Stock pick from the auto ancillaries sector

A manufacturer of shock absorbers for two- as well as four-wheelers, Munjal Showa (MSL) seems to be in a sweet spot as far as its future growth is concerned. With a majority of its revenues coming in from India’s largest two-wheeler manufacturer, Hero MotoCorp, MSL has managed to post a CAGR of more than 24 per cent in its topline and 29 per cent in its bottomline over the past three years. The company has performed exceptionally well in the first nine months of the current year, in which its net profit has more than doubled.

Munjal Showa manufactures front as well as rear shock absorbers, struts, window balancers and rear door lifters. The Showa Corporation of Japan, a global leader in manufacturing shock absorbers, holds a 26 per cent equity stake in the company. In terms of the client profile, 90 per cent of its revenues come from two-wheelers and 10 per cent comes from cars. While it has a strong 60 per cent market share in the two-wheeler segment, it also has a 10 per cent market share in the car segment.

We believe that the financial growth for the company looks sustainable, considering the fact that Hero MotoCorp is expanding its capacity from six million units to seven million units by March 2012. Further, the demand for two wheeler component supplies from Honda is also expected to drive its overall performance going forward, as Honda’s sales volume growth has been very strong in the two-wheeler segment.

However, this is not the only reason why we are recommending MSL. The company has a consistent dividend payment history – it has been paying a dividend for more than 12 years. If it maintains the same rate of dividend in the current year too, then the dividend yield would work out to around 3.50 per cent. As a matter of fact, we expect a better dividend this year due to a surge in its net profit, which would further improve the dividend yield. Other compelling factors for recommending this stock include a strong promoter background of the Hero Group and an expected improvement in margins, as commodity prices have started softening. Raw material costs account for 75 per cent of its revenues, and thus, a fall in commodity prices like steel is expected to be beneficial in reducing raw material costs for the company.

On the valuations front, the CMP of Rs 71 discounts its trailing four quarter earnings by 5.50x. The EV/EBITDA of just 3.38x also seems to be well placed. On the financial front, even in a difficult scenario like that in the year 2008, the company managed to post a growth in its topline. This indicates its ability to grow even in difficult times. For the nine months ended December 2011, its topline stood at Rs 1153 crore as against Rs 933 crore during the same period last year. The bottomline stood at Rs 43 crore as against Rs 21 crore reported during the corresponding period last year.

Considering the likely volume growth and the improvement in margins, we expect a better show from the company going ahead. Thus, we recommend that investors should buy the scrip at the current levels, as we expect 25 per cent capital appreciation from this stock in a year’s time.