Setco Automotive Ltd. Initiating Coverage-SIHL ... - all-mail-archive

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Setco Automotive Ltd. Initiating Coverage-SIHL ... - all-mail-archive

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

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