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Setco Automotive Ltd.13 April 2012 Higher sales in OES segment will lead to margin expansionAlthough headwinds in form of slower GDP growth, high inflation and interest rates pose threat,the Auto industry was expected to face only a moderation in growth and not a slowdown of theorder of 2008-09 (Exhibit 2).Exhibit 2: Trend in industry sales during slowdown periodFY12 FY11 YoY FY09 FY08 YoYTotal Auto Sales 17,409,110 15,511,492 12.2% 9,724,297 9,654,435 0.7%Total CV Sales 797,834 674,662 18.3% 384,194 490,494 -21.7%Total M&HCV Sales 348,070 323,018 7.8% 200,699 215,912 -7.0%Total LCV Sales 449,765 351,644 27.9% 183,495 274,582 -33.2%Source: SIAM Data (provisional), SIHL ResearchAs against a 0.71% growth registered in 2008-09, the auto industry grew at around 12% in thecurrent year i.e. FY12. Despite some slowdown in mining activities, there was some room for thegrowth in CV industry. The Total CV industry grew by 18.2% led by a robust growth in LCVsegment (around 27%).With increasing number of CVs on Indian roads, the market for branded clutches is rising. Wearand tear requires replacement of a clutch every two years or after 200,000km for M&HCVs. Thecover assembly needs to be replaced every 4-5 years. Demand in the replacement market islargely catered to by unorganized manufacturers. Owing to quality and technology issues, thetrend is slowly reversing. OEM measures to promote genuine products, customer awarenessprogrammes and tie-ups with local mechanics have helped the organized sector.On account of its customer profile and nature of the segment (M&HCVs) it caters to, Setco wouldalways have a high replacement market. Also, realizations and margins for Setco’s clutches arevery high. The company caters to the replacement market mainly via OEM’s spare-parts divisions(i.e., OES), which contribute 49% to its turnover. Margins are highest in case of exports around27-28%, while in replacement markets it is at ~22%-24% vs. margins of ~12%-14% in the OEMsegment. Contribution to EBITDA from OES segment is around 58% while that of OEM isonly 29%. Proportional increase in volume in OES segment vis-à-vis OEM would have apositive impact on operational efficiencies.Setco’s business model enables its clients (OEM) to offer quality spare parts to end users andcreate a sustainable source of income for Setco. Hence it clocked a growth from FY06 to FY11(except FY09, the worst year of Indian Auto Industry, Exhibit 2). Due to lower sales of CVvehicles in FY09, the first replacement cycle for clutches for CV vehicles sold in FY09 was lowerin FY12 which is evident from FY12 quarterly results (Around 40% of revenue from OESsegment). At present there are more than 6mn+ CVs in India and more than 2mn M&HCVs wereproduced in India itself. There has been healthy volume growth in OEMs in the past decade,leading to more vehicles on the road, stimulating replacement demand for clutches. The OESsegment for clutches, which commands a higher margin, has significant potential. Going forward,we expect OES segment to contribute ~51% of revenue by FY13 due to robust sales of CV inFY10 and FY11 which would come up in replacement market in FY13 onwards. We expectEBITDA margin to expand to 20.7% in FY13 from 19.0% in FY11.We believe Setco is well placed to cater to the rising demand as it is the largest manufacturer ofM&HCV clutches in India, where it enjoys a ~35% market share. Setco’s clutch realization perpiece is much higher than that of its peers (Exhibit 5) on account of its thrust into higher valueaddedproducts.4 | P a g e


Setco Automotive Ltd.13 April 2012Exhibit 3: Setco Revenue contribution (Segment Wise)OEM OES Exports100%90%80%70%60%50%40%30%20%10%0%8% 8% 7% 8% 8% 8%32% 35% 43%63%56%49%60% 57%50%29%36%43%Source: Company Data, SIHL ResearchExhibit 4: Revenue and EBITDA contribution from OEM, OES and Exports for FY11Revenue(Rs. Cr.)% Contri. toTotal RevenueEBITDAMarginEBITDA(Rs. Cr.)Contribution toEBITDAOEM 131 43% 13.0% 17 29%OES 149 50% 23.0% 34 58%Export 18 6% 27.5% 5 8%Source: SIHL ResearchExhibit 5: Segment-wise Revenue ContributionOEM OES ExportExhibit 6: Segment-wise EBITDA ContributionOEM OES Export6%8%29%43%50%58%Source: Company Data, SIHL ResearchSource: Company Data, SIHL Research Implementation of BS III norms: Higher net realization lead to higher marginWith the implementation of higher emission norms (BS III norms) for CVs introduced in Oct 2010,we estimate significant up-gradation in CV clutches which would translate into higherrealization/clutches. These clutches, being value-added products, are sold premium to itsprevious version and would also improve realizations for Setco Automotive. The OES segmentsales is expected to improve after H1 FY13 after the first batch of M&HCV vehicles would be outin market for clutch replacement. Another factor that will help OE (original equipment) demandtrickle in is the launches planned by CV majors. Currently, realization per clutch is the highest forHCVs at Rs.8,000-14,000 followed by MCVs at Rs.3,000-5000, LCVs at Rs.1,500-2,000 andpassenger cars at Rs.800-1,500. We estimate full impact of realization to get reflected in FY12.We expect improvement in realization and change of mix to lead to expansion in EBITDA marginto 20.7% in FY13 from 19.0% in FY11.5 | P a g e


Setco Automotive Ltd.13 April 2012Exhibit 7: Average realization for Clutch plate (Rs/Unit)Setco Clutch Auto Exedy India3,0002,5002,0001,5001,000500-Source: Company Data, SIHL ResearchExhibit 8: Average realization for Clutch covers (Rs/Unit)5,0004,5004,0003,5003,0002,5002,0001,5001,000500-Setco Clutch Auto Exedy IndiaSource: Company Data, SIHL Research Entry into LCV segment; diversifying its existing businessSetco has recently commenced into supply of clutches for Light Commercial Vehicles (LCV). Thisacts as a good diversifier, considering that LCV are not subject as much to the cyclicality of theindustry as the M&HCVs. Besides, from about 44% of total goods carrier sales in 2007-08, LCVsnow garner about 56% of the total volumes, indicating that supplies to LCVs can partly helpsustain component makers in times of a slowdown.Setco have been developing LCV clutches for the last year and half and since end of last year,Mar 2011, small sales have started which has grown significantly this year. LCV clutch sectorbeing a huge sector attracts a lot of competition. Realization on LCV clutches is lower thanM&HCV clutches; production of LCV clutches will drive volumes going forward and providediversification against slowdown in M&HCV segment. Setco currently accomplish around 15% ofTata Motors LCV clutches requirement. It also currently working on Tata Ace product and onemodel of Eicher and it would start supplying by H1 FY13. EBITDA margin in LCV clutch segmentis 4-5% lower than M&HCV clutches.6 | P a g e


Setco Automotive Ltd.13 April 2012Exhibit 9: LCV contribution to total CV sales in FY12LCV Sales56%M&HCVSales44%Source: SIAM Data, SIHL ResearchSetco will be diversifying more in high end clutches and more in aftermarket sales which wouldenable to maintain overall ~19% EBITDA margin.Despite Setco being a new entrant in LCV clutch segment, it is likely gain market share asproduct approval time would be less (4-6 months), given relationship with OEM v/s any newentrant which would have a gestation period of ~3 years. We estimate LCV clutches contributionto be around 25-30% of the overall Setco volumes in next 3 years. Expansion plans and backward integrationSetco’s plant is currently working at high utilization at around 75% and is planning to increase itscapacity for further growth potential. Setco is also coming up with an R&D centre near its Kalolplant at a cost of around Rs.10-12 cr. The company also is looking at entering new segmentsalong with expanding in newer geographies and setting up an assembly line for clutches in Africain order to meet the growing demand. Currently, the entire African continent has no clutchmanufacturer for the commercial vehicles. Almost all the supplies have been imported from USA,from Europe and all that or China. There is a lot of re-conditioned clutches used there and thereis no such global clutch manufacturer present in African continent. Setting up an assembly line inAfrican continent will give first mover advantage in one of the fastest growing continents.Raw materials accounts for almost 58% of total sales. The major raw material cost comprises ofceramic buttons (25%), Castings (22%), Steel Strips (22%), springs (10%). Setco sources steelstrips from local vendors situated near its plants. Ceramic buttons are manufactured by only twocompanies in world (one in Europe and one in US) as it is highly technologically intensive. Setcoprocures ceramic button from Miba, Austria. Setco has backward integrated by setting up a pressshop in Kalol in FY10 meeting around 30% of its raw material requirement. Subsidiary PerformanceIn Jan 2006, Setco had acquired UK-based automotive clutch manufacturer, Lipe clutch, a whollyowned subsidiary of the $10-billion Dana Corporation of UK and had been a technicalcollaborator of Setco. This facility is now known as Setco Automotive, UK. The company has anagreement since 2000 to use the LIPE brand and has been paying royalty to Dana Corp till 2005.In addition, it acquired the engineering designing capabilities as well as technical competenciesand 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-purchasedeal. It became the sole owner of the LIPE brand globally. It has already commenced hydraulicspressure converters business through its subsidiary in USA and also started supplying toCaterpillar. Both these subsidiaries have broken-even in FY11, contributing ~2% to consolidatedPAT. Going ahead, we believe contribution from subsidiaries to remain more or less in the samerange.7 | P a g e


Key Concerns Slowdown in OEM salesSetco Automotive Ltd.13 April 2012The revenue from OEM segment comprises around 45-47% of total sales. Any slowdown in OEMsales would have a direct impact on Setco’s revenues. OEM slowdown in a particular year alsohas a cascading effect on OES segment after two years or so as less number of units is availablein replacement market. Currency RiskSetco has around 23-25% import dependence on it raw materials, which accounts for 14% oftotal sales. However exports are 6-7% of total sales. Currently it enjoys around 50% of naturalhedge in forex and remaining is kept open which may impose currency risk. However, Setco isworking on it and expects this to be in place shortly. Overall margin dilution due to diversification into lower margin, lower realisation LCVsegment.Despite maximum market share in domestic OEM M&HCV clutch segment, Setco expects togrow revenue at 20-25% on back of incremental business coming in from LCV segment. Thecompany might able to garner 20-25% revenue growth but there could be some dilution inoperating margin as LCV Clutches is low margin business compared to M&HCV segment. Also,intense competition in LCV clutch segment makes it difficult to command premium overcompetition.Peer Group Comparison (Domestic Players)Setco Automotive Clutch Auto Exedy IndiaParticulars FY09 FY10 FY11 FY12E FY13E FY14E FY09 FY10 FY11 FY09 FY10 FY11BV (Rs.) 27.6 35.9 49.9 66.7 85.3 105.5 75.3 82.6 89.3 19.0 37.6 26.8EPS (Rs.) 6.5 10.1 18.6 21.4 23.2 26.0 2.4 4.5 4.7 (12.5) (1.8) (10.8)P/BV, x 7.4 5.7 4.1 3.1 2.4 1.9 0.4 0.3 0.3 18.1 9.1 12.8P/E, x 31.6 20.3 11.0 9.6 8.8 7.9 12.0 6.4 6.1 (27.5) (192.3) (31.8)ROE 23.5% 28.1% 37.3% 32.1% 27.2% 24.7% 3.2% 5.4% 5.2% -65.7% -4.7% -40.2%ROCE 15.8% 22.2% 28.1% 22.7% 23.8% 22.4% 7.5% 7.2% 7.2% -6.3% -3.1% -11.1%EBITDA Margins 13.7% 17.8% 19.0% 19.5% 20.7% 20.3% 14.1% 16.4% 17.0% 0.7% 3.1% -1.1%D/E, x 1.5 1.3 1.1 1.0 0.8 0.8 0.9 1.1 1.2 6.0 2.8 4.8EV/EBITDA 8.7 6.2 5.3 7.3 5.9 4.9 5.0 7.2 6.5 98.0 32.8 (63.3)Source: Ace Equity, SIHL ResearchSetco operates largely in M&HCV clutch segment only and have recently diversified in LCV segment; thiswill lead to a marginal decline in realisations. While Clutch Auto caters to MCV, LCV and Passenger carsegments and Exedy India caters to only LCV and Passenger Car segment.8 | P a g e


Minutes from our Management Meet Setco estimates 10-12% growth in M&HCV OEM vehicles in FY13.Setco Automotive Ltd.13 April 2012 It is setting up new plant in Africa and expects to commence operations by H2 FY13. It wouldbe assembly line and components would be sourced from India. As of now, there is norecognized clutch manufacturer for commercial vehicles in Africa. Africa accounts for only 10%of company's exports in FY 11. It started to supply clutches to LCVs from April 2011. However M&HCV would continue toremain its main focus. The margins in LCV are lower as compared to M&HCV. The interest cost increased by 68% y-o-y in Q2 FY12 due to 300 bps increase in interest rateand higher borrowings especially due to working capital. The working capital increased due toslow down. The company is taking steps to bring working capital to normal levels and thuslower the interest costs in H2 FY12. Morgan Stanley Asia (Singapore) has quadrupled its stake in Setco in February; which nowstands at 2.27% (earlier 0.57%).‣ We believe New Vernon Pvt. Equity has partly exited the company as it has investedat around Rs.120 in 2006. Also Investment horizon period New Vernon usually followsis around 5-6 years.9 | P a g e


Setco Automotive Ltd.13 April 2012Key Assumptions & ValuationDCF Based Valuation for SetcoRs. Cr. FY13E FY14E FY15E FY16E FY17E FY18E FY19E Terminal ValueFree Cash Flow 13 24 26 33 38 43 50 639NPV of Cash Flow 12 21 21 24 25 26 28 -NPV Enterprise Value - - - - - - - 524Source: SIHL ResearchTerminal Growth Rate 4%Beta 0.33Risk Free Rate 9%Market Premium 8%Post Tax Cost of Debt 6.2%Cost of Equity 11.0%WACC 8.6%Debt (Rs. Cr.) 121Equity (Rs. Cr.) 118Total Enterprise Value 524Net Debt (Rs. Cr.) 106No of Shares (Cr.) 1.76Value per Share 237Valuation Subsidy Investment Valuation Method Value per ShareStandalone Business - DCF Valuation 237Setco Automotive UK Ltd 100% 30% discount to FY14 BV of Rs.9.9 7Setco Automotive (NA) Inc 100% 30% discount to FY14 BV of Rs.7.5 5Source: SIHL ResearchTarget Price 249CMP 206Expected Return 21.3%Outlook & ValuationSetco has pro-actively increased its capacity over some years which have helped in maintainingits market dominance. With a CAGR growth of 11-12% of OEMs coupled with largely untappedOES and export segment, we estimate a 20% CAGR growth in revenues from FY12-14E. Due tointroduction of BS III norms for CVs, we estimate significant upgradation in CV clutches whichwould translate into higher realization per clutches. Higher CV sales in FY10 and FY11 will leadto higher demand in OES segment which result into higher operating efficiency as margin in OESis higher as compared to OEM.We recommend a BUY with a Target price of Rs.249 on DCF basis; with an investment horizonof 12 months and upside potential of 21%.10 | P a g e


Company FinancialsExhibit 10: Standalone Balance SheetSetco Automotive Ltd.13 April 2012Particulars, Rs. Cr. FY09 FY10 FY11 FY12E FY13E FY14ESources of FundsShareholder’s Funds 49 63 88 118 150 186Share Capital 9 9 18 18 18 18Reserves & Surplus 40 55 70 100 133 168Total Debt 74 81 95 121 126 141Total Liability 123 145 183 239 276 327Application of FundsGross Block 52 90 102 117 157 202Less: Depreciation 14 20 28 38 54 77Net Block 38 69 75 80 104 125Capital WIP 28 - 0 0 0 0Investment 12 20 28 28 36 36Current Assets, Loans & AdvancesInventory 14 25 35 43 47 57Sundry Debtors 30 35 66 82 91 100Cash & Bank 2 2 2 15 6 25Loans & Advances 17 21 27 39 47 48Total Current Assets 64 83 129 179 192 229Current Liabilities & ProvisionCurrent Liabilities 12 19 33 33 40 48Provision 4 5 11 11 11 11Total Current Liabilities 16 24 44 44 50 58Net Current Assets 47 60 85 136 142 171Total Assets 123 145 183 239 276 327Source: Ace Equity, SIHL ResearchExhibit 11: Standalone Annual Income StatementParticulars, Rs. Cr. FY09 FY10 FY11 FY12E FY13E FY14EGross Sales 173 226 327 348 418 503Less: Excise Duty 10 11 18 19 23 28Net Sales 163 215 309 329 395 475Total Expenditure 141 177 250 265 313 379EBITDA 22 38 59 64 82 97EBITDA Margin % 13.7% 17.8% 19.0% 19.5% 20.7% 20.3%Depreciation 3 6 7 10 16 23EBIT 19 32 51 54 66 73EBIT Margin % 11.9% 15.0% 16.6% 16.5% 16.6% 15.4%Other Income 4 1 1 1 2 2Interest 7 9 10 15 15 16Exceptional Items (3) - - - - -PBT 14 24 42 40 53 59PBT Margin % 8.7% 11.3% 13.7% 12.3% 13.4% 12.5%Tax 3 7 10 3 12 13Effective Tax Rate % 19.4% 26.9% 22.5% 6.3% 22.5% 22.5%PAT 11 18 33 38 41 46PAT Margin % 7.0% 8.3% 10.6% 11.5% 10.4% 9.7%EPS 6.5 10.1 18.6 21.4 23.2 26.0Source: Ace Equity, SIHL Research11 | P a g e


Setco Automotive Ltd.13 April 2012Exhibit 12: Standalone Cash Flow StatementParticulars, Rs. Cr. FY09 FY10 FY11 FY12E FY13E FY14ECash flow from Operations 20 22 26 10 43 59PAT 11 18 33 38 41 46Depreciation 3 6 7 10 16 23Non Cash Adjustment 12 12 17 - - -Change in WC (7) (14) (31) (38) (15) (11)Cash Flow from Investing (22) (18) (21) (15) (48) (45)Capital Expenditure (22) (11) (13) (15) (40) (45)Change in Investment - (8) (8) - (8) -Other Investment Items 0 1 0 - - -Cash Flow from Financing 4 (5) (5) 18 (3) 5Issue of Equity - - - - - -Issue/(Repay) of Debt 13 7 13 26 5 15Dividend Paid (3) (3) (7) (7) (7) (9)Dividend Tax - (0) (1) (1) (1) (1)Other Financing Cash Flow (7) (9) (10) - - -Net Cash 2 (0) (0) 13 (9) 18Opening Balance 1 2 2 2 15 6Closing Balance 2 2 2 15 6 25Source: Ace Equity, SIHL ResearchQ4 FY12 Result EstimatesRs. Cr. Q4 FY12E Q4 FY11 YoY Q3 FY12 QoQNet Sales 88 108 -18.3% 87.97 0.0%EBITDA 18.12 21 -15.5% 17.08 6.1%EBITDA Margin % 20.6% 19.9% 68 bps 19.4% 118 bpsPAT 9.01 13.27 -32.1% 8.45 6.6%PAT Margin % 10.2% 12.3% (208) bps 9.6% 63 bpsEPS 5.1 7.5 -32.1% 4.8 6.6%Source: SIHL Research12 | P a g e


Setco Automotive Ltd.13 April 2012Contact DetailsShah Investor’s Home LtdB /105, 1 st Floor, Sahayog Tower,Above Central Bank of India,S.V. Road, Kandivali (West)Mumbai-400067www.sihl.inContact: research@sihl.in, +91-22-28016715/16You can also access our reports on Bloomberg (ERH SIH)Disclaimer:‐The Information provided by SMS or in newsletter or in any document has been prepared by Shah Investor’s Home Ltd(SIHL). The Information provided by SMS or in newsletter does not constitute an offer or solicitation for the purchase or sale of anyfinancial instrument or as an official confirmation of any transaction. The information contained herein is from publicly available dataor other sources believed to be reliable, but we do not represent that it is accurate or complete and it should not be relied on as such.SIHL or any of its affiliates/ group companies shall not be in any way responsible for any loss or damage that may arise to anyperson from any inadvertent error in the information contained in this report or SMS. This Information provided by SMS, reports or innewsletter is provided for assistance only and is not intended to be and must not alone be taken as the basis for an investmentdecision. The user assumes the entire risk of any use made of this information. Each recipient of this Information provided by SMS,report or in newsletter should make such investigation as it deems necessary to arrive at an independent evaluation of an investmentin the securities of companies referred to in this information provided by SMS, report or in newsletter (including the merits and risksinvolved), and should consult his own advisors to determine the merits and risks of such investment. The investment discussed orviews expressed may not be suitable for all investors. This information is strictly confidential and is being furnished to you solely foryour information.The information should not be reproduced or redistributed or passed on directly or indirectly in any form to any other personor published, copied, in whole or in part, for any purpose. The information provided by report or SMS is not directed or intended fordistribution to, or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or otherjurisdiction, where such distribution, publication, availability or use would be contrary to law, regulation or which would subject SIHLand affiliates/ group companies to any registration or licensing requirements within such jurisdiction. The distribution of thisInformation provided by SMS or in newsletter in certain jurisdictions may be restricted by law, and persons in whose possession thisInformation provided by SMS or in newsletter comes, should inform themselves about and observe, any such restrictions. Theinformation given or Information provided by SMS, report or in newsletter is as of the date of the issue date of report or the date onwhich SMS provided and there can be no assurance that future results or events will be consistent with this information. Thisinformation is subject to change without any prior notice. SIHL reserves the right to make modifications and alterations to thisstatement as may be required from time to time. However, SIHL is under no obligation to update or keep the information current.Nevertheless, SIHL is committed to providing independent and transparent recommendation to its client and would behappy to provide any information in response to specific client queries. Neither SIHL nor any of its affiliates, group companies,directors, employees, agents or representatives shall be liable for any damages whether direct, indirect, special or consequentialincluding lost revenue or lost profits that may arise from or in connection with the use of the information. Past performance is notnecessarily a guide to future performance. The disclosures of interest statements incorporated in the Information provided by SMS,report or in newsletter are provided solely to enhance the transparency and should not be treated as endorsement of the viewsexpressed in the report. The analyst for this report certifies that all of the views expressed in this report accurately reflect his or herpersonal views about the subject company or companies and its or their securities, and no part of his or her compensation was, is orwill be, directly or indirectly related to specific recommendations or views expressed in this report.13 | P a g e

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