Stock Pick From The Auto Ancillaries Sector

Low Priced Scrip is hidden gem, today's underdog, a stock with future potential that is expected to fetch returns within 1 year. This is a stock picked carefully based on a fundamental analysis of the company.

The company recommended as the Low Priced Scrip for this issue is a leading manufacturer of automotive gears in India, and makes gears for commercial vehicles as well as tractors.

Bharat Gears (BGL) is a leading manufacturer of automotive gears in India. Despite surging by over 90 per cent on a YTD basis this year, the valuation still looks attractive. A major factor that goes in its favour is that it makes gears for Commercial Vehicles (CV) as well as tractors, which gives its business a diversified flavour since its operates in two different categories. We are bullish on the scrip as the recent auto sales numbers have shown that there is enough demand in the CV and the tractor segments. After the recent interest rate cuts by the RBI, the interest on auto loans would come down, thereby aiding mortgaged sales of vehicles. The company has posted good numbers in the last three quarters. Thus, we believe that the stock is all set for some re-rating on the valuations front.

BGL makes gears for Commercial Vehicles (CV) as well as tractors, which gives its business a diversified flavour since it operates in two different categories.

• Despite new capacity addition in the last two fiscals, BGL’s capacity utilisation has remained at over 80 per cent, which indicates robust business growth.
• On the valuations front, the counter looks attractive at a PE of only 4x its annualised EPS of Rs 20.

BGL has two factories – one in Mumbra, Maharashtra and one in Faridabad, Haryana. 98 per cent of its revenue comes from auto components and two per cent comes from selling furnaces and tooling developments. 85 per cent of its automotive components sales are to original equipment manufacturers (OEMs), while about 15 per cent comes from the replacement market. The OEM sales include tractors (55 per cent), Commercial Vehicles (20 per cent) and utility vehicles (25 per cent).

Our discussion with the management gives us an indication that the demand for gears would be sustainable even in the future. As per the Society of Indian Automobile Manufacturers (SIAM), the automobiles industry is expected to grow by 10-12 per cent in FY13. The CV segment would grow at about 11 per cent, while two-wheelers will continue to see buoyant sales due to the surge in demand in rural India. Despite new capacity addition in the last two fiscals, BGL’s capacity utilisation has remained at over 80 per cent, which indicates robust business growth.

BGL has a leadership position in the gear manufacturing space. Its strong client base includes some of the big names in the industry, such as Tata Motors, M&M, Ashok Leyland, TAFE, etc. It is also looking at expanding its capacity by another 20 per cent by setting up a new plant near Satara in Maharashtra. This expansion will cost the company around Rs 65 crore, which will be funded by a mix of debt and internal accruals. Expected to be commissioned by the March quarter of FY13, the capacity is expected to add value to its financials in this year itself.

On the financial front, BGL’s performance has been very convincing. Its topline grew by 31 per cent to Rs 307 crore, while its bottomline grew by 90 per cent to Rs 12.63 crore for the nine months ended December 2011. After putting in place some operational measures like the introduction of new metal cutting technology, lowering of energy costs, etc., the company has been able to improve its EBITDA margins by 46 basis points to 10.32 per cent. This margin level looks to be sustainable in the future. Its current debt is Rs 62 crore. The capacity expansion undertaken by BGL is likely to push up its debt, but the company intends to keep it below 1x its equity level.

On the valuations front, the counter looks attractive at a PE of 4x its annualised EPS of Rs 20 vis-à-vis JMT Auto, a peer group company that is available at a PE of 6.8x. Even on the EV/EBITDA level for April-Dec 2011, BGL looks better placed at 3.6x as compared to JMT Auto at 5.4x. Another important fact is that BGL is a consistently dividend-paying company. We advise investors to enter the counter expecting around 15-20 per cent appreciation over the next one year.