DSIJ Mindshare

Auto ancillary: GEARING UP FOR THE BIG RACE

The Indian equity market has been firing on all cylinders for more than one and a half years now. From the lows of August 2013, the bellwether indices have moved up by around 60 per cent till now i.e. March 30, 2015. Nonetheless, there are a few sectors whose share price performance in the same period will dwarf the huge performance of the frontline indices. The automotive ancillary sector is one such that is running at full throttle and has given phenomenal returns in above mentioned period. Although there is no sectoral index that tracks this sector exclusively, a study of some of the major players reveals the average performance of companies engaged in this line of business.

For example, the shares of Bharat Forge, Motherson Sumi Systems, JBM Automotive and Mahindra CIE Automotive have moved up by a massive 524 per cent, 247 per cent, 1,506 per cent and 240 per cent respectively. Such a huge performance in such a short span of time casts a doubt about the future returns from these scrips. In the following paragraphs we will discuss about the factors that led to such extraordinary performance and whether enough juice is left in these scrips for new investors to enter and whether existing investors should hold on to these shares.

The Fundamentals

The Indian automotive ancillary industry is closely linked to the Indian automobile industry which is one of the largest markets of its kind in the world. The demand swing in various automobile segments viz. two-wheelers, passenger vehicles and commercial vehicles directly impacts the automotive ancillary demand. The automotive ancillary industry is driven primarily by demand created by original equipment manufacturers (OEM) and the replacement market. It is estimated that around two-thirds of automotive components’ revenue is derived from the domestic OEM market.

[PAGE BREAK]

India being one of the largest automotive markets across the globe, the secondary or replacement market too has huge potential for automotive ancillaries. Interestingly, the margins for the replacement markets are better compared to the competitive OEM market. However, the OEM supply has bulk volumes over regular intervals that helps create stability for the industry. Hence the expected revival in the Indian automobile industry will definitely boost the automotive ancillary market too.

Further, the country’s export competitiveness too has turned into an advantage for the Indian automotive industry. Previously the Indian automotive ancillary industry was struggling from poor quality of its products. However, technological advancement and quick adoption of automotation across the industry has helped take the production quality to much higher levels. Further, lower labour cost has also worked in favour of the Indian automotive ancillary segment. Traditionally, India has been specialising in exports of forgings, castings and plastics over the years. However, the investment-friendly business environment in India attracted global automotive component players to invest in India. Further, the government’s thrust on ‘Make In India’ campaign will help the industry to produce specialised automotive components along with traditional components in the coming days.

[PAGE BREAK]

According to www.automotiveancillaryshow.com, the automotive component sector clocked a turnover of USD 39.7 billion for 2013, recording a CAGR of 8 per cent during the period of 2008-2013. Further, the automotive ancillary industry is expected to grow to USD 115 billion by 2020, posting a growth of around 15 per cent CAGR that is twice the growth that we witnessed in the last five years (2008-13). The domestic market is expected to contribute up to USD 85 billion while exports will contribute up to USD 30 billion. The automotive component industry contributes a significant chunk of 2.2 per cent to India’s GDP and is expected to extend its contribution to 3.6 per cent by 2020.

Past Sales Scenario

With passenger vehicles registering gains every month, the mood is somewhat good for the Indian automobile industry. In nine out of the past ten months, the passenger vehicle segment has registered growth on a yearly basis. This exhibits good sentiments for the automotive industry which was struggling with high interest rates, wavering customer interest and withdrawal of excise and sales sops. Importantly, on the commercial vehicle front too, the sales growth numbers are turning out to be positive with the last two consecutive months registering notable growth.

This revival in the commercial vehicle segment exhibits positive business sentiments across fleet operators who are expecting a good amount of business coming their way in the near future. However, in the two-wheeler segment the companies were seen struggling to register growth for the last three months after posting double-digit growth during May to September 2014. These companies experienced pressure on volume growth, particularly in the rural market. The recent unexpected rainfall will further create pain in rural India as the unforeseen event is expected to dampen rabbi crop production.

Automotive Volume Growth

Despite volume pressure in the two-wheeler segment, the other two segments have been witnessing good traction and this may translate into a positive growth curve. The newly elected government has placed considerable emphasis on infrastructure development across India with the firm view that infrastructure is the key to economic growth. As such, there are plans to boost the network of roadways in a big way. And given the fact that a vast portion of this network will go through rural India will definitely translate into automotive volume growth. Further, the government has taken constructive steps towards implementation of Good and Service Tax (GST) by 2016. This will eliminate localised storage of goods and increase goods’ movement directly from the point of centralised storage to the point of sales. This will obviously boost the commercial vehicle volume growth in the coming days.

Meanwhile, the recent coal auction by the government was pretty successful and that too is expected to boost demand for commercial vehicles across the coal belt. Predominantly, vehicles in India are purchased through automotive financing. Over the last one year customer interest had been shaky since the interest rate was too high. However, the Reserve Bank of India has already started a big rate cut cycle by reducing policy rates over a couple of instances in 2015. The lower interest rate will definitely boost demand for the automobile industry in the days ahead.

[PAGE BREAK]

Exports and Make In India Campaign

Making the best out of India’s competitiveness in manufacturing, existing and global automobile players are investing in India to manufacture vehicles and export to various markets. The automobile manufacturers present in India have already started to explore and supply to new overseas markets. At present exports constitute about 35 per cent of the industry as against around 20 per cent six years back. The new government’s Make in India campaign will definitely boost automotive component manufacturing activity as the automotive ancillary businesses have an established track record of manufacturing and exporting to overseas markets. Further, the campaign may make India one of the world’s favoured manufacturing hubs for many global players. This will lead to increasing localisation and economies to scale for both domestic and overseas markets and make the automotive ancillary industry more competitive.

Outlook

We are of the opinion that the negatives for the automotive ancillary industry are already over and considerable traction across the industry is its on way. The major hurdle for demand in the automobile industry - the interest rate - has been turning positive for the industry. Also, the price of crude oil seems to be maintaining its lower levels for a quite a long time now. The recent trends in inflation measured by both wholesale price index (WPI) and the consumer price index (CPI) are coming down fast, which will give the central bank leeway to cut interest rate. This will definitely help create a spurt in demand for automobiles. Besides, other factors such as pent up demand, higher income growth, and lower penetration will fuel a higher requirement for automotives in India and in turn automotive ancillaries.

The overall improvement in economy too has begun to have a positive effect on the automobile industry. This has led to automotive component manufacturers riding a new wave of expectations and in fact the rise has been so impressive that many of them are trading at valuations premium to their historical valuations. In fact all the major listed players are trading at their above average historical valuations.

In fact all the major listed players are trading at their above average historical valuations. In our opinion, the valuation multiples may remain at this level as we expect the demand environment to improve from here on. That explains our optimism about this sector and the stocks we have recommended here will outperform the sector and the market.

[PAGE BREAK]

RECOMMENDATIONS

Motherson Sumi Systems Limited

MOTHERSUMI | BSE CODE: 517334 | FACE VALUE: Rs 1 | CMP: Rs 513

Motherson Sumi Systems (MSSL) is a joint venture between Samvardhana Motherson Group and Sumitomo Wiring Systems (Japan). The acquisition of mirror business from Visiocorp (now renamed as Samvardhana Motherson Reflectec) and Peguform (now named Samvardhana Motherson Peguform) has helped MSSL to increase the company’s existing customer connect and do more business with the existing customers. The acquisition has also helped increase its footprint in the European markets.

For the December 2014 quarter, MSSL posted good set of quarterly numbers. The company’s net sales for December 2014 quarter was higher by almost 15 per cent on a yearly basis and 14 per cent on a quarterly basis, predominantly led by growth at SMP and SMR. In Euro terms, the SMR and SMP business segments grew by 13 per cent and 19 per cent respectively during the quarter under review. Further, the EBITDA margins stood at 9.3 per cent during the December 2014 quarter with an expansion of 20 basis points on a sequential basis. Interestingly, EBITDA during the December 2014 quarter showed 11 per cent growth on a yearly basis but showed 17 per cent growth on a sequential basis. The net profit of the company showed a growth of 23 per cent on a yearly basis during the December 2014 quarter.

The Indian automobile industry is expected show good revival in the coming days. Hence, the company is expected to display notable traction with a fuller order book in the future. As the company has excellent rapport with its existing customers, higher business from these customers will yield better margins in the near future. In the past few quarters too the company has posted improvement in its margins and we expect that it will continue to improve its margin in the future also. For the last few quarters, strong revenue growth, improved operational performance and prudent financial management has resulted in the company consistently outperforming the market. As the global and domestic markets are also picking up, we expect the company to keep on delivering an exceptional performance.

[PAGE BREAK]

Sundaram Clayton Limited

SUNCLAYLTD | BSE CODE: 520056 | FACE VALUE: Rs 5 | CMP: Rs 1838

Sundaram Clayton (SCL) is promoted by the USD 5 billion TVS Group, one of the largest automotive components manufacturing and distribution group in India. SCL is a leading supplier of aluminium die castings to the automotive and non-automotive sector. The company’s contribution commences from early design stage to development and supply of finished product. Over the years it has built strategic partnership with global original equipment manufacturers or Tier 1 automotive component companies. With the company’s investments in state-of-the-art technologies, SCL is poised to serve the future needs of the industry in light metal castings.

Recently, Suresh Krishna, who has vast experience in manufacturing, has taken over as the chairman of the TVS Group’s holding company, TV Sundram Iyengar & Sons. He has clearly expressed an intention to focus on manufacturing, distribution and logistics. As a major chunk of the Group’s business comes from trading activity, shifting focus to manufacturing will help it to improve its profitability in the coming days.

Interestingly, the latest balance-sheet of September 2014 showed almost more than 28 per cent reduction of its long-term debt to Rs 69.14 crore from Rs 96.30 crore as of end of March 2014 quarter. This decrease in debt level is expected to increase profitability in the coming days. Further, fall and slow recovery in crude oil prices will help the company to keep low its power and fuel cost for at least the next one year.

SCL derives almost 40 per cent revenue from export business and the rest 60 per cent from the domestic markets. With an improvement in the US’ economy and forced liquidity via financial stimulus in the European economy, the company’s exports revenue seems to possess good visibility over the next 12 months. Further, the company has added a couple of new overseas customers which along with existing customers are expected to give consistent and incremental business to SCL, which holds 57.4 per cent stake in TVS Motors. On the valuation front, the company’s stock is trading at price to earnings ratio of just 18.26x times its current earnings per share (EPS) of Rs 95.88 per equity share. We are of the opinion that the stock will appreciate once recovery in the automobile sector intensifies.

[PAGE BREAK]

Automotive Axles Limited

AUTOAXLES | BSE CODE: 505010 | FACE VALUE: Rs 10 | CMP: Rs 827

Automotive Axles (AAL) is a joint venture of Kalyani Group and Meritor Inc., USA. The company has manufacturing facilities located at Mysore in Karnataka and Pantnagar and Jamshedpur in North India. The company has the reputation of being the largest independent manufacturer of rear drive axle assemblies in India. Over the past 30 years since inception, it has successfully been manufacturing reliable and long-life medium and heavy-duty drive axles, front steer axles, non-drive axles, axles for defense and off-highway applications, and drum and disc brakes. It has now also forayed into manufacturing light-duty drive axles.

The primary customers of AAL are domestic original equipment manufacturers (OEM) which include Ashok Leyland, Tata Motors, Asia Motor Works, Daimler India, Volvo India, SML Isuzu, Volvo Eicher Commercial Vehicles, Vehicle Factory-Jabalpur, BEML, MAN Trucks (P) Ltd., Mahindra Trucks & Buses, CAT, Escorts, TIL and Sonalika. AAL also exports axle parts to USA, France, Italy, China, Brazil and Australia.

Over the years, the company has expanded its manufacturing footprint with a new state-of-the-art plant at Jamshedpur for manufacturing brakes and trailer axles. The plant has 50,000 square feet built-up area and the capacity to make 30,000 brakes and 2,500 tags and trailers per month. As part of Meritor India’s new product development strategy, AAL has installed a facility to manufacture hub reduction axles (HRA) in its Mysore plant. Currently the plant can make 300 sets of HRA per month and this can be extended to 600 sets per month. Further, the company has been implementing improvement projects to help reduce its costs and improve profitability.

AAL has extensive experience of more than 30 years in axle production and also commands technology leadership due to advanced gearing technology know-how acquired from Meritor HVS India. This helps the company to meet the steer, drive and trailer axle requirements of customers satisfactorily. AAL has a large customer base and expects increasing demand in a fast-growing overseas market. Hence it is seen to be in a win-win position to capitalize on the revival expected in the automobile market.

[PAGE BREAK]

Amtek Auto

AMTEKAUTO | BSE CODE: 520077 | FACE VALUE: Rs 2 | CMP: Rs 145

Amtek Auto (Amtek) is one of the largest integrated automotive component manufacturers in India with a strong global presence. The company has world-class facilities in India, Europe and North America. It has a well-diversified business model with the Indian market contributing 57 per cent and international operations contributing 43 per cent to its total revenues. Amtek has significant expertise in machining, forging, iron casting and aluminium casting. Further, the company earns almost 60 per cent revenue from the passenger vehicle segment. The non-auto, commercial vehicles and 2/3-wheeler segment contribute the rest. The company’s non-auto components are manufactured for sectors such as the railways, specialty vehicles, aerospace, agricultural, and heavy earth moving equipment.

Recently, Amtek announced agreements to acquire three highly synergistic businesses in Europe and Southeast Asia. These acquisitions, which are expected to close during the current quarter, will strengthen its worldwide manufacturing footprint. In the last quarter, the global investment firm KKR invested Euro 235 million in Amtek Global Technologies (AGT), a subsidiary of Amtek, for long-term financing to replace its existing bridge loan and consolidate all of the company’s existing debt. This facility will also act as a catalyst to help integrate Amtek Auto’s existing international operations under the Singapore-headquartered AGT.

Amtek has reported another quarter of strong financial performance driven by significant operational excellence initiatives and also by the realisation of tangible benefits from the successful integration of its past acquisitions. On the financial front, the company’s consolidated total income showed a 38.1 per cent yearly growth and 20.8 per cent sequential growth during the December 2014 quarter. Further, its consolidated EBITDA during December 2014 too showed 37 per cent yearly growth and 17.4 per cent sequential growth. Interestingly, the consolidated EBITDA margins of Amtek stood at 21.4 per cent, reflecting an unrelenting focus on its cost structure and operating efficiencies.

The company has also reflected growth momentum in the last quarter and has secured almost Rs 2,600 crore worth of new orders during the quarter. With its business excellence program, the company was able to improve the productivity and utilisation levels, achieving manufacturing cost reductions. The company is now focusing on reducing its debt and the Board of Directors has approved an assessment by the finance committee to disinvest its stake in its subsidiaries to deleverage its balance-sheet. Hence, Amtek is expected to continue its growth momentum in the future also.

DSIJ MINDSHARE

Mkt Commentary28-Mar, 2024

Mindshare29-Mar, 2024

Multibaggers28-Mar, 2024

Interviews28-Mar, 2024

Multibaggers28-Mar, 2024

DALAL STREET INVESTMENT JOURNAL - DEMOCRATIZING WEALTH CREATION

Principal Officer: Mr. Shashikant Singh,
Email: principalofficer@dsij.in
Tel: (+91)-20-66663800

Compliance Officer: Mr. Rajesh Padode
Email: complianceofficer@dsij.in
Tel: (+91)-20-66663800

Grievance Officer: Mr. Rajesh Padode
Email: service@dsij.in
Tel: (+91)-20-66663800

Corresponding SEBI regional/local office address- SEBI Bhavan BKC, Plot No.C4-A, 'G' Block, Bandra-Kurla Complex, Bandra (East), Mumbai - 400051, Maharashtra.
Tel: +91-22-26449000 / 40459000 | Fax : +91-22-26449019-22 / 40459019-22 | E-mail : sebi@sebi.gov.in | Toll Free Investor Helpline: 1800 22 7575 | SEBI SCORES | SMARTODR