annual growth in the next three years, mainly via increased domestic volumes and improved exports.

In the past three years, Gabriel has added three plants: Parwanoo, Khandsa and Sanand. This expansion in shock-absorber capacity has driven growth (ytd FY11 revenue up 35% yoy).

The boom in the automobile industry has resulted in the company planning investment of `1.5bn-2bn in the next 3-4 years to enhance capacity to cater to the rising demand.



Outlook and Valuation

The domestic automobile industry saw a strong 12.7% growth over FY02-10 (against a slight decline in FY08). We expect the trend to continue, boosting demand for shock absorbers in OEM and replacement markets. Consequently, we estimate the domestic shock absorber sector to see a 20-25% CAGR over FY10-13e. Gabriel would benefit from the emerging domestic demand and increased exports opportunity.

Gabriel’s leading position, proximity to OEM clients and capacity expansions lead us to believe that there is substantial upside to the stock. Also, it has bagged orders and increased capacities to cater to the rising demand. This would boost its sales volumes. Profitability would improve on account of the operating leverage, increased exports and after-sales contribution. Given the better long-term growth prospects for shock absorbers, we expect healthy return ratios.

At our target price of `62, the stock would trade at 11x FY12 earnings and EV/EBITDA of 4.6x. We assign some discount to the stock’s five-year average multiple. Gabriel’s one-year-forward PE in the past five years has largely ranged between 2x and 40x. P/BV has ranged between 0.3x and 2.4x. At the current market price of `42, the stock trades at PE of 10.8x and 7.5x FY11e and FY12e earnings respectively and EV/EBITDA of 5.1x and 3.6x. We initiate coverage with a Buy recommendation and a target price of `62.

Fig 7 – Twelve-month forward PE: Mean and standard deviations

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Risks

OEM risk. Nearly 80% of Gabriel’s sales are to OEMs, while only 20% to the replacement market (original equipment suppliers). Hence, low volume growth for OEMs would trim the company’s revenue.

Interest-rate risk. A substantially high percentage of vehicles is purchased through auto finance; as such, with an increase in interest rates, cost of financing rises. This affects volume growth of auto manufacturers, thereby impacting Gabriel’s growth.

High raw-material prices. Raw material costs being as high as 70-75% of sales play a large part in pricing and margins. Steel, aluminium, rubber and oil are key raw materials. Any adverse movement in prices would lead to eroded margins.

We value Gabriel at 11x 12-month-forward earnings;

Target price: `62



Stable auto demand India’s auto sector is likely to see a 13.7% volume CAGR over FY11-13e, boosted by two-wheelers and cars. Demand for shock absorbers in India largely comes from the OEM market; 80% from fresh demand in case of GIL. With the auto revival, prospects for the shock-absorber segment look bright. The launch of many vehicles last year has seen a good response; also, based on further launches in the pipeline for OEMs, we expect healthy volume offtake for Gabriel.

Catering to the booming OEM and replacement markets. The domestic automobile industry has been growing rapidly. The replacement market has broadened, with the number of old vehicles in India increasing (average life of ride-control products is 4-5 years). In such an ever-increasing replacement market, where Gabriel supplies ~20% (including supplies to OES) of its products, it could see 30% revenue growth in the next two years. In the replacement market, it commands higher margins.

Fig 8 - Demand drivers in place


The company has a healthy market share in all segments it operates in. The market size of the ride-control-equipment segment is `23.5bn, of which Gabriel’s market share is 29.7%. It has the lion’s share of 84% in the commercial-vehicle (CV) segment and 44% in the passenger-car segment. Even in the two- and three-wheeler segments, it has an 18% market share, despite not supplying to Hero Honda, the market leader. (Munjal Showa is Hero Honda’s sole supplier.)

“Gabriel” is the most recognized shock-absorber brand



Fig 11 – Passenger-car segment: market share (FY10)

Gabriel, 44%

Showa, 13%

Tenneco, 19%

Others, 24%

Source: Company

Further, with fresh orders from CV OEMs Mahindra Navistar, Tata Motors, Ashok Leyland and Daimler Commercial Vehicles, Gabriel has secured good business. Also, it is bidding for new products from passenger-car manufacturers Tata Motors and Maruti Suzuki. Gabriel expects 25-30% growth in the next two years, mainly through volumes. It has already secured new business for FY11 worth `1.97bn, and `3.16bn for FY12.

Fig 12 – Secured business Revenue (`m)

Segment FY11e FY12e

Two-wheelers 1,121 1,720

Passenger cars 438 739

Commercial vehicles 316 549

Exports 99 153

Total 1,973 3,161

Source: Company

Fig 9 – Commercial-vehicle segment: market share (FY10)

Gabriel, 84%

Showa, 0%

Endurance, 1%

Tenneco, 8%

Others, 7%

Source: Company

Fig 10 – Two-wheeler segment: market share (FY10)

Gabriel, 18%

Showa, 55%

Endurance, 17%

Tenneco, 3%

Others, 7%

Source: Company



Strategic plant location; timely delivery Gabriel’s plants are strategically located, in proximity to OEMs, resulting in timely delivery to clients at lower costs.

Gabriel has established strong relationships with major OEMs Maruti Suzuki, Ashok Leyland, Tata Motors, TVS Motors, Yamaha, Bajaj Auto and M&M. Diverse clients in various segments mitigates the impact of a slowdown in one segment or a single client.

Fig 13 – Key OEM customers (percentage of FY10 revenue)

Maruti Suzuki, 16%

TVS motors, 18%Yamaha, 11%

Bajaj Auto, 11%

SMIL, 5%

M & M, 4%

TATA motors ltd, 10%

HMSI, 1%

Source: Company

Gabriel’s plants are strategically located in proximity to marquee clients, thereby achieving timely delivery at lower transportation costs. Its largest plant, at Hasur (Tamil Nadu), supplies suspension products to OEMs Suzuki, Yamaha and TVS Motors. The plant at Nashik supplies front forks and shock absorbers to Bajaj Auto and Yamaha. Maruti’s plant at Mansesar is being supplied shock absorbers by Gabriel’s Khandsa plant; similarly, Tata Motors, Bajaj Auto, Renault, Volkswagen and the Indian Railways are being served struts and shock absorbers from its Chakan plant at Pune.

Fig 14 – Plant location pieces (m)

Location (client) Capacity(FY10)

Production(FY10)

Khandsa (PC: Maruti Suzuki) 2.4 1.56

Nashik (Bajaj, M&M, Piaggio, Yamaha) 3 2.58

Chakan (PC: Tata Motors, Hyundai, Renault, GM, Ford, Maruti, and Volkswagen) 3.6 2.17

Parwanoo (TVS, Tata Motors, M&M and after-sales market) 5.18 1.98

Dewas (CV: Tata Motors, Eicher, Ashok Leyland, Force Motors, Nano, exports and after-sales market)

4 2.44

Hosur (TVS, Suzuki, HMSI, Yamaha) 4.68 3.83

Sanand, (Tata Nano)

Source: Company



Consistently superior margins to Munjal Showa

On account of its diversified clientele, Gabriel has always enjoyed superior margins to Munjal Showa, which obtains 70% of its revenue from Hero Honda.

Fig 15 – Competitive margin profile

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Adding capacities The boom in the automobile industry has resulted in the company planning investment of `1.5bn-2bn in the next 3-4 years to enhance capacities to cater to the rising demand.

Gabriel plans to leverage its strong brand by increasing its focus on exports. It built units to further strengthen its product range. It is the second-largest manufacturer of shock absorbers (dominated by Munjal Showa, which is the chief supplier to Hero Honda) and commands a 30% share of the organized set-up. It has seen an 11-12% annual growth for the past five years, largely driven by volumes. It aims at a consistent 25% annual growth for the next three years, chiefly via increased domestic volumes and improved exports.

In the past three years, Gabriel has added three plants (Parwanoo, Khandsa and Sanand); this expansion in shock-absorber capacity has driven growth (ytd FY11 revenue up 35% yoy).

The boom in the automobile industry has resulted in Gabriel planning investment of `1.5bn-2bn for the next 3-4 years to enhance capacities to cater to the booming demand.

A just-in-time approach is vital to contain freight costs, critical in the auto sector. To tap the vast and mounting demand from OEMs, the company has strategically set up its plants in proximity to its clients.

New factory to come up in Gurgaon; expansion at Hosur

The company is setting up a factory at Gurgaon to cater to the swelling demand from Maruti there. Utilization at Gabriel’s present plants is ~90%. To capitalise on expected growth, the company plans to expand capacity at both plants (Gurgaon and Hosur). It aims to increase capacity at all its plants by 15% every year for the next three years.

Gabriel plans to invest `1.5bn-2bn in the next 3-4 years on expanding capacity and R&D. The growth in the industry would entail new plant launches and capacity expansions. Current capacity utilization being significantly high, in line with the high market demand, the company aims at increasing annual capacity by 45% in the next three years to meet the increasing demand from automakers. It is looking to set up a new plant in the Gurgaon region for one of its biggest customers, Maruti Suzuki. Also, it plans expanding capacity at its Hosur plant, which is a supplier to two-wheeler companies. Of the investment, `0.4bn-0.5bn has been earmarked for R&D, while the bulk is for fresh capacity additions. In FY11, the company invested `0.6bn-0.7bn. The expansion would be funded through both internal accruals and debt.

Increasing focus on exports and after-market sales

Ahead, Gabriel is looking to increase its global footprint and increase focus on exports. In the next two years, we estimate the share of exports-to-sales to increase to 5% in FY13e from 2% at present. In the exports market, Gabriel supplies to the OEM and replacement segments. It supplies to Renault in Iran as well as to North America and an OEM motorcycle manufacturer in Bangladesh. Also, the company supplies replacement

Expansion in shock absorbers to drive growth.

Full impact of enhanced capacity would be seen in FY13

Auto industry to drive demand



equipment (shock absorbers) to most Indian vehicles exported.

Fig 16 – Growth in share of exports

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Financials Robust demand from the auto sector coupled with Gabriel’s capacity expansion to cater to this demand offer assurance of revenue for the next two years. We expect the company to see CAGRs of 26% in revenue and 42% in net profit over FY11-13e. We believe volumes would increase, with slightly better margins.

26% revenue CAGR over FY11-13e

Following expansion in its shock-absorber capacity on escalating demand, we expect Gabriel to register a robust revenue performance. We expect a 26% revenue CAGR over FY11-13e. We believe the share of exports as well as that of the after-sales market would increase in the next two years.


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We expect an FY11-13e EBITDA margin at a strong 8.2-8.5%, owing to healthy margins in new orders and revenue increases in the replacement and exports segments.


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We expect a 26% CAGR in revenue from FY11 to FY13e

We expect EBITDA margins at a strong 8.2-8.5% over FY11-13e



42% CAGR in net profit over FY11-13e

We expect Gabriel to post a 42% CAGR in net profit over FY11-13e. This growth would be reflected in expanded return ratios. We expect RoE to rise to 24.1% (from 16.3%) and RoCE to 23.1% (from 15.4%) over FY11-13e.


The FY10 net debt-to-equity holds at a manageable 0.8x and falls within the industry range of 0.2x to 2x. We expect it to gradually slip to ~0.6x in FY13e. Working capital days are also lower than peers (70-120). Over FY12-13e, this is expected to further fall below FY10 levels.


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15

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25

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FY10

FY11

e

FY12

e

FY13

e

RoE RoCE

(%)


We expect Gabriel to post a 42% CAGR in net profit over

FY11-13e



Fig 23 - Income statement (`m) Year end 31 March FY09 FY10 FY11e FY12e FY13e Gross sales 5,882 7,580 10,093 13,271 16,412-Excise duty 615 549 593 1,050 1,300Net sales 5,267 7,031 9,500 12,221 15,112-COGS 4,522 5,865 8,179 10,311 12,624Gross profit 745 1,166 1,321 1,910 2,488-Operating costs 456 520 599 904 1,209Operating profit 290 647 722 1,006 1,279+Other recurring income 107 68 7 7 8EBITDA 396 714 729 1,013 1,287-Depreciation/Amortisation 153 202 216 251 281EBIT 244 512 513 762 1,005-Interest expense 171 160 127 197 219PBT 72 352 386 566 787-Tax 16 112 104 158 220PAT 56 240 282 407 566+Share of profits in associates 0 0 0 0 0-Minority interests 0 0 0 0 0 PAT 56 240 282 407 566+Extra-ordinary income/(expense) 0 0 0 0 0Net profit 56 240 282 407 566-Preference dividend 0 0 0 0 0-Dividend paid 50 61 73 88 105-Dividend tax 9 10 12 15 18Transferred to reserves -3 169 196 304 443


Fig 24 - Balance Sheet (`m) Year end 31 March FY09 FY10 FY11e FY12e FY13e Equity 72 72 72 72 72 Reserves 1,252 1,421 1,617 1,921 2,364 Deferred tax liability 106 141 141 141 141 Networth 1,430 1,633 1,829 2,134 2,577 Working capital loans 501 641 - - -Long term debt 1,068 847 1,688 1,888 2,088 Total debt 1,569 1,488 1,688 1,888 2,088 Capital employed 2,999 3,122 3,518 4,022 4,665 Gross block 3,062 3,358 3,858 4,358 4,858 -Accumulated depreciation 1,315 1,514 1,730 1,981 2,262 Net block 1,747 1,844 2,127 2,377 2,596 +CWIP 149 121 - - -Fixed assets 1,896 1,965 2,127 2,377 2,596 Strategic investments 133 133 133 133 133 Financial investments 0 0 - - -Investments 133 133 133 133 133 Debtors 823 773 1,039 1,339 1,658 Inventory 672 800 1,075 1,385 1,715 Loans & advances 605 633 633 633 633 -Creditors 1,048 1,052 1,414 1,823 2,257 -Provisions 121 122 122 122 122 -Other curent liabilities 53 142 142 142 142 Working capital 878 889 1,068 1,270 1,485 +Cash & cash equivalents 91 134 189 242 451 Net current assets 969 1,023 1,257 1,512 1,936 Capital deployed 2,999 3,122 3,518 4,022 4,665





PAT 56 240 282 407 566

+Depreciation 153 202 216 251 281

+Deferred tax 2 35 - - -

Cash profit 211 477 498 658 848

-Increase/(Decrease) in WC (156) 11 179 202 215


-Capex 456 271 379 500 500

Free cash flow (89) 196 (59) (44) 133

-Dividend 59 71 86 103 123

+Equity raised - (0) - - -

+Debt raised 108 (81) 200 200 200


-Investments (10) - 0 - -

-Miscellaneous items - - - - -

Net cash flow (31) 43 55 53 209

+Opening cash 122 91 134 189 242

Closing cash 91 134 189 242 451


Fig 26 - Ratio analysis @ `42 Year end 31 March FY09 FY10 FY11e FY12e FY13e

Basic (`)


Cash EPS 2.9 6.2 6.9 9.2 11.8

EPS Growth (%) (26.7) 329.1 17.2 44.6 39.1


DPS 0.7 0.9 1.0 1.2 1.5

Valuation (x)

P/E 54.2 12.6 10.8 7.5 5.4

Cash P/E 14.6 6.9 6.1 4.6 3.6

EV/EBITDA 9.0 5.0 4.9 3.5 2.8

EV/Sales 0.7 0.5 0.4 0.3 0.2


Dividend Yield (%) 1.7 2.0 2.4 2.9 3.5


RoE 3.9 15.7 16.3 20.6 24.1

RoCE 8.3 16.7 15.4 20.2 23.1

Turnover Ratios

Debtors (Days) 53.6 41.4 34.8 35.5 36.2

Inventory (Days) 38.8 38.2 36.0 36.7 37.4

Creditors (Days) 58.4 54.5 47.4 48.3 49.3


Asset Turnover (x) 0.8 0.6 0.5 0.5 0.4

Leverage Ratio

Debt/Equity (x) 1.1 0.9 0.9 0.9 0.8




Company Background & Management Gabriel India is one of the leaders in shock absorbers, struts and front forks (ride-control products) in India. Operating in all sub-segments of automobiles: commercial vehicles, two- and three-wheelers, passenger cars and utility vehicles All its six plants are strategically located, in proximity to OEM units, thereby leading to just-in-time delivery of products and spares. To benefit from the present robust automobile volumes, the company has expanded capacities of its products.

Brief history and business

Established in 1961, the flagship company of the Anand Group and the market leader in the four-wheeler shock-absorber sub-segment, Gabriel India has six plants manufacturing over 20m shock absorbers, struts and front forks. It caters to the booming auto industry (two-, three- and four-wheelers) as well as to the Indian Railways. Shock absorbers and struts constitute the bulk of its sales. Over FY06-10, Gabriel saw CAGRs of 9% in revenue and 28% in net profit. The promoters have raised their stake by 10% through acquiring, in two tranches, Gabriel International’s stake.

Fig 27 – Key management Key Person Designation Background

Prakash Kulkarni Executive Chairman Mechanical engineer; 37 years’ experience in operations and project management. Was MD, Thermax; director, Sulzer India and Praj Industries

Arvind Walia Managing Director CA, 30 years’ experience in finance, tax, operations, legal matters and project management. Has been associated with Gabriel since 2006. Also associated with Anfilco, Anchemco and Henkel Teroson India.

Deepak Chopra Director Member, ICAI, and The Institute of Company Secretaries of India, New Delhi. Elevated as Anand Group CEO. Has been associated with the company since 2008. Specializes in finance and serves as director in many companies.

Russi Jal Taraporewala

Independent Director An eminent economist. Has been associated with Gabriel since 1962. 48 years’ experience in economics, finance, management. Also serves as chairman of the Investor Grievance Committee of Gabriel and Stanrose Mafatlal Investments & Finance and the Remuneration Committee of Standard Industries.

Padmini Khare Kaicker

Independent Director She is a CA and a Certified Public Accountant from USA. She is a partner in M/s B. K. Khare & Co., a reputed CA firm in Mumbai. She has 17 years of rich experience in Auditing, Company Law and Taxation. She has also served as a Chairperson of the Audit Committee of IndusInd Bank. She is associated with GIL since 2005 and is the Chairman of the Audit Committee of Gabriel India Limited.

Rajeev Vasudeva Independent Director CA with MBA and LLB degrees. Specializes in recruitment and assessment of CEOs, COOs and critical leadership talent in the technology and private equity sectors. Has been associated with Gabriel since 2008.

Gurdeep Singh Independent Director B.Tech, Chemical Engineering, IIT, Delhi. Has been associated with Unilever for over 38 years holding key positions. Specializes in project implementation, HR & industrial relations, business development and technical support. Has been associated with the company since 2009. Serves as director of Blue Star, Halonix, Tecnova India Pvt. Ltd., Everest Kanto Cylinders and Gateway Rail Freight.

Source: Company, as of Dec ’10



Fig 28 – Shareholding pattern

Promoter, 54.6%

Public, 31.1%

Foreign holding, 5.9%

Indian Institutions, 0.6%

other corporate bodies, 7.8%

Source: Company, as of December ’10


India I Equities

Key financials

Year Ending 31 Mar FY09 FY10 FY11e FY12e FY13e

Sales (`m) 11,633 12,326 16,853 19,030 20,443 Net profit (`m) (648) 1,227 1,161 1,541 1,764 EPS (`) (24) 43 34 45 51 Growth (%) - - (22.4) 32.7 14.5 PE (x) - 3.1 4.0 3.0 2.6 PBV (x) 1.7 1.2 0.8 0.7 0.6 RoE (%) (28.4) 45.2 26.7 25.2 23.3 RoCE (%) (6.0) 19.9 14.9 16.8 17.3 Dividend yield (%) - 3.7 3.7 3.7 3.7 Net gearing (%) 191.8 161.0 74.7 47.0 21.6


Chemicals

Update

22 February 2011

Phillips Carbon Black

Powering ahead; maintain Buy

We maintain a Buy on Phillips Carbon Black, with a revised target of `246 (from `261). We are upbeat about the company, given its healthy volume growth and improving high-margin power division. We expect a 23% net profit CAGR over FY11-13e.

Benefiting from rising demand. Demand for tyres would continue rising, in line with the buoyant auto industry. Hence, PCB is likely to benefit from economies of scale. To sustain its leadership and benefit from mounting demand, both domestically and globally, PCB is further expanding capacity.

Capacity expansion to fuel volume growth. PCB’s 360,000tpa expanded capacity now runs at 90% utilization. Another 50,000tpa would be operational by end-1QFY12. Given rising demand, we see the capex as suitably timed.

Power – reduces commodity risk. PCB generates 60.5MW, of which 10.5MW is utilized internally, the rest sold at ~`3/unit. It plans to set up two more plants of 16MW (total) by 2QFY12. We expect this to boost earnings, given the division’s high margin, of up to 80%. Further, PCB plans to tie up some of its spare power capacity through PPAs.

Valuation and risks. At our target of `246, the stock trades at FY12e PE of 5.6x and EV/EBITDA of 4x. We value PCB at FY12e P/BV of 1.25x. Key risks: Volatility in key raw material prices and capacity under-utilization.


Key data PHCB IN/PHIL.BO

52-week high/low `242/ `113Sensex/Nifty 18212 / 54593-m average volume US$0.3m Market cap `4.4bn/US$97mShares outstanding 33.2mFree float 54.2%Promoters 45.8%Foreign Institutions 15.4%Domestic Institutions 25.3%Public 13.5%


PHCB

Sensex

100120140160180200220240260

Feb-

10

Apr-1

0

Jun-

10

Aug-

10

Oct

-10

Dec

-10

Feb-

11

Source: Bloomberg


22 February 2011 Phillips Carbon Black – Powering ahead; maintain Buy



Year end 31 Mar FY09 FY10 FY11e FY12e FY13e

Net sales 11,633 12,326 16,853 19,030 20,443 Sales growth (%) 13 6 37 13 7 - Op. expenses 12,279 10,447 14,669 16,359 17,506 EBITDA (646) 1,879 2,184 2,671 2,937 EBITDA growth (%) - - 16 22 10 EBITDA margins (%) (6) 15 13 14 14 - Interest 294 289 333 294 243- Depreciation 196 312 411 448 491 + Other income 163 28 108 98 118 - Tax (325) 79 387 487 557 PAT (648) 1,227 1,161 1,541 1,764 PAT growth (%) - - (5) 33 14 FDEPS (`/share) (24) 43 34 45 51 CEPS (`/share) (28) 52 41 53 60 DPS (`/share) - 5 5 5 5 Source: Company, Anand Rathi Research

Fig 2 – Balance sheet (`m) Year end 31 Mar FY09 FY10 FY11e FY12e FY13eShare capital 283 283 345 345 345 Reserves & surplus 1,899 2,962 5,096 6,435 7,998 Shareholders’ fund 2,182 3,244 5,441 6,780 8,343 Debt 4256 5555 4755 4055 3355Deferred Tax/ others 10 96 96 96 96 Capital employed 6,447 8,895 10,291 10,931 11,794 Fixed assets 6,107 6,855 6,971 7,323 7,332 Investments 378 378 378 378 378 Working capital (109) 1,332 2,255 2,361 2,535 Cash 71 330 688 869 1,550 Capital deployed 6,447 8,895 10,291 10,931 11,794 No. of shares (m) 28.3 28.3 34.5 34.5 34.5 Net Debt/Equity (%) 191.8 161.0 74.7 47.0 21.6 W C turn (days) 21.7 18.1 38.8 44.3 43.7 Source: Company, Anand Rathi Research

Fig 3 – Cash flow statement (`m) Year end 31 Mar FY09 FY10 FY11e FY12e FY13eReported PAT (648) 1,227 1,161 1,541 1,764 + Depreciation 196 312 411 448 491 Cash profit (452) 1,538 1,572 1,989 2,255 - (Incr)/Decr in WC 1,793 (1,092) (923) (106) (127)Operating cash flow 1,341 446 649 1,883 2,128 - Capex 2424 939 527 800 500Free cash flow (1,083) (493) 122 1083 1628- Dividend 117.2 0.4 201.6 201.6 201.6+ Equity raised 402 - 1,237 - -+ Debt raised 1,327 1,311 (800) (700) (700)- Investments 14 (69) 0 - -- Misc. items (1,377) 922 (0) - (45)Net cash flow (99) 437 358 181 681 + Opening cash 151 71 330 688 869 Closing cash 71 330 688 869 1,550 Source: Company, Anand Rathi Research

Fig 4 – EV/sales Band

PCB

0.4x

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(`m)



PCB

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Fig 6 – PCBL vs. Auto index

PHCB

BSE Auto

100

120

140

160

180

200

220

240

260

280

300

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10

Apr-1

0

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Source: Bloomberg



Investment Argument and Valuation We maintain our Buy recommendation on Phillips Carbon Black, the leader in carbon black production. We revise our target price to `246 and re-iterate our bullish stance, given the company’s capacity expansion and growing high-margin power division. We estimate PCB to register a 23% net profit CAGR over FY11-13e.

Benefiting from mounting demand

In step with the buoyant demand for automobiles, demand for tyres is set to continue rising. Economies of scale would allow PCB to benefit from the upswing in the tyre sector. To retain its dominance in carbon black production and to benefit from rising demand globally and domestically, PCB is further expanding capacity.

Fig 7 – Domestic ranking (FY10) Players Capacity '000 tons Production '000 tons Production share % Exports '000 tons

PCBL 360 258.4 42 41

Hi-Tech 230 233.4 38 43

Continental 65 55 9 0

Himadri Chemicals 50 26 4 -

Cabot 52 44 7 0

Total 757.0 617.2 100.0 84

Source: Industry, Company, Anand Rathi Research Note: The Himadri plant commenced in the Jul ’09 quarter

Capacity expansion to fuel volume growth

PCB’s 360,000-tpa carbon black capacity is running at 90%, and another 50,000tpa would be operational by FY12. Given the buoyant demand, the capacity expansion is suitably timed.

Fig 8 – PCBL: Production and utilization trend

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY13e

71

75

79

83

87

91

95

Capacity Production Utilisation (RHS)

(%)(MT)


Power – reduces commodity risks

Utilizing waste heat, PCB generates 60.5MW, of which 10.5MW is used internally and the rest sold to exchanges/traders at ~`3/unit. It plans to set up two more power plants by 2QFY12, of total capacity of 16MW. Given that the division generates margins as high as 80% (with negligible costs), we expect such expansion to be earnings-accretive.

Being the market leader, PCB enjoys economies of scale

PCB plans to set up two more power plants of 16MW (total) by

2QFY12



Change in Estimates and Valuation

On interaction with the management, we have trimmed our EBITDA estimates for FY11 and FY12 by 3.5% and 5.7% respectively, to factor in the increase in costs. We have also reduced our power tariff (`3.2/unit in FY11 and `3.5 from FY12). We lower our target price to `246 from `261 earlier.

Fig 9 – Change in estimates (`m) FY11e FY12e

Previous Revised % Chg Previous Revised % ChgNet Sales 16,933 16,853 (0.5) 18,312 19,030 3.9 EBITDA 2,264 2,184 (3.5) 2,832 2,671 (5.7)EBITDA Margins (%) 13.4 13.0 (41.0)bp 15 14 (143)bpDepreciation 411 411 - 448 448 -Interest 333 333 - 294 294 -Other income 108 108 (0.0) 98 98 (0.0)Tax 407 387 (4.9) 525 487 (7.4)PAT 1,221 1,161 (4.9) 1,663 1,541 (7.4)FDEPS (`) 35 34 (4.9) 48 45 (7.4)


During 9MFY11, PCB’s domestic volumes grew 12.7%. At our target of `246, the stock would trade at FY12e PE of 5.6x and EV/EBITDA of 4x. We value PCB at target multiple of 1.25x one-year-forward P/BV, in line with the past four-year average.

At the current market price of `134, the stock trades at FY11e and FY12e PE of 4x and 3x and an EV/EBITDA of 3.5x and 2.9x respectively.

Fig 10 – Twelve-month forward P/BV: Mean and standard deviations

Mean

+1SD

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Risks

Volatility in key raw material prices. PCB imports most of its key raw material (carbon black feed-stock, CBFS) requirement. Prices of CBFS strongly co-relate with those of crude. Though a pricing mechanism is in place, any sharp increase in CBFS would affect PCB’s margin if not passed on to end-customers.

Capacity utilization. PCB’s greenfield 90,000tpa plant at Mundra has commenced production. If unable to optimally utilize capacity, profitability would be substantially affected.

Forex fluctuation. PCB imports ~90% of its raw material; hence, any depreciation in exchange rates may squeeze margins.



To benefit from strong industry outlook In step with the buoyant demand for automobiles, demand for tyres is set to continue rising. Its economies of scale would allow PCB to benefit from the upswing in the tyre sector. To retain its dominance in carbon black production and benefit from rising demand globally and domestically, the company is further expanding capacity.

Through FY04-08, the domestic carbon black sector saw a 5% CAGR in capacities added. Yet by FY07, the industry was flooded with excess demand; hence, major players planned capacity expansions. Over FY09-12, capacity additions are expected at ~10.8%. Of all domestic players, only PCB has planned expansions, 50,000tpa at Mundra, to commence in 3-4 months.

On the other hand, in Jun’10, Cabot India closed its 50,000tpa Thane plant. Setting up a carbon black plant involves a gestation period of 18-24 months. Hence, overall effective capacity addition in the next two years would be only 85,000tpa.

The domestic automobile industry is expected to post a 13.7% volume CAGR over FY11-13e following the 25% growth in FY10 and FY11. Based on this, we estimate the carbon black sector to again see 90% capacity utilization by FY13. Further, the domestic carbon black sector would export the surplus to neighboring countries, at a 26% CAGR over FY10-12e. Growth in carbon black production has followed the trend in tyres and automobiles.

Rise in tyre offtake to propel carbon-black growth

The buoyant domestic automobile sector has triggered off capex programs, both greenfield and brownfield, in the tyre sector (the principal consumer of carbon black). Most tyre companies are expected to commence production at their greenfield units in the next three years. Planned capex by tyre companies is `110bn-120bn. Further, expansions in the Asia-Pacific region would trigger demand for carbon black, both in the OEM and replacement markets.

PCB’s fortunes are directly linked to growth in the auto sector

domestically. Automobiles have seen a quick recovery in demand. We expect a 13.7% CAGR in auto

sales in the next two years

Carbon black is ~25% (by weight) and 16% (by value) of the raw

materials used in manufacturing automobile tyres



Capacity expansion likely to fuel volume growth PCB, the domestic market leader in carbon black, would be a key beneficiary of the revival in tyre sales in India. Its 360,000tpa carbon black capacity is running at 90%. The Mundra plant is being expanded by 50,000 tons, scheduled to be operational by end-1QFY12. Given the better demand scenario, this capacity addition is opportune. We expect PCB’s carbon black sales volumes to grow 25.4% in FY11 and another 9% in FY12. We believe the expansion would further strengthen its dominance.

Fig 11 – Quarterly carbon-black volumes

60 6063 63

6063 65

62 6158

4448

6158

6769

75 75

81

30

40

50

60

70

80

90

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3

FY07 FY08 FY09 FY10 FY11

('000 tons)

Improving trend

Source: Company

Expansion boosts volumes; focus on gaining strong global foothold

We expect an 8-9% demand CAGR over FY11-13 in the domestic carbon black sector, based on demand increasing in OEM and replacement markets. To address this, PCB embarked on aggressive capacity expansion. In Oct ’09, it commissioned phase-1 of its 90,000-tpa greenfield Mundra plant, boosting carbon-black capacity to 360,000tpa. It is further expanding capacity at Mundra by 50,000 tons, to be commissioned by end-1QFY12.

The capacity addition would enhance economies of scale and bolster sales (by volume) by 25.4% in FY11e and a further 9% in FY12e. Moreover, with carbon black plants shifting from developed to developing countries, the export potential has substantially risen. On expansion, PCB would be able to fortify its global footprint by leveraging its established brand and leading position vs. earlier being largely restricted to its home market.

Revenue from the expansions would start flowing in from FY12. PCB has already incurred capex of `1.8bn on phase-1 of the Mundra capacity augmentation; the next 50,000 tons would entail `750m-800m, funded by debt-equity of 2:1.

Capacity addition at Mundra to boost export volume

PCB’s new 90,000-tpa carbon black plant, which commenced in FY10, has arrested the volume decline in carbon black exports, which was due to rising domestic demand and capacity constraints. With the Mundra capacity addition, we expect exports to rise to 22% (as percent of sales) in FY11e and ~31% in FY12e (from 16% in FY10).

PCB’s 50,000-ton expansion at Mundra is likely to be

commissioned by end 1QFY12and would raise plant capacity to

410,000 tons



Fig 12 – Exports (as percent of volumes)

Export Volumes

14

18

22

26

30

34

38

FY07

FY08

FY09

FY10

FY11

e

FY12

e

FY13

e

Export Volumes

(%)


Carbon black exports (by volume) have improved manifold (Fig 22). In 1HFY10, exports were only 10,200 tons. On the commissioning of the Mundra plant in 2HFY10, exports more than tripled to 30,947 tons and have shown a positive trend after four consecutive quarters of volume declines. Now, quarterly exports have moved to the 17-18,000tpa range.

Fig 13 – Pick-up in exports on commissioning of Mundra plant

16

23

16 1715

17

14 15

12

10

5 5

16 15

19

14

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0

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15

20

25

Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3

FY07 FY08 FY09 FY10 FY11

('000 tons)

Source: Company

Fig 14 – Proposed carbon-black capacity expansion Current capacity

Location Carbon Black (tons/annum) Commencement

Durgapur 140,000

Baroda 90,000

Kochi 40,000

Mundra 90,000

Total 360,000

Expansion

Mundra 50,000 June’11

Domestic capacity after expansions 410,000

Vietnam International (phase-1) 55,000 (not factored in calculations)


Exports show a positive trend after four consecutive quarters of volume

declines



Power – reduces commodity risk PCB generates 60.5MW (via waste-heat recovery), of which 10.5MW is utilized in house with the rest sold to exchanges at ~`3/unit. It plans to set up two more plants of 16MW (total) by 2QFY12. We expect such expansions to be earnings-accretive, given that the division generates margins as high as 80%.

PCB has considerably reduced power costs by converting waste gases released during carbon-black production into steam (used as fuel) against releasing/flaring such hazardous gases. Its power generation capacity is now 60.5MW. Of this, 10.5MW is utilized in-house and the rest sold to exchanges. Production cost for PCB is only `0.3/unit (mainly for O&M; no raw material costs).

It plans to set up two more power plants: 6MW at Mundra (to be operational by 2QFY12) and 10MW at Kochi (to be operational from 1QFY12). The expansions would boost capacity to 74MW. Of this, it is likely to sell 53MW and 58MW in FY12 and FY13 at ~`3.5/unit respectively.

PCB’s further forward integration into power would expand its margins, mainly from revenue in power percolating to the net profit, leading to a ~80% EBIT margin, given that there are no raw material costs. Hence, besides stabilizing earnings, the sale of power would shore up margins.

Not merely into commodities; Power to drive profitability, reduce volatility

PCB is no more only a carbon-black (commodities) story. It is also a play on Power, which would drive profitability. Over the years, it has improved its performance. Price volatility in CBFS as well as slow off-take of carbon black (with the auto sector slowing down, compounded by global dumping of carbon black in India) hit earnings in 2HFY09.

Hence, it has prudently shifted focus to power. With additional power capacity coming up, its earnings potential has improved as the share of power in EBIT is likely to rise, from 27% in FY10 to 36% in FY12e. During 2QFY11 and 3QFY11, its revenue from power declined as realizations from exchanges were low, at `2.5/unit. In 4QFY11, though, we expect it to be `3/unit and, from FY12, we expect realizations to improve further to `3.5/unit as the company is looking at entering into a short-term PPA.

PCB is setting up two more power plants:6MW at Mundra (to be operational by 2QFY12) and

10MW at Kochi (to be operational from 1QFY12), taking its power

capacity to 74MW



Financials PCB’s capacity expansion in carbon black coupled with rising demand offers assurance of decent revenue in the next two years. We expect it to register revenue and net profit CAGRs of 10% and 23% over FY11-13e.

Revenue CAGR of 10% over FY11-13e

With the carbon black capacity expansions and rising demand from the auto industry, we expect robust revenue growth in PCB, underpinned chiefly by 7% volume CAGR through FY11-13e to 366,536 tons. The utilization level is likely to improve to 90% in FY13e from an estimated 72% in FY10. We expect a 10% revenue CAGR over FY11-13e. We believe the revenue mix would be tilted towards carbon black, but in the next two years the share from Power could inch up to 7-8% of sales.


6,000

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Revenue Revenue growth (RHS)

(Rsm) (%)


Revenue from the high-margin power segment is set to grow exponentially, from `545m in FY10 to ~`1.4bn in FY13e as operations at Kochi and Mundra gather steam.

We expect a 10% revenue CAGR over FY11-13e

Fig 16 – Revenue breakup (FY10)

Power4%

Carbon black96%


Fig 17 – PBIT breakup (FY10)

Power27%

Carbon black73%




Stable margins

With the contribution from Power, we expect a healthy EBITDA margin of 14% over FY12-13e.


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(Rsm) (%)


Net profit CAGR of 23% expected over FY11-13e

We expect PCB to report a 23% net profit CAGR over FY11-13e. Growth in net profit would be reflected in healthy return ratios. From negative return ratios in FY09, we expect the RoE in FY13 at a healthy 23.3%, with RoCE at 17.3%.


The high FY10 net debt-to-equity of 1.7x would fall to 0.9x in FY11. We expect the ratio to gradually slip to ~0.6x in FY12. As most of the capacity expansion is complete and funds for future expansion tied up, we expect debt to fall.

We expect the EBITDA margin over FY12-13e to be 14%

We expect PCB to report a 23% net profit CAGR over

FY11-13e


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RoE RoCE

(%)





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(Days)


Fig 22 – Debt and net-debt-to-equity

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Debt debt - to- equity ratio (RHS)

(Rsm)




Fig 23 – Income statement (`m) Year end 31 March FY09 FY10 FY11e FY12e FY13e

Gross sales 12,875.9 13,380.7 18,631.4 21,009.8 22,557.6-Excise duty 1,243.1 1,118.0 1,778.1 1,980.0 2,114.8Net sales 11,632.8 12,325.7 16,853.3 19,029.9 20,442.9-COGS 10,116.8 9,058.9 11,891.4 13,251.6 14,177.1Gross profit 1,516.0 3,266.8 4,961.9 5,778.2 6,265.7-Operating costs 2,051.0 1,388.3 2,777.8 3,107.4 3,328.9Operating profit -534.9 1,878.5 2,184.1 2,670.8 2,936.9+Other recurring income 51.9 28.2 108.4 98.4 118.1-Depreciation/Amortisation 196.4 311.5 411.1 447.9 490.6-Interest expense 293.6 289.4 332.8 294.0 243.2PBT -973.0 1,305.8 1,548.6 2,027.4 2,321.1-Tax -324.6 78.9 387.1 486.6 557.1PAT -648.4 1,226.9 1,161.4 1,540.8 1,764.1+Share of profits in associates 0.0 0.0 0.0 0.0 0.0-Minority interests 0.0 0.0 0.0 0.0 0.0 PAT -648.4 1,226.9 1,161.4 1,540.8 1,764.1+Extra-ordinary income/(expense) 0.0 0.0 0.0 0.0 0.0Net profit -648.4 1,226.9 1,161.4 1,540.8 1,764.1-Preference dividend 0.0 0.0 0.0 0.0 0.0-Dividend paid 0.0 141.3 172.3 172.3 172.3-Dividend tax 0.0 23.5 29.3 29.3 29.3Transferred to reserves -648.4 1,062.2 959.8 1,339.2 1,562.5


Fig 24 – Balance Sheet (`m) Year end 31 March FY09 FY10 FY11e FY12e FY13e Equity 283 283 345 345 345 Reserves 1,900 2,962 5,096 6,435 7,998 Deferred tax liability 17 96 96 96 96 -Miscellaneous expenses 7 - - - -Networth 2,192 3,340 5,536 6,876 8,438 Working capital loans 130 595 595 595 595 Long term debt 4,126 4,959 4,159 3,459 2,759 Preference equity - - - - -Total debt 4,256 5,555 4,755 4,055 3,355 Minority interests - - - - -Capital employed 6,447 8,895 10,291 10,931 11,793 Gross block 4,405 8,279 9,029 9,829 10,829 -Accumulated depreciation 2,125 2,348 2,759 3,206 3,697 Net block 2,280 5,932 6,271 6,623 7,132 +CWIP 3,828 923 700 700 200 Fixed assets 6,107 6,855 6,971 7,323 7,332 Subsidiary - - - - -Strategic investments 375 375 375 375 375 Financial investments 3 3 3 3 3 Investments 378 378 378 378 378 Debtors 1,808 2,950 3,694 3,910 4,201 Inventory 1,210 1,966 2,255 2,364 2,526 Loans & advances 365 1,328 531 626 672 Other current assets 478 166 600 782 840 -Creditors 3,917 4,876 4,570 5,065 5,449 -Provisions - 202 202 202 202 -Other curent liabilities 53 - 53 53 53 Working capital (109) 1,332 2,255 2,361 2,535 +Cash & cash equivalents 71 330 688 869 1,550 Net current assets (38) 1,662 2,943 3,230 4,085 Capital deployed 6,447 8,895 10,291 10,931 11,793





PAT (648) 1,227 1,161 1,541 1,764

+Depreciation 196 312 411 448 491

+Deferred tax (336) 79 - - -

Cash profit (788) 1,617 1,572 1,989 2,255

-Increase/(Decrease) in WC (1,600) 1,441 923 106 173

Operating cash flow 812 176 649 1,883 2,081

-Capex 2,550 1,059 527 800 500

Free cash flow (1,738) (882) 122 1,083 1,581

-Dividend - 165 202 202 202

+Equity raised 402 1 1,236 (0) 0

+Debt raised 1,351 1,299 (800) (700) (700)


-Investments 97 0 (0) - -

-Miscellaneous items (2) (7) - - -

Net cash flow (79) 259 357 181 680

+Opening cash 151 72 331 688 869

Closing cash 72 331 688 869 1,550


Fig 26 – Ratio @`134 Year end 31 March FY09 FY10 FY11e FY12e FY13e

Basic (`)

EPS Fully Diluted (24) 43 34 45 51

Cash EPS (28) 52 41 53 60

EPS Growth (%) - - (22.4) 32.7 14.5

Book Value per Share 77 115 158 197 242

DPS - 5 5 5 5

Valuation (x)

P/E - 3.1 4.0 3.0 2.6

Cash P/E (4.8) 2.6 3.3 2.5 2.2

EV/EBITDA (13.6) 5.2 4.0 2.9 2.2

EV/Sales 0.8 0.8 0.5 0.4 0.3


Dividend Yield (%) - 3.7 3.7 3.7 3.7


RoE (28) 45 27 25 23

RoCE (6) 20 15 17 17

Turnover Ratios

Debtors (Days) 62 70 72 73 72

Inventory (Days) 43 47 46 44 44

Creditors (Days) 130 185 157 143 146

Working Capital (Days) 22 18 39 44 44

Asset Turnover (x) 2.4 1.9 2.4 2.7 2.8

Leverage Ratio

Debt/Equity (x) 1.9 1.7 0.9 0.6 0.4


Appendix 1 Analyst Certification The views expressed in this research report accurately reflect the personal views of the analyst(s) about the subject securities or issuers and no part of the compensation of the research analyst(s) was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst(s) in this report. The research analysts, strategists, or research associates principally responsible for the preparation of Anand Rathi Research have received compensation based upon various factors, including quality of research, investor client feedback, stock picking, competitive factors, firm revenues and overall investment banking revenues.

Anand Rathi Ratings Definitions

Analysts’ ratings and the corresponding expected returns take into account our definitions of Large Caps (>US$1bn) and Mid/Small Caps (<US$1bn) as described in the Ratings Table below.

Ratings Guide Buy Hold Sell Large Caps (>US$1bn) >20% 5-20% <5% Mid/Small Caps (<US$1bn) >30% 10-30% <10%

Anand Rathi Research Ratings Distribution (as of 6 December 10) Buy Hold Sell Anand Rathi Research stock coverage (138) 69% 17% 14% % who are investment banking clients 5% 4% 0% Other Disclosures This report has been issued by Anand Rathi Financial Services Limited (ARFSL), which is regulated by SEBI.

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