AND Feb 22 2011 16 25 19

India I Equities
Auto Components Sector Report
22 February 2011
India Auto Components

Overseas sales Paving growth
Overweight Nifty/Sensex: 5459 / 18212
Rohan Korde
+9122 6626 6733 rohankorde@rathi.com
Girish Solanki
+9122 6626 6712 girishsolanki@rathi.com
Nirav Bhatt
niravbhatt@rathi.com
Anand Rathi Financial Services, its affiliates and subsidiaries, do and seek to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Disclosures and analyst certifications are located in Appendix 1. Anand Rathi Research India Equities
India I Equities
Auto Components Sector Report
22 February 2011

Overseas sales Paving growth
The Indian auto components sector is primed to benefit from recovery in overseas sales and continuing growth in the domestic auto sector. Streamlining of costs and improving productivity have led to healthier financials; also, diversification in non-auto segment and wider exports coverage are new revenue drivers.
Overweight Nifty/Sensex: 5459 / 18212
Rohan Korde
Girish Solanki
Overseas sales to strengthen. On the ongoing recovery in US and Europe, we expect a rise in auto demand from OEMs/ tier-1 suppliers, fueling overseas revenue for Indian auto-part players. We expect a 28.1% CAGR in standalone exports over FY11-13e for our auto-parts coverage vs. 19.7% for domestic sales. Steady growth in domestic auto sector. After two years of swift growth, the Indian auto sector has now entered a steady growth phase. We expect a 13.7% CAGR in industry volumes over FY1113e, thereby providing firm support to auto components. Improved efficiencies, de-risking. Auto-parts companies are benefiting from efforts to conserve cash, reduce costs and raise productivity. Also, de-risking via entry into the non-auto segment and prudent investments would lead to 21.5% sales CAGR in FY11-13e vs. 15% for the auto industry. Stock picks. Our top picks: Motherson Sumi (diversified), Setco (replacement demand), Gabriel (demand growth), Bharat Forge (good business model), and Amtek Auto (overseas recovery, attractive valuations). Risks are demand slowdown, commodity cost pressures, delay in export ramp-up due to slowdown.
Nirav Bhatt
Auto sector vs Sensex
150 140 130 120 110 100 90
BSE Auto
Sensex
Oct-10
Apr-10
Dec-10
Feb-10
Source: Bloomberg
Valuation matrix - India auto components

Amara Raja Amtek Auto* Banco Balkrishna Products Inds Bharat Forge* Exide Inds Gabriel India Mahindra Motherson Forgings* Sumi* NRB Bearings* Phillips Carbon Setco Auto*
Rating Current price (`) Target price (`) M. Cap. (m US$) EPS CAGR (FY11-13e, %) PE (x) EV/EBITDA (x) RoE (%) RoCE (%) Asset Turnover (x)
Buy 165 210 313.0 22.7 7.8 4.4 22.3 29.0 2.2
Buy 117 225 545.1 23.7 6.0 3.6 8.3 11.1 0.6
Buy 71 103 113.8 26.4 6.2 3.3 23.5 23.2 1.1
Hold 127 144 274.7 8.5 7.7 5.5 16.4 15.0 1.2
Buy 319 396 1,649.1 49.1 16.1 7.1 20.0 20.5 1.3
Hold 130 149 2,464.1 19.5 15.3 8.9 21.7 30.1 1.7
Buy 42 62 71.1 41.8 7.5 3.5 20.6 20.2 0.5
Buy 65 137 133.2 239.6 11.8 4.2 6.0 8.5 2.0
Buy 185 221 1,591.9 32.8 15.1 7.0 31.5 29.4 3.5
Buy 46 68 97.1 18.7 7.3 4.0 23.4 27.6 0.8
Aug-10
Buy 134 246 97.0 14.9 3.0 2.9 25.2 16.8 2.7
45.8 29.3 5.8 3.5 33.1 25.0 0.7
Source: Company, Anand Rathi Research;
Note: Ratios are based upon FY12e earnings, * consolidated
Prices as on 18 February 2011
Feb-11
Jun-10
Buy 117 182
22 February 2011
India Auto Components Overseas sales Paving growth

Overseas sales Paving growth Investment Argument and Valuation .............................................3
Overseas sales to strengthen................................................................... 3 Steady domestic auto growth ................................................................... 3 Improved efficiencies, diversification ........................................................ 4 Valuation .................................................................................................. 5
Overseas sales to strengthen .......................................................7

Increased optimism among OEMS and suppliers ................................ 7 Auto components Upbeat outlook ..................................................... 8 Strong pipeline of some European manufacturers could add to demand............................................................................ 8 India still a considerably attractive low-cost base................................. 9 Quality no longer an issue.................................................................... 9
Steady domestic growth..............................................................11

Resilient domestic auto demand... ..................................................... 11
Improved efficiencies...................................................................13
Steps taken in tough times would now help ....................................... 13 Operating performance to sustain...................................................... 13
Company Profiles ........................................................................16

Motherson Sumi..................................................................................17 Bharat Forge.......................................................................................31 Exide Industries ..................................................................................46 Amtek Auto .........................................................................................58 Amara Raja Batteries..........................................................................74 Balkrishna Industries...........................................................................85 Mahindra Forgings .............................................................................98 NRB Bearings ...................................................................................113 Setco Auto ........................................................................................127 Banco Products.................................................................................142 Gabriel .............................................................................................153 Phillips Carbon Black .......................................................................169
Anand Rathi Research
22 February 2011
Investment Argument and Valuation

The Indian auto components sector is primed to benefit from continuing growth in the domestic auto sector and recovery in overseas sales. Streamlining of costs and improving productivity have led to healthier financials; also, the non-auto segment and wider exports coverage are new revenue drivers. Our top picks are Motherson Sumi Systems, Bharat Forge, Gabriel India, Amtek Auto and Setco Auto.
Overseas sales to strengthen

A steady revival in auto-component exports and overseas revenue improvement from end-FY10, despite overseas demand (excluding incentive schemes) not significantly improving, has been a notable feature of FY11. Ahead, we expect the nascent recovery in export demand to gather steam as auto demand in the US/EU picks up, after having hit bottom through CY08 to CY10. We expect the recovery to benefit dually first, by driving exports and second, by improving growth in overseas subsidiaries. We expect our autoparts universe to see a 28.1% standalone exports CAGR over FY11-13e vs. 19.7% CAGR for domestic sales. Moreover, with skilled manpower readily available, India continues to retain its edge as a low-cost manufacturing base. A key area where India scores over China is in the better protection afforded to intellectual property rights (IPRs).
Fig 1 India among the lowest labour-cost countries
60 50 40 30 20 10 0 Indonesia Argentina Romania Malaysia Mexico Hungary India Thailand Mexico China Philippines Hungary
Indonesia China
Source: globalproduction.com,
Philippines Romania
India Argentina
Thailand Malaysia
Note: on a scale of 1 to 100;m
as of CY09
Steady domestic auto growth

After two years of rapid growth, the Indian auto sector has now entered a sturdy growth phase. We expect industry volumes to see a 13.7% CAGR over FY11-13e, providing a firm backbone to the sector.
Likely key growth drivers are: 1.
Sustained two-wheeler demand: We expect two-wheeler demand in India to continue to swell, while penetration and expansion into new areas globally would boost export growth. In the two-wheeler sector, we expect a 13.7% volume CAGR over FY11-13e.
22 February 2011
2.
India, a global small-car hub: India has emerged as a small-carmanufacturing hub as all major global auto companies have set up manufacturing bases here (VW, Skoda and Nissan among the latest) with the dual aim of capturing local demand and benefiting from the low-cost manufacturing facilities here. Hence, they are likely to use India as an export base. We expect a 13% CAGR over FY11-13e in Indias passenger vehicle sales. Replacement demand: Replacement demand would continue to fuel non-cyclical demand for auto-component companies, especially for batteries and tyres. The replacement demand trajectory would follow an increasing trend due to the robust 14% CAGR in Indias auto sales over FY02-11e.
3.
Fig 2 Auto sector: volume CAGR over FY02-11

(%)
25.0 20.0 15.0 10.0 5.0 0.0 PV
Source: SIAM
LCV
M&HCV
2wh
3wh
Total
Improved efficiencies, diversification

Lower demand in 2HFY09 and spiralling raw material costs just prior to this period led to companies rapidly adopting measures to conserve cash, reduce costs and improve productivity. These steps helped auto-component companies survive the downturn; this augurs well for enhanced profitability ahead. Hence, as compared to a revenue CAGR of 21.5% over FY11-13e, we expect a higher profit CAGR of 28.4%. Given the cyclical trends in the auto industry, players are diversifying/derisking their business models; Bharat Forge, Amtek Auto, Rico Auto and MSSL have already taken such measures in the past two years. We expect this to be an even more widespread trend. We believe that diversified companies would be better performers. Diversifying into the non-auto sub-segment, upgrading to noncommoditised products and broadening the product range would lead to companies emerging stronger. Also, de-risking via entry into the non-auto segment and prudent investments would lead to 21.5% revenue CAGR in FY11-13e vs. 15% for the auto industry.
22 February 2011
Fig 3 Improvement in companies RoE (FY09-13e)

(%) 40 35 30 25 20 15 10 5 0 -5 -10 FY09 FY10 FY11 FY12 FY13 Gabriel India Setco Auto*
Balkrishna Inds Motherson Sumi*
Bharat Forge* NRB Bearings*
Source: Company, Anand Rathi Research, Note: * consolidated
Valuation
The auto-components sector trades at PE of 11.4x FY12e and 9x FY13e earnings (compared with 11.4x FY12e and 10.2x FY13e EPS for the automobile sector, distorted mainly by Tata Motor cheap valuations). We expect revenue CAGR of 21.5% over FY11-13e, and a higher profit CAGR of 28.4% for our coverage universe. . Valuations of companies in our coverage universe are still at a discount to their past averages. We expect the discount to reduce and surpass past averages as the auto-components sector sustains a high-growth phase over FY11-13e despite external factors. Company valuations
Motherson Sumi (Buy; TP: `221): We have a Buy rating on MSS, with a target of `221 (18x target PE, on par with its past six-year average). At the current price, the stock trades at a PE of 15.1x FY12e EPS. Bharat Forge (Buy; TP: `396): We value the stock at 20x FY12e PE. Our target price is `396. At present valuations, BFL trades at 16.1x FY12e EPS. We believe that current valuations do not reflect the significant upside that would accrue from FY13 from the joint ventures with NTPC, Areva, etc., commencing full-scale operations. Exide Industries (Hold; TP: `149): We value the standalone business at one-year forward PE of 16x. We value Exides stake in ING Vysya Life Insurance at `12. Our target price is `149 (from `128). We retain our Hold. Amtek Auto (Buy; TP: `225): We cut our target price from `254 to `225 (10x FY12e EPS, and `29 as value of 38% stake in Amtek India). We value Amtek Auto at 10x FY12e earnings, a 50% discount to the target PE multiple for Bharat Forge. Our current EPS estimate excludes Amtek India, and on considering the recent dilution and change in estimates. At the current market price, the stock trades at attractive valuations of 6x FY12e EPS. Amara Raja Batteries (Buy; TP: `210): We value ARB at 10x FY12e EPS (a 40% discount to the target multiple for market leader Exide Industries). At the ruling market price, the stock trades at 9.5x FY11e and 7.8x FY12e earnings.
5
22 February 2011
Balkrishna Industries (Hold; TP: `144): We value the stock at `144 (8.25x FY12e standalone EPS of `16.5 and `8 as value of its paper business). At the CMP, the upside is not too compelling. We initiate coverage with a Hold. Mahindra Forgings (Buy; TP: `137): We value MFL at `137 (25x FY12e EPS of `5.5). Future re-rating is likely on: i) proven ability to sustain consolidated profitability and ii) likely restructuring of MFL as part of Mahindra Systech. We initiate coverage with a Buy. NRB Bearings (Buy, TP `68): At our target price of `68, the stock would trade at 11x 12-month-forward earnings. NRBs one-yearforward PBV in the past five years has ranged between 0.7x and 3.8x. At `46, NRB trades at PE of 8.9x and 7.3x FY11e and FY12e earnings, respectively, and EV/EBITDA of 4.8x and 4x. Setco Auto (Buy, TP `182): At our target price, the stock would trade at 9x 12-month forward earnings and EV/EBITDA of 5.1x. The target PE is in line with the three-year average. Banco Products (Buy, TP `103): We value the stock at `103, based on 9x FY12e EPS of `11.5. It trades at an attractive 6.2x FY12e standalone PE. After a disappointing FY11, we expect the PE multiple to be re-rated, given stable growth ahead. We initiate with a Buy. Gabriel (Buy, TP `62): At our target price, the stock would trade at 11x FY12e earnings and an EV/EBITDA of 4.8x. The target multiple is at a slight discount to the stocks five-year average. Phillips Carbon Black (Buy, TP `246): At our revised target of `246, the stock trades at FY12e PE of 5.6x and EV/EBITDA of 4x. We value PCB at FY12e P/BV of 1.25x. Rising commodity costs may squeeze margins, particularly in domestic operations. Increasing fuel prices and interest rates may arrest auto demand due to higher costs of acquisition and ownership. Slower-than-expected recovery in Europe and US auto demand would delay the growth trajectory for export-oriented companies.
Risks

Fig 4 Auto component sector: Valuation matrix

Amara Raja Amtek Auto* Banco Balkrishna Products Inds Bharat Forge* Exide Inds Gabriel India Mahindra Motherson Forgings* Sumi* NRB Bearings* Phillips Carbon Setco Auto*
Rating Current price (Rs) Target price (Rs) M.Cap. (m US$) EPS CAGR (FY11-13e, %) PE (x) EV/EBITDA (x) RoE (%) RoCE (%) Asset Turnover (x)
Buy 165 210 313.0 22.7 7.8 4.4 22.3 29.0 2.2
Buy 117 225 545.1 23.7 6.0 3.6 8.3 11.1 0.6
Buy 71 103 113.8 26.4 6.2 3.3 23.5 23.2 1.1
Hold 127 144 274.7 8.5 7.7 5.5 16.4 15.0 1.2
Buy 319 396 1,649.1 49.1 16.1 7.1 20.0 20.5 1.3
Hold 130 149 2,464.1 19.5 15.3 8.9 21.7 30.1 1.7
Buy 42 62 71.1 41.8 7.5 3.5 20.6 20.2 0.5
Buy 65 137 133.2 239.6 11.8 4.2 6.0 8.5 2.0
Buy 185 221 1,591.9 32.8 15.1 7.0 31.5 29.4 3.5
Buy 46 68 97.1 18.7 7.3 4.0 23.4 27.6 0.8
Buy 134 246 97.0 14.9 3.0 2.9 25.2 16.8 2.7
Buy 117 182 45.8 29.3 5.8 3.5 33.1 25.0 0.7
Source: Anand Rathi Research; Note: Ratios are based upon FY12e earnings, * consolidated
22 February 2011
Overseas sales to strengthen

Despite the few short-term growth catalysts in Europe and the US and withdrawal of incentive schemes, we expect increased optimism among OEMs/suppliers regarding long-term growth prospects. This, along with market share gains, would drive overseas revenue for most Indian auto-parts companies. We expect our auto-parts universe to see a 28.1% standalone exports CAGR over FY10-13e vs. 19.7% CAGR for domestic sales. Increased optimism among OEMS and suppliers After a decent demand trend in 10, export growth for auto components would be further underpinned by a cyclical recovery in the US in the next two years and continued optimism among European OEMs/suppliers. In Jan 11, CSM, a widely followed auto-production forecaster, raised its CY11 European production expectations for vehicles to 19m (Dec 10: 18.6m, May 10: 17.3m) and for CY12 to 19.7m (Dec 10: 19.5m May 10: 18.4m), suggesting a 10% and 7% increase in estimates respectively since May and a 2% and 1% increase respectively since December. For North America, mainly the US, CSM expects vehicle production for CY11 to increase to 12.9m (May10: 12.7m) and for CY12 to 13.9m (May10: 13.5m), implying a 2% and 4% increase in estimates respectively since May 10. Although we do not see significant short-term growth catalysts in Europe, given the withdrawal of scrappage/incentive schemes by the UK, France, Germany and Italy, we continue to believe that CSMs estimates are conservative. The revision of CSMs estimates reiterates our view that European and US auto volumes are expected to be better in CY11 and CY12, demonstrating CAGRs of more than 5% for Europe and ~13% for North America over FY09-12e. Direct exports constitute 22.9% of the sectors standalone revenue; total overseas revenue drives this share to nearly 50% for some big autocomponent players (like Bharat Forge, Motherson Sumi and Amtek Auto and Mahindra Forgings). We are upbeat on auto-component exports and overseas revenues, due to the upswing in auto demand, as well as the ongoing inventory restocking by European and US OEMs.
Fig 5 CSM global light vehicle production summary

by Region (000s) CY10 CY11e CY12e CY13e CY14e CY15e CY16e CY17e CAGR CY10-13 % CAGR CY11-13 %
Europe Greater China Japan/Korea Middle East/Africa North America South America South Asia Grand Total
Source: CSM Auto
18,732 14,791 13,162 2,105 11,943 4,140 6,709 71,582
19,042 16,268 12,793 2,159 12,944 4,376 7,653 75,237
19,715 18,139 13,524 2,406 13,919 4,623 8,614 80,940
20,776 19,689 13,965 2,334 14,743 5,055 9,525 86,087
21,956 20,997 13,966 2,409 15,493 5,332 10,129 90,280
22,753 22,003 14,180 2,486 16,078 5,595 10,802 93,897
23,334 22,919 14,181 2,573 16,147 5,786 11,515 96,453
23,867 23,775 14,046 2,665 16,265 6,006 12,101 98,725
3.5 10.0 2.0 3.5 7.3 6.9 12.4 6.3
2.9 6.6 3.0 2.6 4.4 4.9 7.6 4.6
22 February 2011
Fig 6: Direction of Indias exports

South America 3% Middle East 7% Africa 7% Australia 1% Oceania 0% Europe 39%
North America 21%
Asia 22%
Source : ACMA
In Europe, people still need a car. Prospects for auto component manufacturers look upbeat
Auto components Upbeat outlook

In the base-case scenario for Western-Europe car demand, anecdotal evidence suggests that there are ~200m cars in the region. Of this, an average 6% is scrapped annually, leading to replacement demand of ~12m vehicles. This includes fleet rental car demand. This generates certain cyclical demand of ~12m vehicles annually. The European population is expected to increase by 10m in the next 10 years. On average, one car per two individuals would create demand of ~5m cars, translating to structural demand of 0.5m cars a year. Apart from certain sovereign-debt concerns, European GDP growth is now showing a positive trend, and unemployment, after peaking in 09, is on the decline. The above structural growth along with eased macro concerns would prove an important demand catalyst, implying that West European car demand would see further green shoots. Western Europe has a substantial positive impact as the region constitutes ~70% of the total European car-demand pie. A steady revival in auto-component exports and overseas revenue improvement from end-FY10, despite overseas demand (excluding incentive schemes) not significantly improving has been a notable feature of FY11. Ahead, we expect the nascent recovery in export demand to gather steam as auto demand in the US/EU picks up, after having hit bottom through CY08 to CY10. We expect the recovery to benefit dually firstly by driving exports and secondly by improving growth in overseas subsidiaries. We expect our autoparts universe to see a 28.1% standalone exports CAGR over FY11-13e vs. 19.7% CAGR for domestic sales.
Fig 7 Eurostat GDP growth estimates
Eurostat estimates for real GDP growth CY08 CY09 CY10 CY11e CY12e
European Union (27 countries) Euro area (16 countries) United States
Source: Eurostat Data
0.5 0.4 0.0
-4.2 -4.1 -2.6
1.8 1.7 2.7
1.7 1.5 2.1
2.0 1.8 2.5
Strong pipeline of some European manufacturers could add to demand

European OEMs such as Peugeot (20% of product pipeline up for renewal in CY11), BMW (three new models) and Volkswagen have a healthy
22 February 2011
pipeline. We expect the India auto-components segment to benefit as a result, winning new long-term contracts to supply components for some of these platforms. Indian auto component companies could also benefit by supplying to foreign manufacturers Faurecia, Delphi and Magna, which in turn supply components to these new platforms.
India still a considerably attractive low-cost base

India is one of the hottest three destinations for automobile-component manufacturing, on parameters such as lower wage rates, access to cheaper raw materials, availability of engineers and design capabilities, than other low-cost locations. This gives auto-ancillary manufacturers an edge in costs while competing with rivals, who supply to European manufacturers. This helps protect margins. The key cons now are the higher costs of electricity (which has come down over time) and the high transit time to other auto hubs (a location disadvantage). Indias advantages lead to a minimum 20% lower cost, versus the US and other developed nations.
Quality no longer an issue

Indian auto-ancillary product offerings are now benchmarked to stringent global standards. This transformation is partly due to technology tie-ups with global automotive manufacturers, leading to transfer of sophisticated technology, in turn helping produce high-end products, meeting requirements of tier-I manufacturers Daimler, BMW, VW and Volvo. A JD Power survey shows that problems per 1,000 products supplied by Indian manufacturers have reduced 50% from 1997 levels. Auto component companies maintained high standards even while handling huge orders. As a result global auto-component manufacturers Delphi, Bosch and Visteon have operations in India. Ford, Toyota and General Motors have also set up their international purchasing offices in India.
Fig 8 Labour costs sustain
Rank Country Index
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22
Indonesia Philippines India Thailand Mexico China Romania Argentina Malaysia Slovakia Russia Hungary Poland Hong Kong Turkey Brazil Czech South Africa Taiwan Singapore Slovenia South Korea
14.0 17.2 18.7 20.2 23.2 29.2 33.8 35.9 38.3 50.3 53.3 54.8 56.1 59.8 64.9 65.8 70.5 74.6 76.3 80.4 86.2 100.0
Note: Hourly wage cost in major agglomerations, Index hourly wage cost, South Korea = 100 Source: Global Production, Mar 08
22 February 2011
Fig 9 Automotive specialization: Global

Rank Country Index
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25
Argentina Mexico Slovakia Czech Poland Hungary Brazil Turkey Slovenia South Africa South Korea Thailand Romania Russia India Indonesia Taiwan Philippines China Malaysia Singapore Israel Saudi Arabia Hong Kong Pakistan
4.51 3.71 3.62 3.23 3.12 3.08 2.88 2.85 2.61 2.51 1.95 1.25 0.97 0.68 0.49 0.38 0.22 0.21 0.14 0.07 0.05 0.05 0.04 0.01 0.01
Note: Measures the country's specialization in exporting automotive products on a scale of 0 to 5 Source: Global Production, Mar 08
10
22 February 2011
Steady domestic growth

After two years of swift growth, the Indian auto sector has now entered a steady growth phase. We expect an industry volume CAGR of 13.7% over FY11-13e, which would strengthen the sector base.
Resilient domestic auto demand...

Indias auto demand has proved resilient despite the challenging FY08-10 environment. This was mainly owing to:
Fig 10 Auto OEM demand
(m units)
30.0 25.0 20.0 15.0 10.0 10.0 5.0 0.0 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY13e FY14e 5.0 0.0 -5.0
continuance of the stimulus package through FY10 and its success; lower interest rates; and release of pent-up demand.
Fig 11 FY11-13e auto sales growth CAGR
(%)
30.0 25.0 20.0 15.0
16% 15% 14% 13% 12% 11% 10% PV LCV M&HCV 2wh 3wh Total Auto volumes
Total Auto volumes

Source: SIAM, Anand Rathi Research
yoy change (%)

The likely key growth drivers for the auto segment are:
1.
Sustained two-wheeler demand: We expect two-wheeler demand in India to continue, while penetration and expansion into new areas globally would boost export growth. In the two-wheeler sector, we expect a 13.7% volume CAGR over FY11-13e. Turning into a global small-car hub: India has emerged as a small car manufacturing hub as global giants General Motors (plant of 225,000unit capacity annually set up at Talegaon near Pune), Volkswagen (plant at Pune), Nissan (plant at Chennai) and Renault (in partnership with Nissan) have joined the existing India old-hands Suzuki and Hyundai. These companies would not only cater to domestic demand but also use India as an export base in the long run. We expect a 13.7% CAGR over FY11-13e in Indias passenger vehicle sales. Replacement demand: would continue to fuel non-cyclical demand for auto-component companies, especially for batteries and tyres. The replacement demand trajectory would follow an increasing trend due to the robust 14% CAGR in Indias auto sales over FY02-11, particularly in batteries and tyres, continue to fuel non-cyclical demand for autocomponent companies. Direct replacement demand would occur from upgradation of mode of transport, new entrants and additional vehicle purchases.
2.
3.
11
22 February 2011
4.
CV demand in mid-cycle: M&HCV sales have reached mid-cycle, with good demand growth expected on infrastructure development, GDP growth, and the healthy domestic economy.
Replacement demand to be an important growth driver . . . The automobile sector has seen robust growth in the past few years, with a volume CAGR of 14% over FY02-11. The healthier growth rate portrays durability in Indias auto demand over the long-term, even after factoring in cyclical slumps. This high built-up base of automobiles would translate into replacement demand for tyres, batteries, etc., every 3-4 years, thereby bolstering demand for tyres. Replacement demand constitutes almost two-thirds of tyre and battery sales annually. These are non-cyclical segments that would contribute towards steady company revenue, both in an economic downturn and during a highgrowth phase.
Fig 12 Volume CAGR: (FY02-11)
(%) 24.0 22.0 20.0 18.0 16.0 14.0 12.0 10.0 PV
Source: Company
LCV
M&HCV
2wh
3wh
Total
. . . but speed-breakers ahead While demand growth is likely to be sustained, it would not be entirely smooth sailing as speed-breakers are now visible. Key factors that may constrain growth are:

Rise in interest rates would raise the cost of ownership for vehicles, thereby potentially constraining demand growth. Rise in commodity costs would necessitate further increase in vehicle prices, thereby increasing the cost of acquisition. Regulatory changes Increase in excise duty rates to pre-stimulus levels (0% to 2% up) would result in passing on of this cost increase to endusers.
12
22 February 2011
Improved efficiencies
Auto-parts companies are benefiting from efforts to conserve cash, reduce costs and improve productivity. Also, de-risking via entry into the non-auto segment and prudent investments would lead to 21.5% sales CAGR in FY11-13e vs. 15% for the auto industry.
Steps taken in tough times would now help

Lower demand in 2HFY09 and spiraling raw material costs just prior to this period led companies to rapidly adopt measures to conserve cash, reduce costs and improve productivity. Even as these steps helped them survive the downturn, they augur well for enhanced profitability ahead. Another step that gained traction during this period was the need to diversify/de-risk business models to account for cyclical trends. Bharat Forge and MSS had already taken such steps; we expect this to be even more widespread. We believe that diversified companies would be better performers. Diversifying into non-automobile segments, upgrading to noncommoditized products and a broad product range are some of the characteristics of companies that would emerge stronger despite the slowdown.
Operating performance to sustain

A pick-up in demand and lower channel inventories have led to greater capacity utilization and short-term capacity constraints in certain segments. While higher commodity costs would lower EBITDA margins from the peak, we expect them to sustain at FY11 levels. Hence, we expect a 21.5% sales CAGR in FY11-13e vs. 15% for the auto industry. Similarly, the profit CAGR at 28.4% would be higher than that for the auto industry (17.6%).
Fig 13 EBITDA margin trend (FY09-13e)
(%) 17 16 15 14 13 12 FY11e FY12e FY13e FY09 FY10
Auto components universe

Source: Company, Anand Rathi Research
13
22 February 2011
Fig 14: Auto-components sector investments

(`m) 400,000 350,000 300,000 250,000 200,000 150,000 100,000 50,000 0 FY10e
FY13e
FY04
FY05
FY06
FY07
FY08
Source: ACMA
Fig 15 Auto-components sector, improved RoE

(%) 35 30 25 20 15 10 5 0 -5 -10 FY11e FY12e FY13e Gabriel India Setco Auto*
Exide Inds Phillips Carbon
FY09
Balkrishna Inds Motherson Sumi*
FY10
Bharat Forge* NRB Bearings*
Source: Company, Anand Rathi Research * consolidated
Fig 16 and higher asset turnover ..

(x) 4.0
3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 FY09 FY10 FY11e FY12e
Balkrishna Inds Mahindra Forgings*
Bharat Forge* Motherson Sumi*
Source: Company, Anand Rathi Research * consolidated
FY09
14
22 February 2011
Fig 17 Earnings and revenue growth (FY07-12e)

Adj. earnings
(`m)
(`m)
Revenue
500,000 450,000 400,000 350,000 300,000 250,000 200,000 150,000 100,000 50,000 0 FY11e FY12e
40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 0 FY11e FY12e FY13e FY09 FY10

FY13e
FY09
FY10
15
22 February 2011
Company Profiles
16
Auto Components
India I Equities
Update
Change in Estimates Target Reco
22 February 20011
Motherson Sumi Systems

Good performance to continue; Buy
Motherson Sumi Systems is expected to continue on its steady growth path, boosted by robust domestic demand and new order implementation at Samvardhana Motherson Reflectec in FY12 and subsequent operating leverage from FY13. We re-iterate our Buy on the stock, with a target price of `221.
Rating: Buy Target Price: `221 Share Price: `185
Rohan Korde
Nirav Bhatt
Benefits of good domestic car growth. Motherson Sumi has benefited from revved-up growth in domestic passenger cars. Domestic car volumes have risen at a healthy ~31.3%, ytd FY11, and are expected to register a 13% CAGR over FY11e-13e. With a 65% share, MSS dominates the market in passenger-car-wiring harnesses. Further, as it is well-established with upcoming models being launched in India, MSS would register higher-than-industry growth. Steady at SMR. Samvardhana Motherson Reflectec, the rearviewmirror business, has turned around faster than expected after its acquisition by MSS. In ytd FY11, an appreciating rupee capped revenue growth at SMR, but the outlook is robust on new order implementation commencing in FY12 and subsequent operating leverage from FY13. Valuation and risks. We have a Buy rating on MSS, with a target of `221 (18x target PE, on par with its past six-year average). At the current price, the stock trades at a PE of 15.1x FY12e EPS. Risks: slowdown in European demand or delay in new model launches there, currency risk, and the complicated company structure.
Key data
52-week high/low Sensex/Nifty 3-m average volume Market cap Shares outstanding Free float Promoters Foreign Institutions Domestic Institutions Public
MSS IN /MOSS.BO `209/`120 18212 / 5459 US$0.8m `72.6bn/US$1.6bn 387.5m 34.8% 65.2% 9.1% 9.5% 16.2%
Key Financials - Consolidated

Year end 31 March FY09 FY10 FY11e FY12e FY13e
Motherson Sumi vs Sensex

26,397 1,310 3.4 -24.6 55.4 8.5 28.2 12.4 0.7 61.2 68,509 1,880 4.9 43.5 38.6 6.0 20.0 15.1 1.0 51.0 82,774 3,373 8.7 79.4 21.5 5.0 27.7 24.9 1.2 48.4 102,551 4,741 12.2 40.6 15.1 4.0 31.5 29.4 1.3 47.2 121,913 5,947 15.3 25.4 12.2 3.1 31.9 31.6 1.5 42.5
Source: Bloomberg
Sales (`m) Net profit (`m) Diluted EPS (`) Growth (%) PE (x) PBV (x) RoE (%) RoCE (%) Dividend yield (%) Net gearing (%)
200 190 180 170 160 150 140 130 120
MSS
Sensex
Feb-10 Mar-10 Apr-10 May-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11
22 February 2011
Motherson Sumi Systems Good performance to continue; Buy
Quick Glance Financials and Valuations

Fig 1 Consolidated Income Statement (`m)
Fig 4 Consolidated PE Band

102,551 23.9 91,779 10,772 10.5 645 2,594 156 1,922 5,767 4,741 40.6 12.2 21.6 2.5 121,913 18.9 108,732 13,181 10.8 645 2,854 176 2,465 7,394 5,947 25.4 15.3 26.4 2.8
350 300 250 200 150 100 50 0 Sep-05 Aug-08 May-07 Sep-10 Mar-08 Feb-06 Oct-07 Dec-06 Nov-09 Feb-11 6x 300 250 200 150 Motherson Sumi 100 50 0 Sep-05 Aug-08 Sep-10 Apr-05 Mar-08 Feb-06 Apr-10 May-07 Dec-06 Nov-09 Feb-11 Jan-09 Jun-09 Oct-07 Jul-06 2x 1x 5x 4x 3x Apr-05 Jul-06 Jan-09 Jun-09 Apr-10 Motherson Sumi 10x 30x 26x 22x 18x 14x
Net sales Sales growth (%) - Op. expenses EBIDTA EBITDA margins (%) - Interest - Depreciation + Other income - Tax Rep PAT before MI Adjusted PAT Adj PAT growth (%) FDEPS (`/share) CEPS (`/share) DPS (`/share)
26,397 28.6 23,120 3,278 12.4 354 979 50 348 2,212 1,310 -24.6 3.4 9.0 1.4
68,509 159.5 63,056 5,454 8.0 573 2,601 463 1,094 2,334 1,880 43.5 4.9 13.2 1.8
82,774 20.8 74,323 8,451 10.2 645 2,471 139 1,728 4,031 3,373 79.4 8.7 16.8 2.3
Fig 2 Consolidated Balance Sheet (`m)

Year to 31 March FY09 FY10 FY11e FY12e FY13e
Fig 5 Consolidated PB Band

388 17,943 18,330 7,979 2,049 28,359 19,482 471 4,162 4,244 28,359 388 20.4 19 388 22,822 23,210 7,979 2,049 33,238 21,628 471 5,166 5,973 33,238 388 8.6 19
350
Share capital Reserves & surplus Shareholders fund Debt Deferred tax / others Capital employed Fixed assets Investments Working capital Cash Capital deployed No. of shares (m) Net Debt/Equity (%) W C turn (days)
356 7,476 7,831 8,951 1,880 18,662 15,412 81 402 2,766 18,662 356 79.0 26
375 11,275 11,649 8,179 2,049 21,878 16,356 471 1,620 3,431 21,878 375 40.8 19
388 14,173 14,560 7,979 2,049 24,589 17,077 471 3,134 3,906 24,589 388 28.0 19
Fig 3 Cash flow statement (`m)

Fig 6 MSSL vs. BSE Sensex

5,980 2,471 8,451 -1,514 -1,304 5,633 -3,192 2,441 -872 -248 -200 -645 476 3,431 3,906 8,178 2,594 10,772 -1,027 -1,766 7,979 -5,000 2,979 -969 -1,028 0 -645 337 3,906 4,244 10,327 2,854 13,181 -1,004 -2,289 9,888 -5,000 4,888 -1,066 -1,449 0 -645 1,729 4,244 5,973
220 200 180 160 140 120 100 Aug-10 Sep-10 Mar-10 Apr-10 Nov-10 Dec-10 Jun-10 Feb-10 Jan-11 Oct-10 May-10 Feb-11 Jul-10 MSS BSE Auto
Op. pr/(loss) bef. tax + Depreciation Cash profit + Incr/(Decr) in WC + Others Operating cash flow + Capex Free cash flow + Dividend + Chg in net worth + Debt raised + Misc. items Net cash flow + Opening cash Closing cash
2,299 979 3,278 2,531 2,146 7,956 -10,077 -2,122 -480 740 4,060 -386 1,813 954 2,766
2,853 2,601 5,454 -970 -23 4,460 -3,545 915 -674 2,158 -772 -963 664 2,766 3,431
Source: Bloomberg
18
22 February 2011

Motherson Sumi Systems is expected to continue on its steady growth path, boosted by robust domestic demand and new order implementation at SMR in FY12, and subsequent operating leverage from FY13. We re-iterate our Buy on the stock, with a target price of `221. Benefits of good domestic car growth MSS is a key vendor to almost all passenger-car and two-wheeler OEMs and caters to a wide spectrum of the vehicular industry. It has benefited from revved-up growth in domestic passenger cars. Domestic car volumes have risen at a healthy ~31.3% in ytd FY11, and are expected to register a 13% CAGR over FY11e-13e. With a 65% share, MSS dominates the market in passenger-car-wiring harnesses. Further, as it is well-established with upcoming models being launched in India, MSS would register higher-than-industry growth. Steady at SMR On acquiring Samvardhana Motherson Reflectec, the rearview-mirror business, MSS is one of the largest manufacturers of automobile rearview mirrors in the world, with a market share of ~22%. SMR has raised MSSs ability to supply high-level assemblies. Post-acquisition, the latter has been able to turn around operations at Samvardhana faster than expected, and the rapid pace of improvement in operations is expected to be sustained. In ytd FY11, an appreciating rupee capped revenue growth at SMR, but the outlook is robust regarding new order implementation commencing in FY12 and the subsequent operating leverage from FY13. Valuation and risks We have a Buy rating with a target price of `221 (18x target PE, on par with its past six-year average). At the current price, the stock trades at a PE of 15.1x FY12e EPS. The company is securely entrenched in its product segments, with a well-charted five-year plan. In the past, the stock has traded at a premium to the rest of the sector. Risks
Currency fluctuations: As a considerable proportion of its revenue arises from overseas ventures, MSS is highly exposed to risks posed by currency fluctuations. Complicated structure: Its numerous subsidiaries and joint ventures make for a complex company structure. Commodity pressure: With commodity prices on an upward trend, any delay in passing on these costs could affect the short-term operating performance. Slowdown in demand from Europe: Any slowdown in demand growth from Europe or delay in launching new models would cloud prospects for MSS overseas businesses.
19
22 February 2011
Benefits of good domestic car growth

Motherson Sumi Systems has benefited from revved-up growth in domestic passenger cars. Domestic car volumes have risen at a healthy ~31.3% in ytd FY11, and are expected to register a 13% CAGR over FY11e-13e. With a 65% share, MSS dominates the market in passenger-car-wiring harnesses. Further, as it is well-established, with models being launched in India, MSS would register higherthan-industry growth. Leader in the wiring-harness sub-segment Indias leading passenger-car-wiring harness manufacturer, MSS has a domestic market share of over 65%. It is a key vendor to almost all passenger-car and two-wheeler OEMs and sells to a wide spectrum of the vehicular industry. (It also operates in the non-automobile segment, with customers in earth-moving and material-handling sub-segments; and supplies material-handing markets in Europe.) It has more than 25 manufacturing facilities in India, Sharjah, Ireland and the UK to ensure timely supplies to OEMs in India as well as in Europe. The company provides complete in-house design services, which results in quicker development. It benefits from having carried out backward integration for critical inputs for wiring harnesses such as wires, connectors, terminals, fuses and fuse-boxes. It has a technology partnership with Sumitomo of Japan, a leader in wiring harnesses worldwide. It has also tied up with Kyungshin Industrial of South Korea, the wiring-harness supplier to Hyundai Motors in Korea. The wiring-harness business is the second most important business segment for MSS, till FY08 bringing in 73% of its revenue (standalone; and 66% consolidated). However, on acquiring Visiocorps rearview-mirror business, the share of the wiring-harness revenues diminished significantly from FY10. Revenue from its consolidated-wiring-harness sub-segment has seen a robust 27.5% CAGR over FY04-10. Revenue growth has arisen from revved-up growth domestically in passenger cars, its strong presence in Europes two-wheeler and materialhandling-equipment markets, faster growth in exports and capacity expansion by key customers Hyundai and Nissan.
Fig 7 MSS wiring harness business growth (FY04-FY10)
(`m) 20,000 16,000 12,000 8,000 4,000 0 FY04 FY05 FY06 FY07 FY08 FY09 FY10
Standalone
Source: Company
Consolidated
20
22 February 2011
Outlook Even though auto volumes in 2HFY09 slowed considerably, MSS retained its market share in wiring harnesses. Subsequently, as volume growth strongly recovered in India, good revenue growth followed. New model launches from Ford and Nissan would continue to drive MSS revenue growth. Domestic car volumes in India have risen at a healthy 31.3% ytd in FY11. Over FY11e-13e, they are expected to touch a 13% CAGR. As the company is well established with upcoming models being launched in India it would register higher-than-industry growth. A recovery in auto demand, globally, in CY10/11 would significantly boost MSS overseas revenue. Moving up the value chain to manufacture progressively more complex products and modules, and capitalising on SMRs overseas relationships to supply more content per car in the medium term would further enhance volumes and realizations for MSSs wiring-harness division. Other business segments Apart from the wiring harness and mirror sub-segments, MSS other business segments are plastic and polymer components, and rubber components. After acquiring SMR, these divisions now constitute a smaller share of MSS revenue.
Fig 8 MSS revenue mix (%)
IT, design, & manufacturing support, 1 Elastomer processing, 2 Metal working, 1 Others, 4
Wiring harness, 28
Mirrors & modules, 53
Polymer tooling, 9
Source: Company
Fig 9 MSS polymer business growth (FY04-FY10)

(`m)
6,000 5,000 4,000 3,000 2,000 1,000 0 FY04 FY05 FY06 FY07 FY08 FY09 FY10
Standalone
Source: Company
Consolidated
21
22 February 2011
Fig 10 MSS: Growth, rubber components and other products (FY04-10)

(`m)
2,500
2,000
1,500
1,000
500
0 FY04 FY05 FY06 FY07 FY08 FY09 FY10
Standalone
Source: Company
Consolidated
Tie-ups with global leaders hold the technological edge MSS has technology tie-ups/joint ventures with globally leading companies Magna, Sumitomo, Kyungshin Industrial, Continental, Calsonic. Its JVs/tie-ups served the multiple purposes of securing technology, penetrating overseas markets and venturing into new product categories in India. At present, MSS has 24 joint ventures with various partners. Its recent joint venture with Calsonic Kansei has commenced operations, currently supplying to Ritz, Micra. The JV supplies HVAC systems as complete assemblies. (This includes other components such as audio systems, etc., in addition to ACs.)
22
22 February 2011
Steady at SMR
Samvardhana Motherson Reflectec, the rearview-mirror business, has turned around faster than expected after its acquisition by MSS. In YTD FY11, an appreciating rupee capped revenue growth at SMR, but the outlook is robust for new order implementation commencing in FY12 and subsequent operating leverage in FY13. Samvardhana Motherson Reflectec, the rearview-mirror business, is one of the largest manufacturers of passenger car rearview mirrors in the world, with a ~22% market share globally, and ~53% in India. Samvardhana has enhanced MSS ability to supply high-level assemblies. After the acquisition, MSS has been able to turn around operations at Samvardhana faster than initially expected. In ytd FY11, an appreciating rupee capped revenue growth at SMR, but the outlook is robust for new order implementation commencing in FY12 and subsequent operating leverage in FY13. Benefits of the acquisition With the SMR acquisition, the MSS Group is now one of the largest manufacturers of automobile rearview mirrors in the world. Also, SMR has raised to a higher level MSS ability to supply high-level assemblies. Some of the key benefits to MSS from this acquisition are:

The MSS Group is now the largest manufacturer of passenger car mirrors in India. SMR supplies products to nearly every OEM, nearly 400 individual products. It is a technology leader with 300 patents and a history of innovation. SMR is a market leader in exterior rearview mirror systems and brings with it cutting-edge technology, covering the complete range of mirrors from low-end entry segments to high-end luxury segments. The acquisition was made at favourable valuations. Therefore, substantial value-unlocking potential exists under normal conditions in the near future. Since MSS had been in the business in India for over 13 years in partnership with the erstwhile Visiocorp, it built up certain competencies. The acquisition brings with it synergies. Mirrors is a synergistic product and brings re-sourcing value into the already existing lines of wiring harness (28m annual buying), polymer processing and elastomers. The acquisition has opened up new markets such as China, Mexico, the USA, Japan, Spain, France and Hungary. Since SMR is an established tier-I supplier globally, the acquisition has propelled MSS into the worldwide tier-I league. There is good potential for MSS to supply more components to SMRs customers, thereby increasing the content supplied per car.
23
22 February 2011
Fig 11 Market share of SMR

India Global
Others 47% MSS 53%
MSS 22%
Others 78%
Source: Company
SMR: 3Q performance SMRs performance continued to steadily improve. Full recovery, however, was affected by the unfavorable exchange rate. In 3Q, revenue was flat yoy, but was up 8% qoq. Sales in India grew 74.1% yoy, while sales outside India fell 2.7% yoy, the effect of the exchange rate. EBITDA margin was 6% (-50bps, both yoy and qoq). Net profit attributable to MSS was `134m (+47.7% yoy and 95.9% qoq).
Fig 12 SMR: Quarterly performance (`m)
3QFY10 2QFY11 3QFY11 yoy chg (%) qoq chg (%)
Net Sales within India outside India Total expenditure EBITDA EBITDA Margin (%) Restructuring expenses Depreciation Interest PBT PBT margin (%) PBT ex-EO PBT margin (%) Tax ETR (%) PAT MI MI (%) PAT after MI
Source: Company
11,206 423 10,782 10,477 728 6.5 90 383 59 197 1.8 287 2.6 105 53.4 92 44 48.4 47
10,403 655 9,747 9,721 681 6.5 0 310 0 314 3.0 314 3.0 180 57.3 134 66 48.9 69
11,231 737 10,494 10,552 679 6.0 0 313 0 315 2.8 315 2.8 61 19.3 254 120 47.1 134
0.2 74.1 -2.7 0.7 -6.8 -100.0 -18.2 -100.0 60.1 9.7 -42.0 177.0 169.8 183.7
8.0 12.5 7.7 8.5 -0.4
1.1 0.2 0.2 -66.2 89.2 82.2 95.9
24
22 February 2011
Fig 13 Impact of currency on revenue

(m) 200 (`m) 12,000
180
11,250
160
10,500
140
9,750
120 2QFY10 3QFY10 2QFY11 3QFY11
9,000
Revenues - Euros
Source: Company
Revenues - Rupees (RHS)
In CY11, MSS will commission four plants in India and one each in South Africa and Hungary. By end-CY12, SMR will commission a plant each in Brazil and Thailand. Total capex involved would be ~`5bn, half of which would be in India, the balance overseas. Business prospects are upbeat on nearing of new-order execution and good demand.
Fig 14 SMR, a significant revenue driver
SMRs and MSSs revenue trends
(`m) 140,000 120,000 100,000 4,000 80,000 60,000 40,000 20,000 0 FY10 FY11e FY12e FY13e 3,000 2,000 1,000 0 FY10 FY11e FY12e FY13e (`m) 6,000 5,000
SMRs and MSSs profit trends
SMR
MSSL
SMR
MSSL
25
22 February 2011
3QFY11 performance was impressive

MSS registered a good 3QFY11, driven by robust standalone performance and sustained traction at SMR. Standalone quarterly performance impressive MSS reported robust sales growth of 72.1% yoy (+15.2% qoq) to `7.5bn, driven by domestic revenue growth of 76.8% yoy (+15.2% qoq) and exports growth of 37.9% yoy (up 14.6% qoq). Standalone exports saw a healthy increase in sales and continued sequential growth. Other operating income increased ~15.9% yoy to `185m. The EBITDA margin (adjusted for forex) was 16.6%. It fell 100bps yoy to 16.6%, though qoq it was up 200bps. The yoy decline stemmed from higher raw-material-to-sales (by 200bps yoy), partially offset by 70bps lower staff-expenses-to-sales and 50bps lower other-expenditure-to-sales. In absolute terms, EBITDA was up 60.6% yoy and 31.4% qoq. Boosted by healthy revenue growth and higher other income, adjusted profit grew 85.1% yoy to `759m.
Fig 15 Quarterly standalone performance
Y/E 31 March (`m) 3QFY10 2QFY11 3QFY11 yoy change (%) qoq change (%)
Domestic Sales Exports Net Sales Other Operating Income Total Income Total Cost EBITDA EBITDA Margin (%) Other Income Extraordinary Income Extraordinary Loss Total extraordinary income Interest Gross Profit Less: Depreciation PBT Tax Effective Tax Rate (%) Rep. PAT Adj. PAT
Source: Company
3,845 525 4,370 160 4,530 3,733 796 17.6 29 237 0 237 68 995 172 824 224 27.1 600 410
5,898 632 6,530 155 6,685 5,711 974 14.6 103 112 0 112 81 1,109 199 909 250 27.5 659 580
6,796 724 7,521 185 7,706 6,426 1,279 16.6 121 24 0 24 100 1,324 211 1,113 337 30.3 776 759
76.8 37.9 72.1 15.9 70.1 72.1 60.6 310.2 (89.9) NM (89.9) 46.8 33.1 23.1 35.1 50.8 29.3 85.1
15.2 14.6 15.2 19.3 15.3 12.5 31.4 17.1 (78.6) NM (78.6) 23.4 19.5 5.9 22.5 34.7 17.8 30.9
While MSS 3QY11 EBITDA margin was healthy, the rise in copper prices and general commodity cost hikes could impact the EBITDA margin in the next six months, particularly in the standalone operations.
26
22 February 2011
Fig 16 Trend in standalone EBITDA margin

(`m)
1,500 19.4 1,300 1,100 900 700 14.8 500 300 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q FY11 3Q 14.2 14.4 14.1 14.6 14.4 17.9 17.5 17.6 16.6
Fig 17 Trend in standalone raw material-to-sales

(%)
20.0 19.0 4,300 18.0 17.0 16.0 15.0 14.0 13.0 1,500 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q FY11 3Q 2,900 2,200 57.0 57.2 56.5 58.3 3,600 58.9 58.5 58.6 58.5 57.5 60.0 59.5 60.4 (`m) 5,000 59.9 61.1 (%) 61.5 60.6 60.5
FY09 EBITDA
FY10 EBITDA Margin (RHS)
FY09
FY10
Source: Company
Source: Company
Consolidated 3QFY11 performance Net sales in 3Q were up 16.9% yoy (+8.7% qoq) at `20.8bn. Domestic revenue grew 62% yoy, while overseas revenue fell 2.3% yoy. EBITDA margin improved 110bps yoy and 60bp qoq to 10.4%, while EBITDA grew 31.5% yoy to `2.2bn. The better EBITDA margin and lower tax rate drove MSS consolidated profitability 65.6% higher yoy (+27.9% qoq) to `953m.
Fig 18 Quarterly consolidated performance
Y/E 31 March (`m) 3QFY10 2QFY11 3QFY11 yoy change (%) qoq change (%)
Within India Outside India Net Sales Other Operating Income Total income Total Cost EBITDA EBITDA Margin (%) Other Income Extraordinary Income Extraordinary Loss Total extraordinary income Interest Gross Profit Less: Depreciation PBT Tax Effective Tax Rate (%) Rep. PAT bef MI & ASP Minority interest Sh of Profit of Associates Rep. PAT after MI & ASP Adj. PAT
Source: Company
5,334 12,489 17,823 325 18,148 16,463 1,686 9.3 48 307 90 217 139 1,812 642 1,170 389 33.3 781 30 -2 749 575
7,606 11,556 19,162 415 19,576 17,657 1,919 9.8 30 164 0 164 152 1,961 610 1,352 471 34.9 880 21 0 860 745
8,634 12,197 20,831 445 21,276 19,060 2,216 10.4 28 281 123 158 171 2,231 601 1,630 430 26.4 1,200 137 0 1,064 953
61.9 (2.3) 16.9 36.7 17.2 15.8 31.5 (41.5) (8.5) 36.0 (27.0) 23.5 23.1 (6.5) 39.4 10.7 53.7 362.9 (109.1) 42.0 65.6
13.5 5.5 8.7 7.3 8.7 7.9 15.4 (4.4) 70.9 #DIV/0! (3.7) 12.6 13.8 (1.5) 20.6 (8.7) 36.3 562.9 23.7 27.9
27
22 February 2011
Financials
We expect a 21.4% CAGR in MSS revenue from FY11 to FY13, with its EBITDA margin improving from 10.2% in FY11e to 10.8% two years later. The EBITDA CAGR would hence be 24.9%, while the adjusted net profit CAGR would come in at 32.8%. Motherson Sumi Systems supplies wiring harnesses and plastic modules to almost all car manufacturers in India. With its acquisition of SMR it has seen rapid growth (a 64.9% CAGR in net sales from FY07 to FY10) as it has been transformed into a one-stop shop for a wide range of critical components. We expect a 20.7% CAGR over FY11-13 in MSS (standalone) revenue, backed by a stable EBITDA margin of 15.3%, and a 23.8% CAGR in (standalone) adj. net profit. We expect a 21.4% CAGR over FY11-13 in MSS (consolidated) revenue. The EBIDA margin would be 60bps higher as operating leverage on the increased capacities would be seen in FY13. Quicker recovery in global automobile markets would boost growth and lead to upsides to our consolidated earnings estimates. We expect a 32.8% CAGR over FY11-13 in the (consolidated) adj. net profit.
Fig 19 MSS EBITDA margin trend (FY05-FY13e)
(%) 19 17 15 13 11 9 7 FY11e FY12e FY13e FY05 FY06 FY07 FY08 FY09 FY10 Consolidated
Standalone
28
22 February 2011
Fig 20 Consolidated Income statement (`m)

Y/E MARCH FY09 FY10 FY11e FY12e FY13e
Net Sales Change (%) Operating Other Income Total Income Change (%) Expenditure EBITDA Change (%) % of Net Sales Depreciation Interest & Finance Charges Other Income Exceptional Expenses Non-recurring Income PBT Tax Effective Rate (%) PAT Change (%) Minority interest Income from associate PAT after MI Change (%) Adj. PAT Change (%)
Source : Company, Anand Rathi Research
25,956 28.0 441 26,397 28.6 23,120 3,278 1.1 12.4 979 354 50 554 1,119 2,560 348 13.6 2,212 26.5 449 0 1,763 -0.9 1,310 -24.6
67,022 158.2 1,487 68,509 159.5 63,056 5,454 66.4 8.0 2,601 573 463 695 1,380 3,428 1,094 31.9 2,334 5.5 -91 2 2,428 37.7 1,880 43.5
80,915 20.7 1,859 82,774 20.8 74,323 8,451 55.0 10.2 2,471 645 139 216 501 5,759 1,728 30.0 4,031 72.7 461 2 3,570 47.1 3,373 79.4
100,506 24.2 2,045 102,551 23.9 91,779 10,772 27.5 10.5 2,594 645 156 0 0 7,689 1,922 30.0 5,767 43.1 1,028 2 4,739 32.7 4,741 40.6
119,664 19.1 2,250 121,913 18.9 108,732 13,181 22.4 10.8 2,854 645 176 0 0 9,859 2,465 30.0 7,394 28.2 1,449 2 5,945 25.4 5,947 25.4
Fig 21 Consolidated Balance Sheet (`m)

Sources of Funds Share Capital Equity Capital Reserves Net Worth Minority interest Net Deferred Tax Loans Capital Employed Application of Funds Gross Fixed Assets Less: Depreciation Net Fixed Assets Capital WIP Investments Curr.Assets, L & Adv. Inventory Sundry Debtors Cash & Bank Balances Loans & Advances Current Liab. & Prov. Creditors Other Liabilities Provisions Net Current Assets Miscellaneous Expenditures Application of Funds
356 356 7,476 7,831 2,000 145 8,951 18,927
375 375 11,275 11,649 2,027 40 8,179 21,896
388 388 14,173 14,560 2,027 40 7,979 24,606
388 388 17,943 18,330 2,027 40 7,979 28,377
388 388 22,822 23,210 2,027 40 7,979 33,256
30,175 16,276 13,900 1,512 81 19,139 6,112 6,132 2,766 4,129 15,971 10,375 1,911 3,685 3,169 265 18,927
31,821 17,273 14,548 1,808 471 20,971 6,752 7,688 3,431 3,101 15,921 10,925 2,134 2,861 5,051 18 21,896
36,821 19,744 17,077 0 471 24,440 8,151 9,281 3,906 3,101 17,400 13,190 2,134 2,075 7,041 18 24,606
41,821 22,338 19,482 0 471 28,999 10,125 11,528 4,244 3,101 20,593 16,384 2,134 2,075 8,406 18 28,377
46,821 25,192 21,628 0 471 34,855 12,055 13,726 5,973 3,101 23,716 19,506 2,134 2,075 11,139 18 33,256
29
22 February 2011
Fig 22 Consolidated cash-flow statement (`m)

OP/(Loss) before Tax Interest/Div. Received Depreciation & Amort. Direct Taxes Paid (Inc)/Dec in Wkg. Capital Other Items CF from Op. Activity Extra-ordinary Items Other Items CF after EO Items (Inc)/Dec in FA+CWIP (Pur)/Sale of Invest. CF from Inv. Activity Inc./(Dec) in Networth Inc/(Dec) in Debt Interest Paid Dividends Paid CF from Fin. Activity Inc/(Dec) in Cash Add: Beginning Balance Closing Balance
2,299 50 979 -243 2,531 1,774 7,390 566

7,956 -10,077 -32 -10,109 740 4,060 -354 -480 3,966 1,813 954 2,766
2,853 463 2,601 -1,198 -970 27 3,775 685

4,460 -3,545 -390 -3,935 2,158 -772 -573 -674 139 664 2,766 3,431
5,980 139 2,471 -1,728 -1,514 0 5,348 285

5,633 -3,192 0 -3,192 -248 -200 -645 -872 -1,965 476 3,431 3,906
8,178 156 2,594 -1,922 -1,027 0 7,979 0

7,979 -5,000 0 -5,000 -1,028 0 -645 -969 -2,642 337 3,906 4,244
10,327 176 2,854 -2,465 -1,004 0 9,888 0

9,888 -5,000 0 -5,000 -1,449 0 -645 -1,066 -3,160 1,729 4,244 5,973
Fig 23 Ratio analysis @ `185

Basic (`) Diluted EPS Cons. Cons. EPS growth (%) Cash EPS Book Value per Share DPS Payout % Valuation (x) P/E Consolidated (Diluted) Cash P/E EV/EBITDA EV/Sales Price to Book Value Dividend Yield (%) Profitability Ratios (%) RoE RoCE Turnover Ratios Asset Turnover (x) Leverage Ratio Debt/Equity (x)
Source : Company, Bloomberg, Anand Rathi Research
3.4 -24.6 9.0 22.0 1.4 27.2
4.9 43.5 13.2 31.1 1.8 27.8
8.7 79.4 16.8 37.6 2.3 24.4
12.2 40.6 21.6 47.3 2.5 20.4
15.3 25.4 26.4 59.9 2.8 17.9
54.7 20.6 21.9 2.8 8.4 0.7 28.2 12.4 1.4 1.1
38.1 14.0 13.5 1.1 5.9 1.0 20.0 15.1 3.1 0.7
21.2 11.0 8.9 0.9 4.9 1.2 27.7 24.9 3.3 0.5
15.1 8.6 7.0 0.7 3.9 1.4 31.5 29.4 3.5 0.4
12.0 7.0 5.6 0.6 3.1 1.5 31.9 31.6 3.6 0.3
30
Auto Components
India I Equities
Update
22 February 2011
Bharat Forge
Ph-1 complete, ph-2 of re-rating on the anvil; Buy
We expect Bharat Forge, with its diversified business model and domestic market leadership, to register 49.1% consolidated profit CAGR over FY11-13e, given our view that the CV industry would see steady growth over FY11-13e and good overseas demand. We re-iterate our Buy with a target price of `396 (from `317).
Rohan Korde
Nirav Bhatt
To benefit from steady demand. Domestic auto demand is expected to follow a steady growth trend, while overseas markets too are showing signs of improvement. Given that BFL is the domestic market leader and earns ~60% revenue from overseas, we expect it to largely benefit from this growth. JVs, non-auto demand add to revenue. We expect BFLs four non-auto JVs to be operational by end-FY13. The JVs, to cater to power sector requirements, have strong revenue growth and profitability potential. Introducing FY13 estimates. We introduce FY13 estimates and expect sales of `72.2bn, EBITDA margin of 20.7% and EPS of `27.9 (40.9% yoy growth) by FY13. Valuation and risks. We value the stock at 20x FY12e PE. We believe that commencement of operations of JVs would trigger a re-rating of the stock. Our target price is `396. At present valuations, BFL trades at 16.1x FY12e EPS. Risks: slowdown in execution, delayed overseas recovery.
Key data
BHFC IN/BRFG.BO `413/`232 18212 / 5459 US$4.1m `48.97bn/US$1.65bn 232.9m 58.0% 42.1% 14.1% 18.8% 25.0%
Key financials
Relative price performance

47,740 1,518 6.2 -47.1 51.4 4.3 2.5 9.1 0.3 54.4 33,276 153 0.6 -89.9 509.8 4.9 -5.2 3.7 0.3 55.1 48,203 3,070 12.5 1,906.5 25.4 3.7 15.0 16.0 0.5 45.1 59,882 4,844 19.8 57.8 16.1 3.1 20.0 20.5 0.5 40.5 72,168 6,827 27.9 40.9 11.4 2.4 22.4 24.2 0.6 34.4
Source: Bloomberg
450 400 350 300 250 200 Dec-10 Feb-10 Jun-10 Aug-10 Feb-11 Apr-10 Oct-10 Sensex BHFC
Anand Rathi Financial Services Limited does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Disclosures and analyst certifications are located in Appendix 1 Anand Rathi Research India Equities
22 February 2011
Bharat Forge Ph-1 complete, ph-2 of re-rating on the anvil; Buy

Fig 1 Income statement (`m)
Fig 4 Standalone PE Band

48,203 44.9 39,382 8,820 18.3 1,694 2,941 537 1,610 2,989 3,070 1,906.5 12.5 25.5 1.5 59,882 24.2 48,239 11,643 19.4 1,779 3,089 590 2,505 4,862 4,844 57.8 19.8 34.1 1.8 72,168 20.5 57,232 14,936 20.7 1,779 3,274 649 3,687 6,847 6,827 40.9 27.9 43.5 2.0
500 450 400 350 300 18x 250 200 150 100 50 Aug-07 Mar-08 May-09 Oct-08 Nov-05 Dec-09 Feb-11 6x 5x Bharat Forge 4x 3x 300 200 100 0 Sep-05 Aug-08 Sep-10 Apr-05 Mar-08 Feb-06 Apr-10 May-07 Dec-06 Nov-09 Feb-11 Jan-09 Jun-09 Oct-07 Jul-06 2x 1x Apr-05 Jun-06 Jan-07 Jul-10 14x 10x Bharat Forge 30x 26x 22x
Net sales Sales growth (%) - Op. expenses EBIDTA EBITDA margins (%) - Interest - Depreciation + Other income - Tax Rep PAT before MI Adjusted PAT Adj. PAT growth (%) FDEPS (`/share) CEPS (`/share) DPS (`/share)
47,740 2.6 42,176 5,565 11.7 1,291 2,517 687 696 411 1,518 -47.1 6.2 13.1 1.0
33,276 -30.3 29,891 3,385 10.2 1,303 2,451 511 119 -764 153 -89.9 0.6 7.6 1.0
Source: Bloomberg, Anand Rathi Research
Fig 2 Balance sheet (`m)

Fig 5 Standalone Price-to-Book Band

445 14,185 14,630 22,527 1,754 38,911 26,065 2,737 4,132 5,977 38,911 223 113.1 43 466 19,461 19,927 18,510 1,754 40,191 22,636 2,737 9,547 5,270 40,191 233 66.4 62 466 23,830 24,296 18,510 1,754 44,560 22,048 3,737 12,195 6,580 44,560 233 49.1 60 466 30,114 30,580 18,510 1,754 50,844 21,274 5,737 15,201 8,631 50,844 233 32.3 60
800 700 600 500 400
445 16,223 16,669 21,908 2,563 41,140 27,902 2 8,352 4,883 41,140 223 102.1 50

Fig 6 Bharat Forge v/s BSE Auto

4,269 2,941 7,211 5,415 1,796 -487 2,283 407 2,715 -4,017 0 1,280 -706 5,977 5,270 6,050 3,089 9,139 2,648 6,491 2,500 3,991 475 -18 0 1,000 1,188 1,310 5,271 6,580 7,976 3,274 11,250 3,007 8,243 2,500 5,743 543 -19 0 2,000 1,129 2,051 6,580 8,631
450 400 350 BSE Auto 300 BHFC 250 200 Feb-10 Aug-10 Dec-10 Feb-11 Jun-10 Oct-10 Apr-10
Reported PAT + Depreciation Cash profit - Incr/(Decr) in WC Operating cash flow - Capex Free cash flow - Dividend + Chg. in net worth + Debt raised - Investments - Misc. items Net cash flow + Opening cash Closing cash
3,018 2,517 5,536 3,172 2,363 6,812 -4,449 260 -23 5,364 -2,986 1,919 1,700 3,183 4,883
-69 2,451 2,382 -4,220 6,602 619 5,983 271 -1,003 618 2,735 1,499 1,094 4,883 5,977
Source: Bloomberg
32
22 February 2011

We expect Bharat Forge, with its diversified business model and domestic market leadership, to register 49.1% consolidated profit CAGR over FY11-13e, given our view that the CV industry would see steady growth over FY11-13e and good overseas demand. We reiterate our Buy with a target price of `396 (from `317). Beneficiary of demand improvement Domestic auto demand is expected to follow a steady growth trend, while overseas markets, too, are showing signs of improvement. Given that Bharat Forge is a market leader in India and that it earns around ~60% of revenue from overseas, we expect it to be a major beneficiary of the industrys growth ahead. For example, in 3QFY11, the recovery in CV demand and good PV demand has resulted in BFLs revenue growing 50.2% yoy and 11.2% qoq. Production tonnage has improved from a low 18,246 in 4QFY09 to ~35,000 in 3QFY10 and now to ~48,000 tons. Overseas demand recovery and nonauto demand would be the next big growth drivers JVs, non-auto demand add to revenues We expect Bharat Forges four non-auto JVs to be operational by around FY13-end. These JVs to cater to the power sector requirements have good revenue growth and profitability potential. These would add significantly to BFLs revenues and profitability in the long run. Continued robust operating performance Bharat Forge has seen a consistent increase in sales for the past seven quarters, driven by strong growth in exports (driven by new products and customers in US and Europe), higher revenues from the non-automotive business, improved market share and programme ramp-up (in both nonautomotive and automotive). These, along with the companys efforts to lower its breakeven point, sustained efforts to reduce costs, better capacity utilization and improved performance of subsidiaries, have helped it regain its past normalised EBITDA margin of ~24% for its standalone operations and ~18% for its consolidated operations. Valuations In the past, Bharat Forge has commanded a premium to other forgings companies due to its pioneering dual-shore model, diversified nature and healthy EBITDA margin. At present, to work out our target price, the JVs have not been taken into account, as they are likely to commence only by FY13-end. They would, however, be significant value-drivers once they begin operations. We value the stock at 20x FY12e. Our target price is `396. At current valuations, Bharat Forge trades at 16.1x FY12e EPS.
33
22 February 2011
Risks
Currency fluctuations: The rising proportion of exports (both to the US and Europe) in total revenue would raise currency fluctuation risks. The movement of the rupee against the US dollar and the euro would play an important role. Execution risk: Given the nature of new greenfield projects involved, there remains an execution risk. Inability to turn around subsidiaries: Most of BFLs acquisitions were bankrupt companies. Therefore, there is an inherent risk that it may not be able to turn them around or sustain the operations at improved levels
34
22 February 2011
Beneficiary of demand improvement

Domestic auto demand is expected to follow a steady growth trend, while overseas markets, too, are showing signs of improvement. Given that Bharat Forge is a market leader in India and that it earns around ~60% of revenue from overseas, we expect it to be a major beneficiary of the industrys growth ahead, both domestically and internationally. The recovery in CV demand and good PV demand has resulted in BFLs consolidated revenue growing 50.2% yoy and 11.2% qoq in 3QFY11. Production tonnage has improved from a low 18,246 in 4QFY09 to ~35,000 in 3QFY10 and now to ~48,000 tons. BFLs FY11 performance reflects the steady recovery in the global auto industry and strong performance in the domestic M&H CV sector. The move towards greater non-auto share in production is also paying good dividends for Bharat Forge.
Fig 7 Indias CV volumes and Bharat Forges domestic standalone sales
(Nos.) 210,000 190,000 170,000 150,000 130,000 110,000 90,000 70,000 1QFY09 2QFY09 3QFY09 4QFY09 1QFY10 2QFY10 3QFY10 4QFY10 1QFY11 2QFY11 3QFY11 (`m) 5,000 4,500 4,000 3,500 3,000 2,500 2,000 1,500
Total CV sales
Source: Company, SIAM
Standalone domestic revenues (RHS)
Fig 8 M&HCV sales and impact on Bharat Forges EBITDA margin

(units) 90,000 80,000 70,000 60,000 50,000 40,000 30,000 20,000 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q FY11 3Q (%) 29 27 25 23 21 19 17 15
FY09 M&HCV sales

Source: Company, SIAM
FY10 EBITDA margin (RHS)
Exports contribute ~40% of BFLs revenue (standalone), with overseas sales (including those of overseas subsidiaries) bringing in around ~60% of its (consolidated) revenue. The overseas subsidiaries have borne the brunt of the global slump in automobile demand, with their sales falling
35
22 February 2011
45-75% in FY10. The steady improvement in demand overseas has benefited Bharat Forges overseas revenues as well, with the growth expected to be sustained ahead.
Fig 9 Decline and recovery in Bharat Forges standalone exports
(`m) 4,000 3,500 3,000 2,500 2,000 1,500 1,000 1QFY09 2QFY09 3QFY09 4QFY09 1QFY10 2QFY10 3QFY10 4QFY10 1QFY11 2QFY11 3QFY11
Source: Company
In FY09, Bharat Forges exports to the US were `4,359m, dropping from `4,855m the year prior. As a result, Europe overtook the US as the major importer of the companys products. However, with US demand expected to recover strongly on the back of the oldest fleet of trucks in recent history, demand recovery there is expected to be extremely robust.
Fig 10 Bharat Forges consolidated region-wise revenue breakup
(%) 60
50 40 30 20 10 0 India Europe FY09
Source: Company
USA FY10
Asia Pacific
Fig 11 Bharat Forges consolidated segment-wise revenue breakup

(%) 35
30 25 20 15 10 Commercial Vehicle Diesel Engine Passenger Vehicle Non Auto
FY09
Source: Company
FY10
36
22 February 2011
We expect the domestic CV sector to sustain good growth ahead, at a CAGR of 13.1% over FY11-13e. The global automobile market recovery ahead, after bottoming out in 2009-2010, is an added positive. As a significant proportion of its revenue derives from overseas and because of its leading position in India, Bharat Forge would be the prime beneficiary of an FY12 recovery.
Fig 12 Bharat Forge: Rise in revenue (FY06-FY12e)
(%) 80 60 40 20 0 -20 -40 FY11e FY12e Consolidated FY06 FY07 FY08 FY09 FY10
Standalone Domestic
Standalone Exports
Total Standalone
CV demand in the US and Europe to be robust Recent data released by FTR Associates (a leading North American transportation forecaster) on truck sales, indicates that Class 8 (heavy commercial vehicle) truck orders for major North American OEMs have shown consistent high percentage-point increases in the last five months. January Class 8 truck net orders were 27,009 units for major North American OEMs, a modest 1% mom increase but 324% yoy. These order levels were also the highest since May 06.
Fig 13 North America Class 8 and 4-7 production (000)
Source: FTR Associates
Ahead, FTR expects orders to show a normal seasonal increase to a level of between 22,000-25,000 units a month. Since the orders for class 8 trucks are showing exceedingly high growth rates, we expect the positive spillover effect to impact M&HCV (class 4-7 trucks) segment as well. All these point to the fact that truckers are willing to start ordering equipment, indicating a recovery for the truck-equipment market in North America. We think that most of these orders would come from leasing companies
Anand Rathi Research 37
22 February 2011
and large fleets; small and medium-sized companies would also participate in this recovery.
Fig 14 U.S. truck freight-ton miles
(Trillions) 3 2.9 2.8 2.7 2.6 2.5 2.4 2.3 2.2 2.1 CY04 CY05 CY06 CY07 CY08 CY09 CY10 CY11 CY12
472 380 303 100 0 CY04 CY05 CY06 CY07 CY08 CY09 CY10 CY11 CY12 196
2.85 2.78
2.89
2.90 2.74 2.65 2.54 2.42 2.78
Source: FTR Associates
As per ACEA (European Automobile Manufacturers Association) data, the European CV market is also in a recovery phase. In Dec 10, demand for new commercial vehicles continued to soar (+12.5% yoy) in all subsegments, except buses and coaches (-1.4% yoy). In CY10, EU markets for vans and trucks expanded while registrations of buses and coaches fell, leading to an overall 8% growth in Europe. As a result, European truck manufacturers have substantially increased production levels, indicating restocking by vendors on improved demand.
Fig 15 Western Europe medium and heavy truck production GVW>6t (000)
('000) 600 500 400 300 200 422 442 478 535
545
Source: JD Power and Associates
38
22 February 2011
JVs, non-auto demand add to revenues

We expect Bharat Forges four non-auto JVs to be operational by around FY13-end. These address power sector requirements, have good revenue growth and profitability potential and would add significantly to BFLs revenues and profitability in the long run. Non-automotive segment a growth driver The non-automotive business, which comes from the industrial and oil & gas industries, currently accounts for 19% of BFLs consolidated and ~38% of its standalone sales. Due to the ongoing capex in the Indian economy and large-scale global oil & gas exploration, BFLs expects strong growth in this segment. Forgings have varied industrial applications in turbines for power plants, in parts of aircraft, in machined parts for the steel and cement industries, and in rigs for oil exploration. The greater share of revenue from the non-auto segment would increasingly de-risk BFLs business model, and result in a diversified product range. The sharper focus on the non-automotive business would see the higher proportion of CVs in the global revenue mix declining a little. The non-automotive business remains a lucrative segment for BFL.
Fig 16 Bharat Forges non-automotive capacity
Plant Capacity
Baramati
Baramati
Mundhwa
Source: Company
An 80-metre counterblow hammer for production of heavy forgings for large diesel engines and aerospace applications, and a machining line for heavy-duty and medium-duty crankshafts. Commenced operations in Mar 09. Completed installation of a ring-rolling mill capable of rolling rings up to 4.5 metres in diameter and 50mm in height, along with its blanking press. Operational in Jun 09. Secured orders from wind-turbine and large gearbox manufacturers from global OEMs. A 4,000-ton open-die forgings press, commissioned in Aug 08 and now fully operational.
Fig 17 Bharat Forge: Growth in share of non-automotive revenue (FY05-12e)

(%) 40 35 30 25 20 15 10 5 0 FY11e FY12e FY05 FY06 FY07 FY08 FY09 FY10
Source: Company, Anand Rathi research
Entry into the non-automotive space would further de-risk BFLs business model and this segment is expected to contribute up to 40% of global revenues by FY12 (17% in FY07, and 20% in FY10e).
39
22 February 2011
JVs Through its joint ventures with Alstom and NTPC, Bharat Forge would be tapping growth in segments where demand is high and supply is constrained.
Fig 18 Details of Bharat Forges new JVs
JVs Description
BF-NTPC
BF-Alstom BF-Alstom 1 (BF 49%) BF-Alstom 1 (BF 51%)
BF - Areva
Source: Company
Energy Systems (BFL 51%) - aimed at the power sector, in the balance-of-plant space. High-pressure piping, pumps, valves, related forgings and castings. A business plan would be developed on the appointment of a consultant. To manufacture sub-critical and super-critical turbines and generators at a port in India. Aims at further exploring possibilities for manufacturing turbines and generators for gas and nuclear power plants. Plants of these companies are expected to be ready by 2012. To manufacture 5000 MW of turbines and generators of 300-800 MW+ range annually for coal-based power plants. To manufacture sub-critical and super-critical turbines and generators at a port-based location in India. To manufacture a range of heat exchangers, condensers, de-aerators, and other auxiliaries for these power plants. To build a plant for heavy forgings in India. Would meet requirements of the indigenous power-generation sector. Exploring locations, JV would have a state-of-the-art 14,000-ton open-die forgings press with associated equipment and an integrated steel-making facility.
40
22 February 2011
Continued robust operating performance

Successive sales increases, strong growth in exports, higher nonautomotive revenues, capacity increases, efforts to lower breakeven point and sustained efforts to reduce costs have helped Bharat Forge regain its past normalised EBITDA margin of ~24% for standalone operations and ~18% for consolidated operations. Bharat Forge has seen a consistent increase in sales for the past seven quarters, driven by strong growth in exports (driven by new products and customers in US and Europe), higher revenues from the non-automotive business, improved market share and program ramp-up (in both nonautomotive and automotive). These, along with the companys efforts to lower its breakeven point, sustained efforts to reduce costs, better capacity utilization and improved performance of subsidiaries, have helped it regain its past normalised EBITDA margin of ~24% for its standalone operations and ~18% for its consolidated operations. The recovery in CV demand and good PV demand has resulted in BFLs consolidated revenue growing 50.2% yoy and 11.2% qoq in 3QFY11. Production tonnage has improved from a low 18,246 in 4QFY09 to ~35,000 in 3QFY10 and now to ~48,000 tons. In 3QFY11 volumes were up 4.3% qoq due to strong growth in exports and continued ramp-up of non-automotive capacities. The 3QFY11 standalone EBITDA margin improved 90bps yoy and 10bps qoq to 24.3%, while EBITDA increased 58% yoy and 8% qoq. The yoy improvement in the EBITDA margin came mainly from the lower staff cost-to-sales ratio (60bps lower yoy and 10bps qoq), lower manufacturing cost-to-sales ratio (80bps lower yoy but qoq 40bps higher) and lower other expenditure to sales (60bps qoq lower but 10 bps higher yoy). The 3QFY11 standalone adjusted PAT increased more than 2x yoy. The share of the non-automotive business to sales increased to 37%, from 26% in 3QFY10, due to the ramp-up of new programmes at the new dedicated facilities, as well as to increase in market share with existing clients. Consolidated performance BFLs 3QFY11 combined performance (India + overseas operations excl. China) marked the continuing qoq improvement as subsidiaries did well, driven by strong international operations due to a recovery in the European CV market. Revenue growth was 11.2% qoq and 50.2% yoy; the adjusted PAT increased 29.9% qoq to `787m. There was an exceptional expense of `81m for a one-time cost incurred regarding concessions on labour union negotiations in Bharat Forge America as well as on business transfer expenses from Bharat Forge Scottish Stampings. The company said that the non-auto growth stemmed from new customer additions, higher value-addition of critical components and expanded product range. In CYFY11, it expects a better performance from subsidiaries post-restructuring, better capacity utilization and cost control.
41
22 February 2011
Financials
We expect a 22.4% CAGR in Bharat Forges consolidated revenues from FY11 to FY13e, with the EBITDA margin improving from 10.2% to 20.7% and an adjusted net profit CAGR of 49.1%. We expect a 24.2% CAGR in Bharat Forges (standalone) revenue from FY11 to FY13e, but a 220bps EBITDA margin decline, and a 26% CAGR in the standalone adj. net profit. We expect a 22.4% CAGR in (consolidated) revenue from FY11 to FY13e, backed by robust EBITDA margin improvement. The margin improvement in subsidiaries would be driven by higher capacity utilization, following mounting demand in the global auto market. We expect a 49.1% CAGR in the consolidated adj. net profit from FY11 to FY13e.
Fig 19 Bharat Forge: Improvement in net profit (FY05-FY12e)
(`m) 4,800 4,000 3,200 2,400 1,600 800 0 FY11e FY12e FY05 FY06 FY07 FY08 FY09 FY10
S/a PAT
Cons PAT
Fig 20 Bharat Forge: Improvement in EBITDA (FY05-FY12e)

(`m) 13,500 12,000 10,500 9,000 7,500 6,000 4,500 3,000 FY11e FY12e FY05 FY06 FY07 FY08 FY09 FY10 (%) 29 26 23 20 17 14 11 8
S/a EBITDA S/a EBITDA margin (RHS)

Cons EBITDA Cons EBITDA margin (RHS)
42
22 February 2011
Fig 21 Bharat Forge: Increase in capacity utilization (FY04-FY12e)

(%) 100 90 80 70 60 50 40 FY11e FY12e FY04 FY05 FY06 FY07 FY08 FY09 FY10
Steel Forgings
Finished Machined Crankshaft
Introducing FY13e We introduce FY13 estimates; we expect sales of `72.2bn, EBITDA margin of 20.7% and EPS of `27.9 (40.9% yoy growth).
43
22 February 2011
Fig 22 Income statement

Net Sales Change (%) Operating Other Income Total Income Expenditure EBITDA Change (%) % of Net Sales Depreciation Interest & Finance Charges Other Income Exceptional Expenses Non-recurring Income PBT Tax Effective Rate (%) PAT Change (%) Adj. PAT Change (%)
46,730 2.4 1,011 47,740 42,176 5,565 -21.0 11.7 2,517 1,291 687 1,336 0 1,107 696 62.9 411 -85.9 1,518 -47.1
32,616 -30.2 660 33,276 29,891 3,385 -39.2 10.2 2,451 1,303 511 787 0 -645 119 -18.4 -764 -286.0 153 -89.9
47,477 45.6 726 48,203 39,382 8,820 160.6 18.3 2,941 1,694 537 123 0 4,599 1,610 35.0 2,989 -491.0 3,070 1,906.5
59,084 24.4 799 59,882 48,239 11,643 32.0 19.4 3,089 1,779 590 0 0 7,367 2,505 34.0 4,862 62.6 4,844 57.8
71,290 20.7 878 72,168 57,232 14,936 28.3 20.7 3,274 1,779 649 0 0 10,533 3,687 35.0 6,847 40.8 6,827 40.9
Fig 23 Balance sheet

Sources of Funds Share Capital Equity Capital Reserves Net Worth Minority interest Loans Capital Employed Application of Funds Gross Fixed Assets Less: Depreciation Net Fixed Assets Capital WIP Investments Curr.Assets, L & Adv. Inventory Sundry Debtors Cash & Bank Balances Loans & Advances Others Current Liab. & Prov. Current Liabilities Net Current Assets Miscellaneous Expenditures Application of Funds
445 445 16,223 16,669 954 21,908 41,140 40,271 15,594 24,676 3,219 2 25,316 7,916 5,313 4,883 5,784 1,420 12,081 8,538 13,236 0 41,140
445 445 14,185 14,630 783 22,527 38,911 41,340 17,267 24,073 1,987 2,737 24,171 6,575 5,044 5,977 5,204 1,372 14,062 11,164 10,109 0 38,911
466 466 19,461 19,927 783 18,510 40,191 42,840 20,208 22,632 0 2,737 27,415 8,065 6,504 5,270 6,204 1,372 12,597 9,932 14,817 0 40,191
466 466 23,830 24,296 783 18,510 44,560 45,340 23,297 22,043 0 3,737 32,962 9,712 8,094 6,580 7,204 1,372 14,187 11,522 18,775 0 44,560
466 466 30,114 30,580 783 18,510 50,844 47,840 26,571 21,269 0 5,737 39,692 11,719 9,766 8,631 8,204 1,372 15,859 13,194 23,833 0 50,844
44
22 February 2011
Fig 24 Ratios @`319

Basic (`) EPS Consolidated Diluted EPS Cons. Cons. EPS growth (%) Cash EPS Book Value per Share DPS Payout % Valuation (x) P/E Consolidated (Diluted) Cash P/E EV/EBITDA EV/Sales Price to Book Value Dividend Yield (%) Profitability Ratios (%) RoE RoCE Turnover Ratios Asset Turnover (x) Leverage Ratio Debt/Equity (x)
2.6 6.2 -47.1 13.1 74.8 1.0 63.4 51.4 24.2 15.8 1.9 4.3 0.3 2.5 9.1 1.1 1.3
-2.8 0.6 -89.9 7.6 65.7 1.0 -35.5 509.8 42.1 25.0 2.6 4.9 0.3 -5.2 3.7 0.8 1.5
12.8 12.5 1,906.5 25.5 85.6 1.5 13.6 25.4 12.5 9.6 1.8 3.7 0.5 15.0 16.0 1.2 0.9
20.8 19.8 57.8 34.1 104.3 1.8 9.8 16.1 9.3 7.1 1.4 3.1 0.5 20.0 20.5 1.3 0.8
29.3 27.9 40.9 43.5 131.3 2.0 7.9 11.4 7.3 5.2 1.1 2.4 0.6 22.4 24.2 1.4 0.6
Fig 25 Cash flow statement

OP/(Loss) before Tax Interest/Div. Received Depreciation & Amort. Direct Taxes Paid (Inc)/Dec in Wkg. Capital Other Items CF from Op. Activity Extra-ordinary Items CF after EO Items (Inc)/Dec in FA+CWIP (Pur)/Sale of Invest. CF from Inv. Activity Inc./(Dec) in Networth Inc/(Dec) in Debt Interest Paid Dividends Paid CF from Fin. Activity Inc/(Dec) in Cash Add: Beginning Balance Closing Balance
3,047 687 2,517 -29 -3,172 22 3,072 -1,336 1,736 -6,812 2,986 -3,826 -23 5,364 -1,291 -260 3,790 1,700 3,183 4,883
934 511 2,451 -1,003 4,220 79 7,192 -787 6,405 -619 -2,735 -3,353 -1,003 618 -1,303 -271 -1,959 1,093 4,883 5,976
5,879 537 2,941 -1,610 -5,415 0 2,333 -123 2,210 487 0 487 2,715 -4,017 -1,694 -407 -3,403 -706 5,977 5,270
8,555 590 3,089 -2,505 -2,648 0 7,081 0 7,081 -2,500 -1,000 -3,500 -18 0 -1,779 -475 -2,272 1,310 5,270 6,580
11,662 649 3,274 -3,687 -3,007 0 8,892 0 8,892 -2,500 -2,000 -4,500 -19 0 -1,779 -543 -2,341 2,051 6,580 8,631
45
Auto Components
India I Equities
Update
22 February 2011
Exide Industries
Industrial slowdown impact; maintain Hold
Its industry dominance and backward integration measures are long-running positives for Exide. However, slowdown in industrial demand and hence lower pricing power, short-term capacity constraints and fair valuations lead us to re-iterate our Hold rating.
Rating: Hold Target Price: `149 Share Price: `130
Rohan Korde
4Q to be subdued. Capacity commissioning for Exides auto segment in Apr 11 would help it address replacement demand, which is now inadequately serviced. However in 4Q, weaker demand from the industrial segment and continuing capacity constraints in the auto segment are likely to temper Exides sales growth and profitability. Industrial segment slowdown. The slowdown in user segments, power, telecoms and railways, led to sluggish demand. Poor demand has lowered Exides pricing power in the industrialbattery segment, where it had been able to pass on price increases. Change in estimates. We reduce our FY12e EBITDA margin for Exide, by 3%, partially set off by higher other income, thereby lowering our FY12e standalone EPS, by 3.8%. Valuation and risks. We value the standalone business at oneyear forward PE of 16x. We value Exides stake in ING Vysya Life Insurance at `12. Our target price is `149 (from `128). We retain our Hold. Risks: Upside: recovery in industrial demand, lower lead prices. Downside: auto demand slowdown, delayed capex, industrial demand and pricing power being further lowered.
Nirav Bhatt
Key data
EXID IN/EXID.BO `180/`105 18212 / 5459 US$6.8m `107.9bn/US$2.5bn 850m 54.0% 46.0% 15.5% 16.4% 22.1%
Key financials

33,929 3,207 3.8 39.0 34.6 8.3 25.7 33.4 0.5 33.9 37,940 5,229 6.2 63.0 21.2 5.0 23.6 33.9 0.8 20.8 44,974 6,006 7.1 14.9 18.5 4.0 21.8 29.1 1.0 17.7 58,739 7,270 8.6 21.0 15.3 3.3 21.7 30.1 1.1 18.7 69,706 8,580 10.1 18.0 12.9 2.7 21.1 30.5 1.3 11.5
Source: Bloomberg
180 170 160 150 140 130 120 110 100 Aug-10 Feb-10 Jun-10 Apr-10
EXID
Sensex
Dec-10
Oct-10
Feb-11
22 February 2011
Exide Industries Industrial slowdown impact; maintain Hold

Fig 4 PE Band
44,974 18.5 36,596 8,378 18.6 54 818 892 2,583 6,392 6,006 14.9 7.1 8.0 1.3 58,739 30.6 48,153 10,586 18.0 54 937 903 3,228 7,270 7,270 21.0 8.6 9.7 1.5 69,706 18.7 56,746 12,960 18.6 54 1,025 925 4,226 8,580 8,580 18.0 10.1 11.3 1.8
Net sales Sales growth (%) - Op. expenses EBIDTA EBITDA margins (%) - Interest - Depreciation + Other income - Tax Reported PAT Adjusted PAT Adj. PAT growth (%) FDEPS (Rs/share) CEPS (Rs/share) DPS (Rs/share)
33,929 19.3 27,939 5,990 17.7 479 679 65 1,510 2,843 3,207 39.0 3.8 4.9 0.6
37,940 11.8 29,231 8,709 23.0 139 807 121 2,735 5,371 5,229 63.0 6.2 7.1 1.0
240 26x 200 22x 160 120 80 40 0 Aug-07 Apr-05 Mar-08 Nov-05 May-09 Dec-09 Feb-11 6x 5x 4x Exide Industries 3x 2x 1x Jun-06 Jan-07 Oct-08 Jul-10 Exide Industries 18x 14x 10x 6x

Fig 5 Price-to-Book Band

850 21,348 22,198 900 590 23,688 7,144 13,354 3,161 29 23,688 850 3.9 41 850 26,677 27,527 900 590 29,017 10,077 14,354 3,981 605 29,017 850 1.1 41 850 32,672 33,522 900 590 35,012 11,640 16,854 6,332 186 35,012 850 2.1 46 850 39,765 40,615 900 590 42,105 11,615 19,354 7,714 3,421 42,105 850 -6.2 46
240 200 160 120
800 11,704 12,504 3,172 412 16,087 6,853 6,682 2,215 337 16,087 800 22.7 36
80 40 0 Aug-07 Apr-05 Mar-08 May-09 Nov-05 Dec-09 Feb-11 Jun-06 Jan-07 Oct-08 Jul-10

Year end 31 March FY09 FY10e FY11e FY12e FY13e
Fig 6 Exide vs BSE Auto

4,978 818 5,795 821 4,975 3,750 1,225 1,063 0 0 1,000 -1,414 576 29 605 6,421 937 7,358 2,351 5,007 2,500 2,507 1,275 0 0 2,500 -849 -419 605 186 7,709 1,025 8,734 1,382 7,352 1,000 6,352 1,488 0 0 2,500 -871 3,235 186 3,421
180 170 160 150 140 BSE Auto 130 120 110 100 Aug-10 Apr-10 Dec-10 Jun-10 Feb-10 Oct-10 Feb-11 EXID
Reported PAT + Depreciation Cash profit - Incr/(Decr) in WC Operating cash flow - Capex Free cash flow - Dividend + Equity raised + Debt raised - Investments - Misc. items Net cash flow + Opening cash Closing cash
3,734 679 4,413 -808 5,221 1,515 3,706 480 0 -326 1,499 1,081 320 17 337
5,346 807 6,152 945 5,207 1,098 4,109 850 50 -2,272 6,672 -5,327 -308 337 29
Source: Bloomberg
47
22 February 2011

Its industry dominance and backward integration measures are longrunning positives for Exide Industries. However, the slowdown in industrial demand and hence lower pricing power, short-term capacity constraints and fair valuations lead us to re-iterate our Hold rating. 4QFY11 to be subdued Exide is expected to temper the rise in lead prices by increased in-house sourcing of the raw material from its lead smelters. The commissioning of its automobile-battery capacities, in Apr 11, would help it address replacement demand, which is now inadequately serviced. However, in 4Q, weaker demand for industrial batteries and continuing capacity constraints in its automobile-battery division are likely to temper Exides sales growth and profitability. Moreover, delayed recovery in industrial demand would lead to further lowering of our FY12 estimates. Industrial-batteries division slowdown The industrials segment, encompassing power, telecoms, railways, is seeing sluggish demand due to a slowdown in user segments. Additionally, poor demand has lessened Exides pricing power in a segment where, in the past, it had been able to pass on price increases. The slowdown, which commenced in telecoms, has been more widespread in 3Q, as it affected demand for power inverters. Replacement demand, key trigger in the automobile-battery division The automobile OEM sector would register lower growth ahead, but the good 14% CAGR in auto volumes from FY02 to FY11 has generated high potential for replacement demand. Moreover, the high-volume Nano is a potential trigger when production accelerates. The completion of Exides capex in 1QFY12 would address replacement demand, which is now inadequately serviced due to higher demand from OEMs. Valuations We value Exides standalone business at one-year forward standalone PE of 16x (average of the past two years one-year-forward PE; the past six years average is 15x). We value Exides stake in ING Vysya Life Insurance at `12. Our new target price is `149 (from `128). We retain our Hold rating. Upside risks

A faster-than-anticipated recovery in demand in Exides industrialbattery division. Lower lead prices. A lower economic interest in the insurance business would lower Exides target price to that extent. Imports are a significant threat to Indian battery manufacturers. Exide has strong brand equity and products at various prices. Hence, its OEM-segment share is unlikely to be hit. However, imports could
48
Downside risks

22 February 2011
impact its replacement-market sales.

Delayed capex. Industrial demand and pricing power being further lowered.
49
22 February 2011
4QFY11 to be subdued
In 4Q, weaker demand in Exides industrial-battery division and continuing capacity constraints in its automobile-battery division are likely to temper its sales growth and profitability. Moreover, recovery in industrial demand, if delayed, would lead to a lowering of FY12 estimates. 3Q performance reflected industrial slowdown and lower replacement demand Exides 3QFY11 sales rose only 15% yoy to `10.5bn, due to capacity constraints in its automobile-battery division and weaker performance in its industrial-battery division. Its EBITDA margin slid 800bps yoy to 14.7%. The company says this was chiefly due to: i) more OEM sales, diverting capacity from the replacement segment; ii) lack of buoyancy in the industrials segment; iii) high commodity prices lead prices rose 18.4% qoq and 4% yoy; and iv) cautiousness in passing on costs in the replacement market. Exides adjusted profit declined 1.5% yoy to `1.2bn; this was lower than its EBITDA decline owing to considerably low interest costs and significantly higher other income. Demand not being serviced OE demand is buoyant and Exide is a strong player with OE relationships built over the years; this could also have a reverse effect. In 3QFY11, Exide looked to supply more to OEMs in order to maintain this relationship. Hence, the OE to replacement (& trade) ratio has been adverse in 3QFY11. For the past four or five years, the replacement-OE ratio was 1.4:1 or 1.45:1. In the downturn, when OE sales crashed, the ratio went to 1.6:1. In FY10, it was 1.61:1; the FY11 target was 1.65:1. In 1QFY11, this went to 1.32:1, while in 3QFY11, this was further lower at 1.17:1. Although the ratio has grown increasingly adverse, the two-year target is 1.75:1. Exide is expected to temper the rise in lead prices by increased in-house sourcing of the raw material from its lead smelters. Its commissioning of capacities in its automobile-battery division, in Apr 11, would help it address replacement demand, which is now inadequately serviced. However, in 4Q, weaker demand for industrial batteries and continuing capacity constraints in its automobile-battery division are likely to temper its sales growth and profitability. Moreover, recovery in industrial demand, if delayed, would lead to a lowering of FY12 estimates.
50
22 February 2011
Fig 7 Exide: EBITDA margin trend

(`m) 3,000 2,600 2,200 1,800 17.5 1,400 1,000 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q FY11 3Q 17.4 16.8 14.7 18.5 21.7 19 16 13 22.7 25.8 20.8 22.4 (%) 28 25 22
23.1
FY09 EBITDA
Source: Company
FY10 As a % of Sales (RHS)
51
22 February 2011
Industrial segment slowdown

The industrials segment, encompassing power, telecoms, railways, is seeing sluggish demand due to a slowdown in user segments. Additionally, poor demand has lessened Exides pricing power in a segment where, in the past, it had been able to pass on price increases. Exide is strongly represented in industrial batteries, with a 55% market share. This division (batteries for industry) brings in about 35-40% of its revenue. The industrial division, manufacturing batteries for power equipment, telecoms, the railways, etc., has seen lower demand due to sluggish telecom demand, higher power generation leading to lower requirement of inverters, and lower pricing power due to the lower demand. Unlike in the OEM battery segment, Exide has higher pricing power in the industrial-battery segment. It would frequently hike prices of batteries for the industrial segment, particularly for inverters and UPS. Its pricing power in this segment helped it sustain profitability even when other auto-parts companies started feeling their profitability pinch. In the present context, though, this is no longer true. Hence, the scope for greater profitability stands substantially reduced. Commodity price risk escalates The cost of lead comprises 70% of raw material cost for batteries. Lead prices corrected off their peak of US$3,800 a ton in 3QFY08 to less than half that, at US$1,500 in 1QFY10. Subsequently, it has steadily risen to ~US$2,500 a ton. Weak industrial demand raises concerns since Exide would not be able to pass on lead price increases.
Fig 8 Lead prices (Apr 06-Feb 11)
($/tonne) 3,800 3,300 2,800 2,300 1,800 1,300 800 Oct-06 Oct-07 Oct-08 Oct-09 Jan-07 Jan-08 Jan-09 Jan-10 Oct-10 Jan-11 Apr-06 Apr-07 Apr-08 Apr-09 Apr-10 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10
LME cash
Source: LME
52
22 February 2011
Fig 9 Exide: Raw material costs-to-sales trend

(`m) 8,200 7,600 63.7 7,000 6,400 5,800 5,200 4,600 4,000 1Q 2Q 3Q 4Q 1Q 55.1 2Q 3Q 4Q 1Q 2Q FY11 3Q 61.6 60.1 58.3 58.0 60.0 59.4 64 62 60 58 56 54 67.4 65.6 65.5 (%) 68 66
FY09 Raw-material
FY10 As a % of Sales (RHS)
53
22 February 2011
Replacement-demand recovery, the key

The good 14% CAGR in automobile volumes from FY02 to FY11 has generated high potential for replacement demand. Completion of Exides capex in 1QFY12 would help it address replacement demand, which is now inadequately serviced due to higher supply pressure from OEMs. Exide dominates the car-battery market, with a ~50% share, and is the leader in the organised sector for replacement batteries. Being a market leader, it is ensured steady volume growth, offsetting lower margins in OEM sales through greater economies of scale. Further, its well-established connection with OEMs helps brand-building and goodwill, boosting replacement-market sales and offering greater pricing power than the competition. Implementation of the more stringent norms pertaining to recycling of used batteries is another positive trigger. This would reduce the number of unorganised players in the replacement market. The auto OEM segment would register relatively lower growth ahead, but the good 14% CAGR in auto volumes from FY02 to FY11 has generated great potential in replacement demand. Moreover, the high-volume Nano is a potential trigger ahead when production accelerates. Completion of Exides capex in 1QFY12 would help it address the replacement demand, which is now inadequately serviced due to higher supply pressure from OEMs. Further, Exide would benefit from the 13.7% CAGR expected in auto OEM sales growth over FY11-13e.
Fig 10 Auto OEM growth expected
(000' Nos.) 25,000 20,000 15,000 10,000 5,000 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY13e (%) 30 25 20 15 10 5 0 -5
Total Auto volumes
yoy change (RHS)
54
22 February 2011
Financials
We expect a 24.5% CAGR in Exides revenue from FY11 to FY13e, with a steady EBITDA margin of 18.6% and a 19.5% CAGR in adjusted net profit. We expect a 24.5% CAGR in Exides revenue, based on assumptions of timely completion of capex and better industrial demand in the next 2-3 years (than in 2HFY11). However, we lower our estimates to factor in more pressure from a further rise in the price of lead, short-term reduced supply to the auto replacement segment and lower demand and pricing power in the industrial-battery division. We also factor in higher other income on the back of an increase in dividend from subsidiaries (Leadage Alloys and Chloride Metals). Our revised EBITDA margin expectation is 18% for FY12e (3% lower). The net impact on our FY12e standalone EPS estimate is 3.8% lower. The expected volatility in commodity prices would only be partially neutralized by Exides backward integration step of purchasing lead smelters. We expect a 19.5% CAGR in adjusted net profit (standalone) from FY11 to FY13e.
Fig 11 Change in estimates
Previous estimate (`m) FY11e FY12e Revised estimate FY11e FY12e Change (%) FY11e FY12e
Income EBITDA EBITDA Margin (%) Adjusted PAT EPS (`)

Source: Anand Rathi Research
47,746 9,892 20.7 6,011 7.1
58,794 12,352 21.0 7,560 8.9
44,974 8,378 18.6 6,006 7.1
58,739 10,586 18.0 7,270 8.6
-5.8 -15.3 -0.1 -0.1
-0.1 -14.3 -3.8 -3.8
55
22 February 2011

Net Sales Change (%) Expenditure EBITDA Change (%) % of Net Sales Depreciation EBIT Interest & Finance Charges Other Income Non-recurring Expense Non-recurring Income PBT Tax Effective Rate (%) Adj. PAT (bef. Extra) Change (%) % of Net Sales Rep. PAT Change (%)
33,929 19.3 27,939 5,990 36.0 17.7 679 5,311 479 65 543 4,353 1,510 34.7 3,207 39.0 9.5 2,843 13.6
37,940 11.8 29,231 8,709 45.4 23.0 807 7,903 139 121 5 226 8,106 2,735 33.7 5,229 63.0 13.8 5,371 88.9
44,974 18.5 36,596 8,378 -3.8 18.6 818 7,560 54 892 576 8,974 2,583 28.8 6,006 14.9 13.4 6,392 19.0
58,739 30.6 48,153 10,586 26.4 18.0 937 9,649 54 903 10,498 3,228 30.8 7,270 21.0 12.4 7,270 13.7
69,706 18.7 56,746 12,960 22.4 18.6 1,025 11,935 54 925 12,806 4,226 33.0 8,580 18.0 12.3 8,580 18.0
Fig 13 Balance sheet

Share Capital Reserves Net Worth Loans Deferred Tax Liability Capital Employed Gross Fixed Assets Less: Depreciation Net Fixed Assets Capital WIP Investments Curr.Assets, L & Adv. Inventory Sundry Debtors Cash & Bank Balances Loans & Advances Current Liab. & Prov. Sundry Creditors Other Liabilities Provisions Net Current Assets Application of Funds
800 11,704 12,504 3,172 412 16,087 12,567 5,887 6,680 173 6,682 7,419 4,385 2,310 337 387 4,866 3,343 465 1,059 2,552 16,087
850 21,348 22,198 900 590 23,688 13,365 6,598 6,767 378 13,354 9,118 6,068 2,546 29 476 5,929 4,382 561 985 3,190 23,688
850 26,677 27,527 900 590 29,017 17,492 7,416 10,077 14,354 11,308 7,270 2,957 605 476 6,721 5,175 561 985 4,587 29,017
850 32,672 33,522 900 590 35,012 19,992 8,353 11,640 16,854 14,502 9,978 3,862 186 476 7,984 6,437 561 985 6,518 35,012
850 39,765 40,615 900 590 42,105 20,992 9,377 11,615 19,354 20,321 11,840 4,583 3,421 476 9,185 7,639 561 985 11,136 42,105
56
22 February 2011
Fig 14 Ratio @`130

Y/E MARCH FY09 3.8 2.7 4.9 39.0 15.6 0.6 15.0 FY10 6.2 5.8 7.1 63.0 26.1 1.0 16.3 FY11e 7.1 7.3 8.0 14.9 32.4 1.3 17.7 FY12e 8.6 8.9 9.7 21.0 39.4 1.5 17.5 FY13e 10.1 10.7 11.3 18.0 47.8 1.8 17.3
Basic (`)
Standalone Diluted EPS Consol. EPS Cash EPS EPS Growth (%) Book Value per Share DPS Payout (Incl. Div. Tax) % Valuation (x)
P/E Consol. P/E Cash P/E EV/EBITDA EV/Sales Price to Book Value Dividend Yield (%)
Profitability Ratios (%) RoE RoCE Turnover Ratios Asset Turnover (x) Leverage Ratio Debt/Equity (x) Source: Company, Anand Rathi Research
34.6 48.7 26.9 16.8 3.0 8.3 0.5

25.7 33.4 2.1 0.25
21.2 22.5 18.4 11.3 2.6 5.0 0.8

23.6 33.9 1.6 0.04
18.5 18.0 16.2 11.6 2.2 4.0 1.0

21.8 29.1 1.5 0.03
15.3 14.6 13.5 8.9 1.6 3.3 1.1

21.7 30.1 1.7 0.03
12.9 12.2 11.5 6.9 1.3 2.7 1.3

21.1 30.5 1.7 0.02

OP/(Loss) before Tax Depreciation & Amortisation Direct Taxes Paid (Inc)/Dec in Working Capital Other Items CF from Oper. Activity Extra-ordinary Items CF after EO Items (Inc)/Dec in FA+CWIP (Pur)/Sale of Invest. CF from Inv. Activity Issue of Shares Inc/(Dec) in Debt Interest Rec./(Paid) Dividends Paid CF from Fin. Activity Inc/(Dec) in Cash Add: Beginning Balance Closing Balance
5,311 679 -1,577 808 -123 5,098 -543 4,555 -1,515 -1,499 -3,014 0 -326 -414 -480 -1,221 320 17 337
7,903 807 -2,557 -945 5,123 10,330 221 10,551 -1,098 -6,672 -7,770 50 -2,272 -18 -850 -3,089 -308 337 29
7,560 818 -2,583 -821 0 4,975 576 5,551 -3,750 -1,000 -4,750 0 0 838 -1,063 -224 577 29 605
9,649 937 -3,228 -2,351 0 5,007 0 5,007 -2,500 -2,500 -5,000 0 0 849 -1,275 -426 -419 605 186
11,935 1,025 -4,226 -1,382 0 7,352 0 7,352 -1,000 -2,500 -3,500 0 0 871 -1,488 -617 3,235 186 3,421
57
Auto Components
India I Equities
Update
22 February 2011
Amtek Auto
Better times ahead; maintain Buy
We expect Amtek Auto to benefit from sustained auto demand locally and the nascent global recovery, along with market-share gains overseas. Its completed organizational restructuring and near completion of its non-auto capex are added positives. We trim our target price from `254 to `225, while maintaining a Buy.
Rohan Korde
Nirav Bhatt
Improvement in demand. Domestic auto demand has entered a steady growth mode, which would continue to provide a firm base for Amteks future operations. As demand in overseas auto markets recovers, Amteks sales volumes would further improve due to new orders, raising its market-share. Better operating leverage in its overseas subsidiaries would boost its profitability. Non-auto capex nearing completion. Amtek Autos non-auto capex is nearing completion, thereby significantly raising its revenue potential. Further, on the successful completion of the open offer, Amtek India is now close to being a subsidiary. This has led to all forgings and castings units being brought under the Amtek Auto umbrella. We expect this to result in better integrated operations, clearer efficiencies in sourcing and negotiations, and greater transparency in operations. Valuation and risks. We cut our target price from `254 to `225 (10x FY12e EPS, and `29 as value of 38% stake in Amtek India). Risks: slower-than-expected demand ramp-up in Europe, unfavourable currency fluctuations and commodity-cost increases.
Key data
AMTK IN/AMTK.BO `201/`106 18211 / 5459 US$4.7m `25.4bn/US$0.56bn 209.1m 69.74% 30.3% 33.4% 11.5% 24.9%
Key financials

33,211 1,238 5.3 -66.1 22.3 0.5 3.8 5.1 0.5 48.5 35,429 2,480 10.5 100.4 11.1 0.5 5.4 7.0 1.0 38.9 45,187 3,719 15.8 50.0 7.4 0.5 7.4 9.6 0.8 36.7 55,972 4,604 19.6 23.8 6.0 0.4 8.3 11.1 0.9 34.3 66,722 5,686 24.2 23.5 4.9 0.4 9.2 12.7 1.1 32.4
Source: Bloomberg
240 220 200 180 160 140 120 100 Aug-10 Jun-10 Feb-10 Oct-10 Apr-10
Sensex
AMTK Dec-10 Feb-11
22 February 2011
Amtek Auto Better times ahead; maintain Buy

Fig 4 PE Band
45,187 27.5 34,749 10,439 23.1 2,478 3,370 1,517 1,832 4,275 3,719 50.0 15.8 54.2 1.0 55,972 23.9 43,182 12,790 22.9 2,984 3,622 1,555 2,322 5,417 4,604 23.8 19.6 64.1 1.0 66,722 19.2 51,309 15,413 23.1 2,884 4,215 1,594 2,972 6,935 5,686 23.5 24.2 79.1 1.3
600 500 400 300 200 100 0 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jul-10 Jan-11 6x 5x 400 4x 300 Amtek Auto 3x 2x 100 1x 0 Sep-06 Aug-09 Mar-10 Feb-06 Nov-07 Jun-08 Jan-09 Oct-10 Jul-05 Apr-07 Amtek Auto
Net sales Sales growth (%) - Op. expenses EBIDTA EBITDA margins (%) - Interest - Depreciation + Other income - Tax Rep PAT before MI Adjusted PAT Adj. PAT growth (%) FDEPS (`/share) CEPS (`/share) DPS (`/share)
33,211 -26.1 27,381 5,830 17.6 1,523 2,728 685 849 1,414 1,238 -66.1 5.3 32.9 0.6
35,429 6.7 27,719 7,710 21.8 2,051 3,102 1,480 1,216 2,783 2,480 100.4 10.5 41.2 1.2
30x 26x 22x 18x 14x 10x


403 45,749 46,152 40,506 -1 86,657 58,312 2,814 17,284 8,247 86,657 202 69.9 125 418 49,821 50,239 38,786 -1 89,024 60,353 4,814 13,856 10,002 89,024 209 57.3 70 418 55,021 55,439 40,786 -1 96,224 62,251 6,814 14,391 12,769 96,224 209 50.5 60 418 61,678 62,097 38,786 -1 100,882 63,665 8,814 16,158 12,245 100,882 209 42.7 60
600 500
282 32,204 32,486 41,207 0 73,693 53,024 491 12,197 7,981 73,693 141 102.3 87
200

Fig 6 Amtek Auto vs. BSE Auto

5,236 3,370 8,606 -3,428 12,035 5,411 6,623 234 15 -1,720 -2,000 4,931 1,754 8,247 10,001 6,846 3,622 10,468 535 9,933 5,520 4,414 249 0 2,000 -2,000 5,397 2,767 10,002 12,769 8,225 4,215 12,441 1,767 10,674 5,630 5,044 319 0 -2,000 -2,000 5,249 -524 12,769 12,245
280 260 240 220 200 180 160 140 120 100 Aug-10 Apr-10 Dec-10 Jun-10 Feb-10 Oct-10 Feb-11 AMTK BSE Auto
2,252 2,728 4,980 3,405 1,575 13,956 -12,381 101 0 9,820 125 -395 -2,391 10,373 7,982
3,391 3,102 6,493 5,088 1,406 8,390 -6,985 271 121 -701 -2,323 -5,777 265 7,981 8,247
Source: Bloomberg
59
22 February 2011

We expect Amtek Auto to benefit from sustained auto demand locally and the nascent global recovery, along with market-share gains overseas. Its completed organizational restructuring and near completion of its non-auto capex are added positives. We trim our target price to `225 and re-iterate our Buy on the stock. Improvement in demand Amtek is the only Indian company, and one of the select few globally, to have integrated component-manufacturing facilities in forgings, iron castings, aluminium castings, machining and sub-assemblies of auto and non-auto components. Domestic demand for automobiles has entered a secular growth mode, which would continue to provide a firm base for Amteks operations. In the next 2-3 years, as demand in overseas auto markets recovers, Amteks sales volumes would further improve due to its market-share gains. Operating leverage at overseas subsidiaries Mounting demand would raise capacity utilization and prove the key to Amteks operating performance improvement Amteks overseas subsidiaries are now recovering, benefiting from improved auto demand in Europe, new orders from OEMs there and job work to boost revenues, especially in the German subsidiary. Improved operating leverage in its overseas subsidiaries would further boost Amteks profitability and help counter raw material cost increases. Non-auto capex, restructuring nearing completion Amteks non-auto capex is nearly complete, thereby significantly increasing its revenue potential. This would enable it to compete for wagon demand (from Oct 11), expected to be strong in India. Additional avenues being targeted are demand from Defence, aerospace, specialty vehicles, etc. Further, on the successful completion of the open offer, Amtek India is now close to becoming a subsidiary. This has resulted in bringing all the forgings and castings units of all group companies under the Amtek Auto umbrella. We expect this to lead to better integration of operations, clearer efficiencies in sourcing and negotiations, and greater transparency in operations. Valuation We cut our target price from `254 to `225 (10x FY12e EPS, and `29 as the value of 38% stake in Amtek India). We value Amtek Auto at 10x FY12e earnings, a 50% discount to the target PE multiple for Bharat Forge. Our current EPS estimate excludes Amtek India and takes into account the recent dilution and change in estimates. At the current market price, the stock trades at attractive valuations of 6x FY12e EPS.
60
22 February 2011
Risks

Slower-than-expected demand ramp-up in Europe and unfavourable currency fluctuations Commodity cost increases Corporate governance issues in the past.
61
22 February 2011
Improvement in demand
Domestic auto demand has entered a secular growth mode, which would continue to provide a firm base for operations. In the next 2-3 years, as demand in overseas auto markets recovers, Amteks sales volumes would further improve due to its market-share gains Amtek Auto is the only Indian company, and among a select few globally, to have integrated component-manufacturing facilities in forgings, iron castings, aluminium castings, machining and sub-assemblies of auto and non-auto components. Given its wide reach, at home and overseas, Amtek would benefit from economic growth in India as well as from the global recovery. Steady growth ahead The domestic automobile industry is on a good growth trajectory. The global auto-components market is seeing qoq improvement after bottoming out in CY09-10. Exports, which used to bring in a significant 22% of Amteks standalone revenue, had dipped to a low of just 3-4% in 2HFY09. The steady recovery overseas has seen this increase to ~8% of revenue now (on the higher base of robust domestic demand).
Fig 7 Trend in Amtek Autos standalone exports
(`m) 900 800 700 600 500 400 300 200 100 0 Q1FY09 Q2FY09 Q3FY09 Q4FY09 Q1FY10 Q2FY10 Q3FY10 Q4FY10 Q1FY11 Q2FY11 (%) 30 25 20 15 10 5 0
Standalone exports
Source : Company
% of net sales (RHS)
Amtek would strongly benefit from this demand improvement, given its wide geographical reach. We expect a robust 37.9% CAGR (excl. the impact of the merger) in its (consolidated) profit over FY10-13. Similarly, its revenue growth would also be at a solid 23.5% CAGR over FY10-13e.
62
22 February 2011
Fig 8 Net sales trend (FY06-12e)

(`m) 60,000 50,000 40,000 6.7 30,000 20,000 10,000 FY06 FY07 FY08 FY09 FY10 FY11e FY12e
Tractors 7% 2/3 wheelers 9% Commercial Vehicles 11%
52.5 31.0 23.8 27.5
(%) 60.0 40.0 24.0 20.0 0.0 -26.1 -20.0 -40.0
Net Sales
yoy change (RHS)
Revenue breakup, region-wise
Europe: Amtek markets its products in Europe, exporting from the Indian parent and group companies, and through European subsidiaries. Products for Europe span the entire Amtek Auto and Amtek India range. Major customers are Jaguar, Land Rover, Ford, Audi, Mercedes, BMW, PSA and Renault. US: Sales to the US used to be through a US subsidiary. The product range was relatively smaller: flexplates and ring-gear assemblies. To lower costs, production plants in the US were moved to India and now the entire product range is being manufactured in India. India: The entire range of Amtek Auto and Amtek India products are marketed in India through the parent company and other group entities. Major customers are Maruti, M&M, Tata Motors, Chrysler and GM.
Fig 9 Revenue breakup FY08 (segment-wise)
Others 4% Tractors 7% 2/3 wheelers 8% Passenger cars 71% Commercial Vehicles 10%
Passenger cars 62%
FY10 (segment-wise)
Others 11%
FY09 (region-wise)
US 2%
FY10 (region-wise)
US 1% Europe 20%
Europe 35%
India 63%
India 79%
Source: Company
63
22 February 2011
Fig 10 Global customer base

Segment Customer Base
2/3 wheelers Passenger cars LCVs HCVs Tractors Railways Other non-auto
Source : Company
Hero Honda, HMSI, Musashi, M&M, Suzuki, TVS, Yamaha. Aston Martin, Chrysler, Ford, Hyundai, Jaguar, LR, Maruti Suzuki, Nissan, Tata, BMW, Fiat, GM, HM, Lada, Mercedes Benz, Toyota, VW. Ashok Leyland, Eicher, Swaraj Mazda, Tata. Cummins, Detroit Diesel, Force-Man, Navistar, Tata. CNH, Eicher, Escorts, JD, Kubota, Sonalika. Indian Railways, Diesel Locomotive Works, Diesel Loco Modernisation Works, GE Transportation. Briggs & Stratton, JCB, Ingersoll Rand, Kawasaki, the Knorr-Bremse Group, LG, Tecumseh.
With its integrated facilities across India, Europe and North America, Amtek Auto is poised to benefit from improving demand. It has 43 manufacturing locations (38 domestic, five overseas). Amtek has made the most of low-cost manufacturing sites, giving it an edge over its global peers. Further, its JVs with international manufacturers offer opportunities for accelerated growth, not just in terms of a broader product range, but also rising internal demand (as would be seen in its joint venture with American Railcar, Inc.).
Amteks growth potential is highlighted by the following projections:
No customer accounts for more than 15% of revenues
Two-year growth CAGR (FY11-13) in India: PVs 13% and twowheelers 13.7%. FY02-11 PV growth CAGR was 16.8%; twowheelers, 13%.2. Indian auto-components sub-segment expected to increase to US$29.1bn in FY13 from US$21.1bn in FY10 (11% growth CAGR). FY05-10 growth CAGR was 21.1%. Indian auto-components exports sub-segment expected to increase to US$8.6bn in FY13 from US$4.7bn in FY10 (22.8% growth CAGR). FY05-10 growth CAGR was 23.7%.
64
22 February 2011
Overseas operating leverage

Improved operating leverage in its overseas subsidiaries would further boost Amteks profitability and help offset raw material cost increases. Its average capacity utilization has risen through FY10 to 2QFY11. Amteks overseas subsidiaries are now recovering, benefiting from rising automobile demand in Europe, fresh orders from OEMs there and taking up job work to boost revenues, especially in its German subsidiary, Amtek Deutschland. Improved operating leverage in its overseas subsidiaries would further boost profitability and help offset raw material cost increases. Improved operating leverage Its UK operations are showing the biggest sign of improvement as a result of increased volumes from Amteks largest customers. The robust increase in sales in the UK is being driven by the above-market performance of Amteks customers. Moreover, the restructuring of overseas operations has been completed and Amtek would benefit from sustained higher margins in these markets. The European market lagged that of the UK; also, currency movements in Europe were unfavourable. Overall, the European operations have secured fresh orders in 1Q and are expected to see higher capacity utilisation in FY12. Its US order book has been transferred to India, from where products are being exported to Amteks North American distribution centres, resulting in a significant increase in profitability.
65
22 February 2011
Non-auto capex, restructuring nearing completion

Amteks non-auto capex is nearly complete, thereby significantly increasing its revenue potential. Further, the open offer for Amtek India has been successfully completed. We expect this to lead to better integration of operations, clearer efficiencies in sourcing and negotiations, and greater transparency in operations.
Non-auto capex
Amteks non-auto capex is nearing completion, thereby significantly increasing its revenue potential. This would enable it to compete for wagon demand, which is expected to be strong in India. Additional avenues being targeted are Defence, aerospace, specialty vehicles, etc. Amtek is sharpening its focus on the non-auto segment, the share of which is targeted to be raised from 18% to 25% in the current upswing. Amteks non-auto strategy includes:
Increase in Defence-related sales, focused on Defence markets in India and South Africa. (~US$30bn has been earmarked to upgrade the Indian army). Opportunities abound in ammunition shell forgings, armoured vehicles, and upgrading military tanks. Railcars to significantly contribute, with increase in sales revenue. Wagon manufacturing would contribute US$400m to sales in the JV over four years (Amteks share is 50%). American Railcar would provide technical expertise. Targeting the Indian Railways and the Middle East markets. Railcar-components business to grow significantly in the next four years. New ventures of specialty vehicles to address increasing demand. Aerospace to be developed in future.
Restructuring
The open offer for Amtek India has been successfully completed. After the last stage of restructuring, Amtek India is likely to be made a subsidiary of Amtek Auto, by Mar 11. This has resulted in bringing all the forgings and castings units under the Amtek Auto umbrella. We expect this to lead to better integration of operations, clearer efficiencies in sourcing and negotiations, and greater transparency in operations. Rationale for the Amtek India open offer:

Simplifying the group structure, Achieving greater economies of scale, Improving fund allocation across business units, and Strengthening the balance sheet.
66
22 February 2011
Financials
We expect a 23.5% CAGR in Amteks revenues over FY10-13 (with the EBITDA margin improving from 21.8% to 23.1%) and a 31.9% CAGR in adjusted net profit. We expect a 23.5% CAGR in Amteks revenue over FY10-13e, following a 130bps better EBITDA margin owing to lower raw material costs, a more favourable product mix (towards machined products), greater capacity utilization and a larger share of non-automotive products. We expect a 31.9% CAGR in adjusted net profit over FY10-13. Its robust financial performance leads us to expect Amteks RoCE would improve, from a low 7% in FY10 to 12.7% three years later.
Fig 11 EBITDA and net-profit margin EBITDA
(`m) 2,800 2,600 2,400 2,200 2,000 1,800 1,600 1,400 1,200 1,000 800 22.2 19.8 20.6 19.2 23.6 23.1 22.6 22.5 (%) 24.0 22.0 20.0 18.0 15.3 16.0 14.0 10.9 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 12.0 10.0 (`m) 1,000 900 800 700 600 500 400 300 200 100
Net Profit
(%) 14.0 10.1 8.2 6.1 2.5 6.7 5.2 1.7 6.2 8.9 8.4 12.0 10.0 8.0 6.0 4.0 2.0 0.0 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q
FY09 EBITDA
Source: Company
FY10 FY11 As a % of Sales(RHS)
FY09 PAT
FY10
FY11
As a % of Sales(RHS)
Fig 12 AAL: standalone and consolidated EBITDA margins (FY04-12e)

(%) 37.0 32.0 27.0 22.0 17.0 12.0 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e
Standalone OPM
Consolidated OPM
67
22 February 2011
Change in estimates
We raise our estimates to factor in a faster-than-expected recovery in Amteks overseas business, reflected in better operating leverage, benefits of cost restructuring and new orders overseas. We raise our EBITDA margin estimate for FY12, by 290bps, and factor in higher depreciation, interest expense and minority interest. The net effect on our FY12 profit estimate is to raise it by 2.8%.
Previous estimate `m FY11e FY12e Revised estimate FY11e FY12e Change (%) FY11e FY12e
Income EBITDA EBITDA Mrg (%) Adjusted PAT
41,563 7,897 19.0 3,012
52,581 10,122 19.3 4,477
45,187 10,438 23.1 3,719
55,972 12,790 22.9 4,604
8.7 32.2 23.5
6.4 26.4 2.8
Fig 14 - Income statement (`m)

Y/E JUNE FY09 FY10 FY11e FY12e FY13e
Net Sales Change (%) Expenditure EBITDA Change (%) % of Net Sales Depreciation EBIT Interest & Finance Charges Other Income Non-recurring Expense PBT Tax Effective Rate (%) PAT Adj. PAT Change (%) Minority Interest PAT (After MI) Change (%)
33,211 -26.1 27,381 5,830 -27.1 17.6 2,728 3,101 1,523 685 -490 2,753 849 30.9 1,904 1,414 (64.9) 176 1,238 (66.1)
35,429 6.7 27,719 7,709 32.2 21.8 3,102 4,607 2,051 1,480 112 3,924 1,216 31.0 2,708 2,783 96.9 303 2,480 100.4
45,187 27.5 34,749 10,438 35.4 23.1 3,370 7,068 2,478 1,517 0 6,107 1,832 30.0 4,275 4,275 53.6 556 3,719 50.0
55,972 23.9 43,182 12,790 22.5 22.9 3,622 9,168 2,984 1,555 0 7,739 2,322 30.0 5,417 5,417 26.7 813 4,604 23.8
66,722 19.2 51,309 15,413 20.5 23.1 4,215 11,197 2,884 1,594 0 9,907 2,972 30.0 6,935 6,935 28.0 1,248 5,686 23.5
68
22 February 2011

Share Capital Share warrants Reserves Net Worth Loans Minority Interest Capital Employed Application of Funds Gross Fixed Assets Less: Depreciation Net Fixed Assets Goodwill Investments Curr.Assets, L & Adv. Inventory Sundry Debtors Cash & Bank Balances Loans & Advances Others Current Liab. & Prov. Sundry Creditors Other Liabilities Provisions Net Current Assets Miscellaneous Expenditures Application of Funds
282 499 31,706 32,486 41,207 2,226 73,693
403 2,154 43,595 46,152 40,506 2,419 86,658
418 2,154 47,667 50,239 38,786 2,419 89,025
418 2,154 52,867 55,439 40,786 2,419 96,225
418 2,154 59,524 62,097 38,786 2,419 100,882
62,335 13,255 49,080 3,944 491 30,929 7,554 5,220 7,981 10,156 17 10,751 4,884 5,759 108 20,178 0 73,693
70,564 16,102 54,462 3,850 2,814 33,557 8,122 6,405 8,247 10,740 42 8,025 2,433 5,248 344 25,532 1 86,658
75,975 19,473 56,503 3,850 4,814 35,640 8,047 6,809 10,002 10,740 42 11,782 6,190 5,248 344 23,858 1 89,025
81,495 23,095 58,400 3,850 6,814 40,420 9,201 7,667 12,769 10,740 42 13,260 7,667 5,248 344 27,160 1 96,225
87,125 27,310 59,815 3,850 8,814 43,135 10,968 9,140 12,245 10,740 42 14,732 9,140 5,248 344 28,403 1 100,882
Fig 16 Ratios @`117

Basic (`) Diluted Cons EPS Cons. EPS (inc.Amtek India) EPS Growth (%) Cons. EPS Growth (%) Cash EPS Book Value per Share DPS Payout (Incl. Div. Tax) % Valuation (x) Cons P/E Cash P/E EV/EBITDA EV/Sales Price to Book Value Dividend Yield (%) Profitability Ratios (%) RoE RoCE Turnover Ratios Asset Turnover (x) Fixed Asset Turnover Leverage Ratio Debt/Equity (x)
5.3 -66.1 n.m 32.9 230.4 0.6 8.1 22.3 3.6 8.5 1.5 0.5 0.5 3.8 5.1 0.5 0.7 1.3
10.5 11.8 100.4 n.m 41.2 228.8 1.2 10.9 11.1 2.8 6.9 1.5 0.5 1.0 5.4 7.0 0.4 0.7 0.9
15.8 17.8 50.0 50.9 54.2 240.3 1.0 6.3 7.4 2.2 4.6 1.1 0.5 0.8 7.4 9.6 0.5 0.8 0.8
19.6 22.3 23.8 28.5 64.1 265.1 1.0 5.4 6.0 1.8 3.6 0.8 0.4 0.9 8.3 11.1 0.6 1.0 0.7
24.2 27.6 23.5 27.1 79.1 297.0 1.3 5.6 4.9 1.5 2.7 0.6 0.4 1.1 9.2 12.7 0.7 1.1 0.6
69
22 February 2011

OP/(Loss) before Tax Interest/Div. Received Depreciation & Amort. Direct Taxes Paid (Inc)/Dec in Working Capital Other Items CF from Oper. Activity (Inc)/Dec in FA+CWIP (Pur)/Sale of Invest. CF from Inv. Activity Issue of Shares Inc/(Dec) in Debt Interest Paid Dividends Paid CF from Fin. Activity Inc/(Dec) in Cash Add: Beginning Balance Closing Balance
3,101 685 2,728 -849 -3,405 493 2,753 -13,956 125 -13,831 0 9,820 -1,523 -101 8,197 -2,391 10,373 7,981
4,607 1,480 3,102 -1,216 -5,088 11107 13,992 -8,390 -2,323 -10,713 121 -701 -2,051 -271 -2,901 266 7,981 8,247
7,068 1,517 3,370 -1,832 3,428 30 13,582 -5,411 -2,000 -7,411 15 -1,720 -2,478 -234 -4,416 1,754 8,247 10,002
9,168 1,555 3,622 -2,322 -535 33 11,521 -5,520 -2,000 -7,520 0 2,000 -2,984 -249 -1,233 2,768 10,002 12,769
11,197 1,594 4,215 -2,972 -1,767 42 12,309 -5,630 -2,000 -7,630 0 -2,000 -2,884 -319 -5,203 -524 12,769 12,245
70
22 February 2011
Annexure 1 Subsidiaries performance

Fig 18 Key subsidiaries performances
Year end Jun (`m) FY09 FY10 FY11e FY12e FY13e
Ahmednagar Forgings Revenue Growth (%) Net Profit % growth GWK (Amtek Investments, UK) Revenue Growth (%) Net Profit % growth Smith Jones Revenue Growth (%) Net Profit % growth Zelter Revenue Growth (%) Net Profit % growth Amtek Auto Total Revenue Growth (%) Net Profit % growth Benda Amtek Revenue Growth (%) Net Profit % growth Amtek Siccardi Revenue Growth (%) Net Profit % growth NPM
5,176 -21.7 359 -43.4 7,928 -45.4 -349 -166.0 705 -14.8 -28 -248.7 4,834 -42.3 2 -99.4 10,525 -17.9 1,032 -55.6 2,347 2.3 175 -29.7 3,115 1.6 319 53.4 10.2
6,653 28.6 641 78.4 3,813 -51.9 -77 -77.9 230 -67.4 -33 17.6 3,389 -29.9 -145 -9,780.0 12,764 21.3 1,509 46.2 3,725 58.8 427 143.3 4,461 43.2 420 31.8 9.4
9,562 43.7 1,098 71.3 4,194 10.0 189 -345.1 57 -75.0 -23 -31.3 3,050 -10.0 -61 -58.0 18,013 41.1 2,216 46.9 4,657 25.0 419 -1.8 4,907 10.0 442 5.1 9.0
12,008 25.6 1,421 29.4 4,823 15.0 217 15.0 0 -100.0 0 -100.0 3,507 15.0 2 -102.9 22,700 26.0 2,782 25.5 5,355 15.0 482 15.0 5,643 15.0 508 15.0 9.0
14,189 18.2 1,765 24.2 5,787 20.0 260 20.0 0 0.0 0 NA 4,033 15.0 81 4,500.0 26,992 18.9 3,661 31.6 5,998 12.0 540 12.0 6,320 12.0 569 12.0 9.0
71
22 February 2011
Fig 19 Quarterly performance of subsidiaries

Sales Contribution, company-wise (`m) (`m) 1QFY10 2QFY10 3QFY10 4QFY10 1QFY11 2QFY11
Amtek Auto % YoY growth Ahmednagar Forgings % YoY growth GWK % YoY growth Zelter % YoY growth Smith Jones % YoY growth Benda Amtek % YoY growth Amtek Siccardi % YoY growth Others % YoY growth Total % YoY growth
Company-Wise Ebitda Contribution (`m) (`m)
2,674 -15.2 1,394 -7.4 831 -78.4 1,007 -49.9 87 -53.6 728 14.2 1,015 47.7 108 -5.3 7,842 -35.4
1QFY10
3,022 25.2 1,592 39.1 1,068 -55.1 838 -23.9 61 -71.5 867 87.1 1,132 123.0 99 -1.9 8,678 4.2
2QFY10
3,404 28.1 1,783 42.4 997 -10.8 766 -4.2 56 -71.3 978 63.2 1,232 63.2 107 201.1 9,323 25.8
3QFY10
3,664 45.3 1,882 49.2 917 55.8 778 -16.0 26 -76.3 1,153 78.3 1,081 -7.2 61 -62.0 9,562 29.6
4QFY10
4,091 53.0 2,135 53.2 1,010 21.6 700 -30.4 10 -88.9 1,147 57.6 1,114 9.7 155 44.1 10,362 32.1
1QFY11
4,319 42.9 2,297 44.3 1,102 3.2 848 1.2 0 -100.0 1,172 35.2 1,193 5.4 165 67.5 11,097 27.9
2QFY11
Amtek Auto EBITDA margin (%) Ahmednagar Forgings EBITDA margin (%) GWK EBITDA margin (%) Zelter EBITDA margin (%) Smith Jones EBITDA margin (%) Benda Amtek EBITDA margin (%) Amtek Siccardi EBITDA margin (%) Others EBITDA margin (%) Total Cons EBITDA margin (%)
676 25.3 372 26.7 6 0.8 37 3.7 -5 -5.9 199 27.3 211 20.8 11 10.5 1,507 19.2
804 26.6 418 26.3 23 2.1 44 5.3 -9 -14.2 246 28.4 259 22.9 4 4.1 1,789 20.6
936 27.5 463 26.0 95 9.6 38 4.9 15 27.5 283 28.9 261 21.1 14 13.2 2,105 22.6
1,017 27.8 509 27.1 68 7.4 77 9.8 -10 -39.1 266 23.1 240 22.2 -11 -18.0 2,155 22.5
1,148 28.0 575 26.9 156 15.4 31 4.4 -3 -28.1 255 22.2 268 24.1 12 7.7 2,442 23.6
1,207 27.9 624 27.1 144 13.1 29 3.4 0 NA 265 22.6 313 26.2 -21 -12.5 2,560 23.1
72
22 February 2011
Fig 20 Quarterly performance of subsidiaries

Profit contribution, company wise (`m) 1QFY10 2QFY10 3QFY10 4QFY10 1QFY11 2QFY11
Amtek Auto Net Profit margin (%) Ahmednagar Forgings Net Profit margin (%) GWK Net Profit margin (%) Zelter Net Profit margin (%) Smith Jones Net Profit margin (%) Benda Amtek Net Profit margin (%) Amtek Siccardi Net Profit margin (%) Others Net Profit margin (%) Profit bef. minority int. Minority interest Profit after MI
305 11.4 114 8.1 -81 -9.7 -39 -3.8 -13 -14.7 84 11.5 90 8.9 2 1.7 462 57 405
351 11.6 145 9.1 -10 -1.0 -55 -6.6 -15 -24.5 116 13.4 123 10.8 -1 -1.4 652 69 583
424 12.5 181 10.1 17 1.7 -20 -2.6 10 17.1 116 11.8 119 9.6 6 6.0 852 85 767
352 9.6 198 10.5 -2 -0.3 -32 -4.1 -15 -58.2 111 9.6 89 8.2 -13 -21.6 687 93 594
546 13.3 255 11.9 72 7.1 -26 -3.7 -3 -28.1 103 8.9 97 8.7 -1 -0.8 1,041 124 917
583 13.5 280 12.2 50 4.6 -19 -2.2 0 91 7.7 115 9.6 -32 -19.3 1,067 136 932
Fig 21 Associate performance trend: Amtek India

Income Statement Year end Jun (`m) FY08 FY09 FY10 1QFY11 2QFY11
Net Sales Change (%) Operating Other Income Total Income Expenditure EBITDA Change (%) % of Net Sales Depreciation EBIT Deferred Revenue Exp. Interest & Finance Charges Other Income Non-recurring Expense Non-recurring Income PBT Tax Effective Rate (%) Rep. PAT Change (%) Adj. PAT Change (%) Adj. PAT (After MI) Change (%)
10,673 16.5 0 10,673 8,030 2,643 21.1 24.8 540 2,103 0 306 361 66 2,220 4,312 783 18.2 3,529 173.8 1,374 6.7 1,374 6.7
8,094 -24.2 0 8,094 6,332 1,762 -33.3 21.8 706 1,056 0 442 216 0 0 830 248 29.9 582 -83.5 582 (57.6) 582 (57.6)
9,814 21.2 0 9,814 7,459 2,355 33.6 24.0 962 1,393 0 830 551 0 0 1,113 326 29.3 787 35.2 787 35.2 787 35.2
10,362 32.1 0 10,362 7,921 2,442 62.0 23.6 825 1,617 0 546 366 0 0 1,437 395 27.5 1,041 125.4 NA NA 917 126.3
11,097 27.9 0 11,097 8,537 2,560 43.1 23.1 810 1,750 0 648 387 0 0 1,489 421 28.3 1,067 63.7 NA NA 932 59.8
73
Auto Components
India I Equities
Update
22 February 2011
Amara Raja Batteries

Short-term concerns, positive potential; maintain Buy
We expect the structural soundness of Amara Raja Batteries business to play out over the long term and, hence, help it outperform its peers. Even though short-term concerns persist regarding the rise in commodity prices and lower industrial demand, we yet maintain our Buy recommendation.
Rohan Korde
Girish Solanki
+9122 66266712 girishsolanki@rathi.com
Branding is key. Amara Raja is Indias second-largest battery maker in the regulated sector and has made its mark via branding, strong retail network and entry into the two-wheeler segment. Healthy automotive demand. ARB operates in the auto replacement market and caters to some OEMs as well. With the strong automotive demand expected, a 13.7% CAGR over FY1113e, we expect good growth in ARBs automotive battery sales. Industrials, a key segment. Notwithstanding the present industrial slowdown, we expect the segment to recover from the current lows in the medium to long term and drive demand in the long term. Being a significant revenue contributor for ARB, industrial demand recovery in FY12 would be a major positive. Valuation and risks. We value ARB at 10x FY12e EPS (a 40% discount to the target multiple for market leader Exide Industries). At the ruling market price, the stock trades at 9.5x FY11e and 7.8x FY12e earnings. Risks: Delayed industrial demand recovery, further increase in the price of lead.
Key data
AMRJ IN/AMAR.BO `228/`140 18212 / 5459 US$0.7m `14.04bn/US$313m 85.4m 47.9% 52.1% 2.4% 19.4% 26.1%
Key financials
Year end 31 Mar FY09 FY10 FY11e FY12e FY13e

13,177 947 11.1 -33.1 14.8 3.5 19.8 22.8 0.5 40.8 14,652 1,590 18.6 67.8 8.8 2.6 30.7 38.0 1.8 23.7 17,388 1,470 17.2 -7.5 9.5 2.1 22.6 27.6 2.4 23.6 20,596 1,793 21.0 22.0 7.8 1.7 22.3 29.0 2.2 24.4 24,184 2,213 25.9 23.4 6.3 1.4 22.3 30.3 2.4 18.0
Source: Bloomberg
230 220 210 200 190 180 170 160 150 Aug-10 Jun-10 Feb-10 Apr-10
AMRJ
Sensex Dec-10 Oct-10 Feb-11
22 February 2011
Amara Raja Batteries Short-term concerns, positive potential; maintain Buy

Fig 4 PE Band
17,388 18.7 14,807 2,581 14.8 19 422 50 728 1,486 1,470 -7.5 17.2 22.3 4.0 20,596 18.5 17,488 3,109 15.1 18 471 50 876 1,793 1,793 22.0 21.0 26.5 3.5 24,184 17.4 20,413 3,771 15.6 14 511 50 1,082 2,213 2,213 23.4 25.9 31.9 3.9
350 16x 300 250 200 150 100 50 1x 0 Sep-05 Aug-08 May-07 Sep-10 Mar-08 Feb-06 Oct-07 Dec-06 Nov-09 Feb-11 3x 300 250 200 150 100 50 0 Sep-05 Aug-08 Sep-10 Apr-05 Mar-08 Feb-06 Apr-10 May-07 Dec-06 Nov-09 Feb-11 Oct-07 Jan-09 Jun-09 Jul-06 Amara Raja Batteries Ltd 2.5x 2x 1.5x 1x 0.5x Apr-05 Jul-06 Jan-09 Jun-09 Apr-10 Amara Raja Battries Ltd 13x 10x 7x 4x
Net sales Sales growth (%) - Op. expenses EBIDTA EBITDA margins (%) - Interest - Depreciation + Other income - Tax Reported PAT Adjusted PAT Adj. PAT growth (%) FDEPS (`/share) CEPS (`/share) DPS (`/share)
13,177 21.6 11,291 1,886 14.3 182 346 81 422 805 947 0.4 11.1 13.5 0.8
14,652 11.2 11,779 2,873 19.6 68 429 50 876 1,670 1,590 67.8 18.6 24.6 2.9


171 5,266 5,436 912 216 6,565 3,284 161 2,495 625 6,565 85 5.3 80 171 6,398 6,569 1,012 414 7,995 3,362 461 3,539 634 7,995 85 5.8 84 171 7,874 8,045 812 414 9,271 3,391 761 4,880 238 9,271 85 7.1 95 171 9,742 9,913 612 414 10,939 3,380 1,061 5,814 684 10,939 85 -0.7 95
350
171 3,885 4,056 2,859 183 7,097 3,209 471 2,714 703 7,097 85 53.2 76

Fig 6 BSE auto v/s Amara Raja

1,629 422 2,051 1,059 991 500 491 338 0 100 300 -56 9 625 634 1,762 471 2,233 1,342 891 500 391 302 0 -200 300 -16 -395 634 238 2,177 511 2,688 934 1,755 500 1,255 330 0 -200 300 -20 445 238 684
240 230 220 210 200 190 180 170 160 150 140 Aug-10 Apr-10 Dec-10 Feb-10 Jun-10 Oct-10 Feb-11 BSE Auto
1,132 346 1,478 -730 2,207 1,009 1,198 68 57 -304 309 383 191 511 703
1,602 429 2,031 -171 2,202 504 1,698 248 0 -1,947 -310 -108 -79 703 625
AMRJ
Source: Bloomberg
75
22 February 2011

Even though short-term concerns regarding higher commodity prices and lower industrial demand persist, we expect the structural soundness of Amara Raja Batteries business to play out in the long term and result in it outperforming its peers. We maintain our Buy recommendation.
Branding, the key

Amara Raja Batteries is Indias second-largest battery manufacturer in the regulated sector. It has made its mark through branding, a strong retail network and entry into the two-wheeler segment. It has been steadily expanding its after-sales retail network, which now comprises more than 200 franchisees and over 18,000 active retailers. A wider retail network would assist in further penetration in the replacement market.
ARB has focussed on branding and retail network expansion
Good automotive demand

Amara Raja largely operates in the auto-replacement market and caters to some OEMs. With good automotive demand expected (a 13% CAGR over FY10-13e), we expect good growth in ARBs battery sales. Further, the strong 9.3% CAGR in auto volumes over FY02-09 could generate high replacement demand. This would continue to fuel replacement demand.
Industrials, a key segment

Notwithstanding the current industrial slowdown, we expect the segment to recover in the medium to long term and thereby drive demand over this period. Being a significant revenue contributor for ARB, industrial demand recovery in FY12 would be a major positive. The segment is crucial as it accounts for 40% of sales, by value, of the Indian storage-battery market. This segment registered a 25% CAGR in the past four years. VRLA (valve-regulated lead-acid) batteries constitute 60% of the industrial storage-battery market in India. The medium-VRLA segment accounts for the biggest sub-segment, growing 30% historically. Highly fragmented, the industrial battery segment's biggest consumers consist of telecoms, IT and ITeS, BFSI and companies/organizations.
Valuation
We value Amara Raja Batteries at 10x FY12e EPS (a 40% discount to the target multiple for market leader Exide Industries). At the ruling market price, the stock trades at 9.5x FY11e and 7.8x FY12e earnings. Risks
The battery-replacement market in India has not yet matured to a situation where batteries are picked up off the shelf. Hence, the retail focus of ARB may see hurdles to growth. A slower-than-anticipated growth in OEM production and lukewarm demand for the Nano would lessen demand potential from the automobile segment.
76
22 February 2011
Imports constitute a significant threat to Indian battery manufacturers. Imports could whittle down sales in the replacement market. Continuing lower demand from the industrial segment would be an added concern. Higher lead prices even from current levels would threaten profitability.
($/tonne) 3,800 3,300 2,800 2,300 1,800 1,300 800 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Oct-06 Oct-07 Oct-08 Oct-09 Oct-10 Apr-06 Apr-07 Apr-08 Apr-09 Apr-10 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10
Fig 7 Lead prices (Apr 06-Feb 11)
LME cash
Source: LME
77
22 February 2011
Expanding retail network

Amara Raja Batteries is Indias second-largest battery manufacturer in the organised sector. It has made its mark through branding, a strong retail network and entry in the two-wheeler segment. A wider retail network would assist in further penetration into the replacement market. ARB has been steadily expanding its after-sales retail network, which now comprises more than 200 franchisees and over 18,000 active retailers. A wider retail network would assist in deeper penetration into the replacement market. To boost volumes and improve market share in the higher-margin replacement market, the company has conceptualized retail outlets called PowerZones, to be set up in rural and semi-urban areas.
Key initiatives by ARB in this respect 1. 2.
A network of 18,000 active retailers has given ARB a touch point in urban India at almost every 5km. ARB has also pioneered the concept of Amaron Pitstop and PowerZone, of which it has ~150 and 700 outlets, respectively, to provide a unique shopping experience in urban and rural regions. Another of its innovations is the introduction of unconventional distribution channels small shopkeepers, telephone-booth operators, auto-mechanics and lube sellers. ARB has widened its reach through the 70 Aqua distribution network, which caters to replacement demand in industrial batteries. ARBs batteries are now used by more than 10m consumers. There are 175,000 live battery banks, providing uninterrupted backup power for various critical applications.
Fig 9 EBITDA and sales volume growth
(`m) 3,500 3,000 2,500 2,000 40 1,500 60 (%) 80
3.
4. 5.
Fig 8 Installed capacity

(m nos) 11 9 8 6 5
1,000
3
500
20
2 0 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10
0 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10
EBITDA
Sales Volume Growth (RHS)
Source: Company
Source: Company
78
22 February 2011
High auto-replacement potential

ARB operates in the auto replacement market and caters to some OEMs. With good automotive demand expected (a 13.7% CAGR over FY11-13e), we anticipate good growth in ARBs battery sales. Further, the strong 14% CAGR in auto volumes over FY02-11 would generate high replacement demand. This would further fuel replacement demand.
Fig 10 Auto OEM growth expected
(Nos.) 25,000,000 20,000,000 15,000,000 10,000,000 5,000,000 0 FY11e FY12e FY13e FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 (%) 30.0 25.0 20.0 15.0 10.0 5.0 0.0 -5.0
Total Auto volumes

yoy change (RHS)
Although ARBs OE market share is relatively lower, anticipated growth in this segment is a positive for it from the point of view of greater demand and increased replacement-demand potential. Entry into the two-wheeler sub-segment In May 08, ARB launched VLRA batteries in the two-wheeler subsegment. VLRA technology is normally used in luxury cars. The entry into the two-wheeler segment with a good product and adequate installed capacity could help penetration there. ARB manufactures VLRA batteries with technology from its JV partner Johnson Controls, Inc. In addition to the traditional segments, the regulated replacement-battery market growth is fueled by the greater popularity of the high-end twowheelers and new users of non-gear scooters from urban and semi-urban women. The increasing shift from kick-start to self-start bikes also increases the importance of battery technology.
79
22 February 2011
Industrials, a key segment

Notwithstanding the current industrial slowdown, we expect the segment to recover from the lows in the medium to long term and drive demand over this period. Being a significant revenue contributor for ARB, industrial demand recovery over FY12 would be a major positive. The high exposure of ARB to the telecom batteries segment (~30% of revenues) and ~17-18% from the inverter segment make it vulnerable to the current slowdown in demand there. However, we expect the segment to recover from the recent lows and to grow at a good clip ahead. Fundamental factors would continue to drive growth in the industrials segment. The segment is crucial as it accounts for 40% of sales, by value, of the Indian storage-battery market. This segment registered a 25% CAGR in the past four years. VRLA batteries constitutes 60% of the industrial storage-battery market in India. The medium VRLA segment accounts for the biggest sub-segment, growing 30% annually, historically. Highly fragmented, the industrial battery segment's biggest consumers comprise telecoms, IT and ITeS, BFSI and companies/organizations.
The key growth recovery factors are : 1. 2.
Replacement demand from telecoms-tower batteries Entry of new players and introduction of new services (3G) in the telecoms sector Increasing computerisation, especially among government agencies Demand from IT, ITeS, and BFSI sectors Rising automation across business enterprises Power deficit, enhancing the need for back-up batteries in critical equipment and processes Part of the telecoms capacity to be utilized to support the UPS business
3. 4. 5. 6.
7.
ARBs strength in the segment is that it is the preferred vendor among domestic utilities, government agencies, multi-nationals and domestic telecoms service providers. The company plans to strengthen its presence in high-growth sectors and create products for specific user segments.
80
22 February 2011
Financials
We expect a 17.9% CAGR in Amara Rajas revenue over FY11-13 with the EBITDA margin improving from 14.8% to 15.6%and a 22.7% CAGR in adjusted net profit. From FY11 to FY13 we expect a 17.9% CAGR in ARBs revenue, with the EBITDA margin improving from a low 14.8% to 15.6%. The expected volatility in commodity prices would be countered by ARBs increasing presence in the industrials segment and greater replacement-market share. The volatility in lead price can impact ARBs EBITDA margin either way, since it does not have the fall-back of backward integration like Exide Industries. We expect a 22.7% CAGR in adjusted net profit from FY11 to FY13e. To support growth, ARB would aggressively expand its capacity: fourwheeler batteries from 4.2m to 6m, and two-wheeler batteries from 1.8m to 5m.
Fig 11 Amara Rajas sales and net profit growth (FY04-12)
(`m)
25,000 20,000 15,000 10,000 5,000 0 FY10e FY11e FY12e FY04 FY05 FY06 FY07 FY08 FY09
(`m)
2,000 1,600 1,200 800 400 0
Sales
PAT (RHS)
Despite the ongoing capex and the decline in profitability in FY11, ARB has maintained healthy return ratios of over 20%.
Fig 12 Amara Rajas RoE, RoCE and asset turnover (FY04-12e)
(%) 40 35 30 25 20 15 10 5 0 FY10e FY11e FY12e FY04 FY05 FY06 FY07 FY08 FY09 0.5 1.0 1.5 2.0 (x) 2.5
RoE
RoCE
Asset Turnover (RHS)
81
22 February 2011
Change in estimates
We lower our estimates to factor in the short-term concerns regarding commodity price increases and lower demand for industrial batteries. We trim our EBITDA margin estimate for FY12, by 300bps, and factor in higher raw material and employee costs. We also cut our FY12 profit estimates, by 12.9%.
Previous estimate `m FY11e FY12e Revised estimate FY11e FY12e Change (%) FY11e FY12e
Income EBITDA EBITDA Mrg (%) Adjusted PAT
17,547 3,344 19.1 1,787
20,965 3,786 18.1 2,059
17,388 2,581 14.8 1,470
20,596 3,109 15.1 1,793
-0.9 -22.8 -17.7
-1.8 -17.9 -12.9
Commodity prices, a concern The cost of lead works out to 70% of raw material cost of batteries. The price of lead has corrected off its peak of US$3,850 a ton in 4QFY08 to less than half that, at US$1,500 in 1QFY10. Subsequently, though, it has bounced back to US$2,500 now, thereby eating into margins in FY11.
Fig 14 EBITDA margin

(`m) 800 700 600 500 14.2 400 300 7.7 200 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q FY11 3Q 6 13.0 18.0 16.1 23.4 22.5 19.6 18 15.6 14 13.9 14.5 10 (%) 26 22
Fig 15 Raw material costs

(`m) 3,000 2,500 2,000 61.0 1,500 56.4 1,000 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q FY11 3Q 54 58.0 60.0 58 72.8 68.1 66.5 64.2 66.6 66 63.8 64.5 62 (%) 74 70
FY09 EBITDA
Source: Company
FY10
FY09 Raw-material cost

Source: Company
FY10
As a % of Sales (RHS)
As a % of Sales (RHS)
82
22 February 2011
Fig 16 Income Statement

Year end 31 Mar (`m) FY09 FY10 FY11e FY12e FY13e
Net Sales Change (%) Expenditure EBITDA Change (%) EBITDA Margin (%) Depreciation EBIT Interest & Finance Charges Other Income Non-recurring Expense Non-recurring Income PBT Tax Effective Rate (%) Rep. PAT Change (%) Adj. PAT Change (%)
13,177 21.6 11,291 1,886 19.6 14.3 346 1,541 182 81 212 0 1,227 422 34.4 805 -14.7 947 0.4
14,652 11.2 11,779 2,873 52.3 19.6 429 2,444 68 50 0 121 2,546 876 34.4 1,670 107.5 1,590 67.8
17,388 18.7 14,807 2,581 -10.2 14.8 422 2,159 19 50 2 27 2,214 728 32.9 1,486 -11.0 1,470 -7.5
20,596 18.5 17,488 3,109 20.4 15.1 471 2,637 18 50 0 0 2,669 876 32.8 1,793 20.7 1,793 22.0
24,184 17.4 20,413 3,771 21.3 15.6 511 3,260 14 50 0 0 3,295 1,082 32.9 2,213 23.4 2,213 23.4
Fig 17 Balance Sheet

Sources of Funds Share Capital Reserves Net Worth Loans Deferred Tax Liability Capital Employed Application of Funds Gross Fixed Assets Less: Depreciation Net Fixed Assets Capital WIP Investments Curr.Assets, L & Adv. Inventory Sundry Debtors Cash & Bank Balances Loans & Advances Other Current Assets Current Liab. & Prov. Sundry Creditors Other Liabilities Provisions Net Current Assets Application of Funds
171 3,885 4,056 2,859 183 7,097 4,271 1,458 2,813 396 471 5,260 1,608 2,078 703 870 0 1,843 937 201 705 3,417 7,097
171 5,266 5,436 912 216 6,565 4,911 1,854 3,057 227 161 6,311 2,176 2,423 625 1,087 0 3,191 1,376 281 1,534 3,120 6,565
171 6,398 6,569 1,012 414 7,995 5,638 2,276 3,362 0 461 7,169 2,573 2,875 634 1,087 0 2,997 1,429 281 1,287 4,172 7,995
171 7,874 8,045 812 414 9,271 6,138 2,747 3,391 0 761 8,379 3,386 3,668 238 1,087 0 3,260 1,693 281 1,287 5,119 9,271
171 9,742 9,913 612 414 10,939 6,638 3,258 3,380 0 1,061 10,053 3,975 4,307 684 1,087 0 3,555 1,988 281 1,287 6,498 10,939
83
22 February 2011
Fig 18 Ratios @`165

Basic (`) EPS EPS Fully Diluted Cash EPS EPS Growth (%) Book Value per Share DPS Payout (Incl. Div. Tax) % Valuation (x) P/E Cash P/E EV/EBITDA EV/Sales Price to Book Value Dividend Yield (%) Profitability Ratios (%) RoE RoCE Turnover Ratios Asset Turnover (x) Leverage Ratio Debt/Equity (x)
11.1 11.1 13.5 -33.1 47.5 0.8 0.1 14.8 12.2 8.3 1.2 3.5 0.5 19.8 22.8 1.9 0.7
18.6 18.6 24.6 67.8 63.7 2.9 0.2 8.8 6.7 4.9 1.0 2.6 1.8 30.7 38.0 2.2 0.2
17.2 17.2 22.3 -7.5 76.9 4.0 0.2 9.5 7.3 5.4 0.8 2.1 2.4 22.6 27.6 2.2 0.2
21.0 21.0 26.5 22.0 94.2 3.5 0.2 7.8 6.2 4.4 0.7 1.7 2.2 22.3 29.0 2.2 0.1
25.9 25.9 31.9 23.4 116.1 3.9 0.1 6.3 5.1 3.4 0.5 1.4 2.4 22.3 30.3 2.2 0.1

OP/(Loss) before Tax Interest/Dividends Received Depreciation & Amortisation Direct Taxes Paid (Inc)/Dec in Working Capital Other Items CF from Oper. Activity Extra-ordinary Items Other Items CF after EO Items (Inc)/Dec in FA+CWIP (Pur)/Sale of Invest. CF from Inv. Activity Issue of Shares Inc/(Dec) in Debt Interest Rec./(Paid) Dividends Paid CF from Fin. Activity Inc/(Dec) in Cash Add: Beginning Balance Closing Balance
1,541 346 -409 730 -69 2,138 -212 1,926 -1,009 -309 -1,318 57 -304 -102 -68 -417 191 511 703
2,444 429 -842 171 6 2,208 121 2,328 -504 310 -194 0 -1,947 -18 -248 -2,213 -78 703 625
2,159 422 -530 -1,059 1 993 25 1,017 -500 -300 -800 0 100 30 -338 -208 9 625 634
2,637 471 -876 -1,342 -15 876 0 876 -500 -300 -800 0 -200 31 -302 -471 -395 634 238
3,260 511 -1,082 -934 -15 1,740 0 1,740 -500 -300 -800 0 -200 35 -330 -494 445 238 684
84
Auto Components
India I Equities
Initiating Coverage
22 February 2011
Balkrishna Industries
Good business model, rubber concerns; initiate with Hold
Balkrishna Industries focuses on agricultural tyres and the offroad sub-segment overseas. It typically enjoys higher margins than domestic peers. However, short-term capacity constraints and rising rubber prices have dampened its short- to mediumterm outlook. We initiate coverage on BIL with a Hold recommendation.
Rating: Hold Target Price: `144 Share Price: `127
Rohan Korde
Girish Solanki
Robust business model. Balkrishna mainly caters to the highermargin segmentsoff-road vehicles and agricultural tyres. As it supplies heavier tyres mainly for export, it enjoys higher-thanindustry margins. Rubber is a concern. The escalating price of rubber is a concern for the entire tyre industry. While Balkrishnas forward contracts at lower prices insure it from higher rubber prices in FY11, the impact cannot be avoided in FY12. Peaking capacity. While demand for tyres is robust, BILs peaking capacity utilisation indicates that its revenue growth would be constrained in FY12. Valuations and risks. We value the stock at `144 (8.25x FY12e standalone EPS of `16.5 and `8 as value of its paper business). At the CMP, the upside is not too compelling. We initiate coverage with a Hold. Upside risks: decline in rubber prices, faster-thanexpected ramp-up in new capacities, and more-than-expected price increases. Downside risk: unfavourable currency movement.
Key data
BIL In/BLKI.BO `162/`104 18211 / 5459 US$0.3m `12.36bn/US$274.7m 97.4m 45.7% 54.4% 14.2% 16.2% 15.2%
Key financials

12,523 700 7.2 -32.9 17.6 2.6 15.0 14.6 0.9 54.6 13,870 2,069 21.3 195.5 6.0 1.9 31.3 28.0 1.1 47.4 19,435 1,798 18.5 -13.1 6.9 1.5 21.7 20.0 1.0 47.2 23,015 1,601 16.5 -10.9 7.7 1.3 16.4 15.0 0.9 52.4 27,171 2,116 21.8 32.1 5.8 1.1 18.0 16.2 1.1 52.5
Source: Bloomberg
Sales (`m) Net profit (`m) EPS (`) Growth (%) PE (x) PBV (x) RoE (%) RoCE (%) Dividend yield (%) Net gearing (%)
170 160 150 140 130 120 110 100 Dec-10 Aug-10 Jun-10 Feb-10 Oct-10 Apr-10
Sensex
BIL Feb-11
22 February 2011
Balkrishna Industries Good business model, rubber concerns; initiate with Hold

Fig 4 PE Band
19,435 40.1 15,834 3,601 18.5 212 750 40 883 1,806 1,798 -13.1 18.5 26.3 1.3 23,015 18.4 19,390 3,625 15.8 424 855 44 789 1,601 1,601 -10.9 16.5 25.3 1.1 27,171 18.1 22,552 4,619 17.0 530 1,026 49 996 2,116 2,116 32.1 21.8 32.4 1.4
600 500 26x 400 21x 300 200 100 0 Oct-05 Apr-06 Oct-06 Apr-07 Oct-07 Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10
5.5x 500 4.5x 400 3.5x 300 2.5x 200 100 0 Oct-05 Oct-06 Oct-07 Oct-08 Oct-09 Oct-10 Apr-06 Apr-07 Apr-08 Apr-09 Apr-10 Apr-05 1.5 x 0.5x
12,523 26.3 10,553 1,970 15.7 375 565 49 379 703 700 -32.9 7.2 13.1 1.2
13,870 10.8 10,172 3,698 26.7 187 662 264 1,048 2,087 2,069 195.5 21.3 28.4 1.4
16x 11x 6x 1x Apr-05


193 6,414 6,608 4,643 548 11,799 6,738 807 4,212 42 11,799 97 69.6 94 194 8,102 8,296 5,643 548 14,488 8,399 807 5,232 50 14,488 97 67.4 87 194 9,577 9,771 8,393 548 18,713 12,543 807 5,329 33 18,713 97 85.6 75 194 11,542 11,736 10,243 548 22,527 15,517 807 6,181 22 22,527 97 87.1 75
600
193 4,485 4,678 4,728 524 9,930 6,093 322 3,404 111 9,930 97 98.7 82

Fig 6 BIL vs BSE Auto

1,806 750 2,556 1,019 1,537 3,000 -1,463 122 1 -1,000 0 -2,592 8 42 50 1,601 855 2,457 98 2,359 5,000 -2,641 110 0 -2,750 0 -5,484 -17 50 33 2,116 1,026 3,142 852 2,290 4,000 -1,710 132 0 -1,850 0 -3,680 -11 33 22
170 160 150 140 130 120 110 100 Aug-10 Apr-10 Dec-10 Jun-10 Feb-10 Oct-10 Feb-11 BIL BSE Auto
703 565 1,268 -538 1,806 1,667 139 116 0 620 -19 638 24 87 111
2,087 662 2,749 808 1,941 1,327 615 135 0 85 485 148 -69 111 42
Source: Bloomberg
86
22 February 2011

Focussed on the agricultural-tyre and off-road sub-segments in the overseas market, Balkrishna Industries typically enjoys margins higher than its peers. However, short-term capacity constraints and rising rubber prices have dampened its short- to medium-term outlook. We initiate coverage on BIL with a Hold recommendation. Robust business model Balkrishna Industries mainly addresses the higher-margin tyre segments off-road vehicles and agricultural tyres. As it supplies heavier tyres mainly for export, it enjoys higher-than-industry margins.
Fig 7 Comparative EBITDA margins of tyre companies
(%) 30 25 20
FY05
FY06
FY07
FY08
FY09
FY10
BIL
Apollo Tyres
Ceat
MRF
Source: Company, Anand Rathi Research.
Rubber is a concern The escalating price of rubber is a concern for the entire tyre industry, Balkrishna included. While its forward contracts at lower prices insure it against higher rubber prices in FY11, the impact cannot be avoided in FY12. High rubber prices are a function of a rise in international prices of rubber (due to abnormal weather conditions), a surge in demand backed by robust auto demand, an increase in the price of crude oil, and plateauing production at plantations. Peaking capacity While demand for tyres is robust, BILs peaking capacity utilisation indicates that its revenue growth would be constrained in FY12. For immediate additional capacity, it is undertaking de-bottlenecking. By Oct 11, de-bottlenecking of 10,000 tons, at `2bn, would be complete. Of this, `600m-700m has already been incurred. By Mar 11, an additional `200m300m would have been incurred. This de-bottlenecking involves adding equipment, increasing radial capacity, mixing capacity at Waluj, building a raw-material and finishedgoods warehouse, and adding a press. The greenfield complex being set up at Bhuj would be completed only by 4QFY13.
FY11e
Focus on exports; supply to the offroad & agricultural-tyre subsegments and successful hedging policy have helped Balkrishna register better-than-industry EBITDA margins
15 10 5 0
87
22 February 2011
Valuations not too compelling We value the stock at `144 (8.25x FY12e standalone EPS of `16.5 and `8 as the value of the paper business). Our target PE multiple is at a 15% discount to the five-year average PE multiple of 9.75x. We attribute this discount to escalating rubber prices. At the current market price, the upside is not too compelling. We initiate coverage on the stock, with a Hold rating.
Fig 8 BIL EV/EBITDA Band
20
16
12
0 May-09 Nov-05 Dec-09 Aug-07 Mar-08 Feb-11 Oct-08 Apr-05 Jun-06 Jan-07 Jul-10
Source: Company
Risks

Upside: Decline in rubber prices, faster-than-expected ramp-up in fresh capacities, and more-than-expected price increases. Downside: Currency fluctuations.
88
22 February 2011
Robust business model

Balkrishna Industries mainly addresses the higher-margin tyre segmentsoff-road vehicles and agricultural tyres. As it supplies heavier tyres mainly for export, it enjoys margins higher-thanindustry peers. Off-road, exports, key sub-segments Balkrishna Industries is a leading manufacturer of a broad range of offroad tyres in agriculture, construction, industrials, earthmovers and ATVs (all-terrain vehicles). It has three manufacturing plants and one die/tooling unit in Rajasthan and Maharashtra. Products for which tyres are supplied vary from tractors, trailers and other farm equipment in agriculture to heavy earthmovers, compactors, graders, underground mining and backhoes in non-agriculture. Demand drivers
Large farms in Europe have a high degree of mechanisation. Hence, agricultural-tyre requirement is higher, both from OEMs and in the replacement market. Growth in the agricultural and mining sector in the Americas, coupled with the fast-growing South American economies. Trend towards large farm equipment in America. Growth in agriculture and infrastructure in Asia-Pacific and movement from traditional to larger equipment. Growth in the off-road segment in India would be an additional demand driver. While Indias share of Balkrishnas turnover is just 11%, on completion of its greenfield plant, Balkrishna would be in a position to further its penetration in India. To this end, it is tying up with new OEMs and establishing a distribution network.
(`m) 7,500 6,000 4,500 3,000 1,500 0 Europe America RoW India FY10 Asia FY06
Fig 9 Revenue break-up by region
Source: Company
Balkrishna has benefited from this demand With a wide product range of 1,900 stock-keeping units (SKUs), Balkrishna is Indias leading exporter of off-highway tyres, and addresses markets in more than 120 countries in Europe, America, Asia-Pacific, the Middle East, etc. To cater to more markets, it has taken aggressive steps in
22 February 2011
the past five years:

Increasing achievable production capacity by ~2.5x from 48,750 tons to 120,000 tons, and setting up a third plant. The markets being serviced increased from 75 to 120. The number of distributors was increased from 120 to over 200.
The company has a range of over 1,800 types of tyres, from 5kg to 1,500kg. Thus, its product-mix is more versatile, but entails a longer turnaround time between products. Further, BILs product profile has 1,900 SKUs; daily, 1,200 SKUs are active. Also, typically, a mould is changed every three days; but this could go up to 30 days per mould. All sizes are manufactured at all plants. User segments for BILs off-highway tyres:
Agriculture: Constituting ~70% of revenues, these include tyres for tractors, trailers, forestry, farm equipment, and specifically designed as per farm requirement. The agriculture segment also has more pricing power. OTR: Constituting ~26% of revenues, these include industrial, construction, and earthmover tyres, for dump trucks, loaders, underground mines, and port applications. Others: Constituting ~4% of revenues, these include tyres for sports and utility vehicles such as golf carts, lawn & garden tyres, and allterrain-vehicle tyres.
Fig 10 Sales breakup

Off-take 10% OEM 15%
Distributors 75%
Source: Company
Competitors
Global leaders like Bridgestone and Michelin manufacture off-highway tyres; off-road tyres comprise less than 5% of their revenues. However, their off-road tyre volumes are higher than BILs. The Chinese are largely absent in the agri-segment, which has low volumes and great variety; hence, is not a volumes game. This is a positive for BIL. BILs line of business is differentiated from other tyre manufacturers and is tough to replicate. BIL is the only Indian manufacturer that supplies off-road radials abroad. In India, off-road tyre suppliers are local players such as Apollo Tyres. BIL does not supply extensively in the home market, but prefers to export. Capacity constraints do not allow it to tap the domestic market in the near term.
90
22 February 2011
Rubber is a concern
The escalating price of rubber is a concern for the entire tyre industry, Balkrishna included. While, its forward contracts at lower prices insure it against higher rubber prices in FY11, the impact cannot be avoided in FY12. RM prices scaling a new peak Natural rubber, a key input, has been scaling new peaks. This, in turn, has translated into higher raw material costs for most tyre companies. High rubber prices are a function of a rise in international prices of rubber (due to abnormal weather conditions), a surge in demand (backed by robust auto demand), an increase in the price of crude and plateauing production at plantations.
Fig 11 Trend in rubber prices
(`/quintal) 23,500 20,500 17,500 14,500 11,500 8,500 5,500 Oct-08 Aug-07 May-09 Nov-05 Dec-09 Feb-11 Jun-06 Jan-07 Apr-05 Mar-08 Jul-10
Domestic Rubber price

Source: Rubber Board of India
BIL, a short-term exception to higher rubber prices Balkrishna booked natural rubber (NR) contracts at US$3,400/ton and synthetic rubber (SR) contracts at US$2,700/ton. These contracts would run till Mar 11. Spot prices of NR are US$5,200 in India and US$6,200 internationally. Approximately 60% of BILs operating costs are raw material costs. If NR increases 10%, the company would need to raise prices 1-1.5%.
Fig 12 Key raw-material composition, by volume (%)
Fabric 6% Chemicals 16% Bead wire 3% Natural rubber 32%
Synthetic rubber 16% Carbon black 27%

Source: Company
91
22 February 2011
In the past, imported rubber has been cheaper, by `20/kg, due to lower import duties. Recent trends in rubber prices, however, have been against the grain. The advance-license scheme availed of by BIL implies even lower costs. Advance licenses are given on export quantities; since 90% of BILs production is exported, the company benefits. Transportation too constitutes a huge cost. Freight costs work out to 910% of revenue. Hence, the company has three-month contracts with shipping companies. In a month, it exports 900-1,000 containers. Imports comprise 40% of exports. Benefits of the DEPB (duty-exempt passbook) scheme are received after exports; advance licenses are given before exporting. Though the net benefit in a stable raw-material price context is similar, in a fluctuating rawmaterial price context, the advance license proves beneficial. A rubber plant takes seven years before it begins to produce rubber. In FY05-06, plantations saw an increase in the number of rubber saplings planted. The life of a rubber plant is 25 years. Supply constraints in natural rubber are expected to ease only by end-CY12.
Fig 13 Comparative RM/sales and rubber price trend
(`/quintal) 25,040 21,040 17,040 13,040 9,040 5,040 4QFY11e
FY11e
(%) 65 60 55 50 45 40 1QFY08 2QFY08 3QFY08 4QFY08 1QFY09 2QFY09 3QFY09 4QFY09 1QFY10 2QFY10 3QFY10 4QFY10 1QFY11 2QFY11 3QFY11
Rubber price
RM/Sales (RHS)
Fig 14 Ratio of BIL's average rubber price to spot price
On average, BILs contracting policies have been very astute
(x) 1.1
0.9
0.8
0.7 FY06 FY07 FY08 FY09 FY10
92
22 February 2011
Peaking capacity
While demand for tyres is robust, BILs peaking capacity utilisation indicates that its revenue growth would be constrained in FY12. Greenfield capacity two years away In the short term, Balkrishna would be faced with capacity constraints. Moreover, since various SKUs are involved in the production mix, 100% capacity utilisation is not possible. While demand for tyres is robust, BILs peaking capacity utilisation indicates that its revenue growth would be constrained in FY12. To gain some immediate additional capacity, the company is undertaking de-bottlenecking. By Oct 11, de-bottlenecking of 10,000 tons, at `2bn, would be complete. Of this, `600m-700m has been incurred. By Mar 11 an additional `200m-300m would have been incurred. The debottlenecking would improve achievable production capacity by 10,000 tons to 130,000 tons. This de-bottlenecking involves adding equipment, increasing radial capacity, mixing capacity at Waluj, building a raw-material and finishedgoods warehouse, and adding a press. Balkrishna is also setting up a greenfield complex at Bhuj, Gujarat. This would be ready only by 4QFY13, taking 16 months to ramp up to full capacity. It would have installed capacity of 120,000 tons and achievable capacity of 90,000 tons.
Fig 15 Trend in BILs installed capacity
(MT 300,000 250,000 200,000 150,000 100,000 50,000 0 FY06 FY10 FY12e FY14e
Installed capacity
Source: Company
Achievable capacity
93
22 February 2011
Financials
We expect BIL to register an 8.5% profit CAGR over FY11-13. We expect an 18.2% revenue CAGR (driven mainly by price hikes) and an EBITDA margin decline of 150bps. Three major factors restricting Balkrishnas revenue and profit expansion would be the surge in input costs, capacity constraints and the greenfield project at Bhuj, which would raise interest costs. The de-bottlenecking is being carried out with internal accruals, while the greenfield project would be financed by external debt. Balkrishnas working capital cycle is 90 days. Its exports are on vanilla terms only. Debt drawal is in Jan 11, but unlinked to project progress. The facility is available for six years, with a moratorium of three years. The rate would be LIBOR+3%. Considering the planned capex, the company does not plan to significantly increase dividend from the 10-15% current payout. Under these assumptions, we expect BIL to register an 8.5% profit CAGR over FY11-13e. We expect an18.2% revenue CAGR (driven mainly by price hikes) and an EBITDA margin decline of 150bps.
Fig 16 Revenue and profit trend standalone
(`m 30,000 25,000 20,000 15,000 10,000 5,000 0 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY13e (`m) 2,300 2,000 1,700 1,400 1,100 800 500
Revenue
Profit (RHS)
94
22 February 2011

Year-end 31 March FY09 FY10 FY11e FY12e FY13e
Net Sales Change (%) Operating Other Income Total Income Change (%) Expenditure EBITDA Change (%) % of Net Sales Depreciation EBIT Deferred Revenue Exp. Interest & Finance Charges Other Income Non-recurring Expense Non-recurring Income PBT Tax Effective Rate (%) Rep. PAT Change (%) Adj. PAT Change (%)
12,523 26.3 0 12,523 26.3 10,553 1,970 -9.4 15.7 565 1,405 0 375 49 3 6 1,082 379 35.1 703 -33.4 700 (32.9)
13,870 10.8 0 13,870 10.8 10,172 3,698 87.7 26.7 662 3,036 0 187 264 2 24 3,135 1,048 33.4 2,087 196.9 2,069 195.5
19,339 39.4 95 19,435 40.1 15,834 3,601 -2.6 18.5 750 2,851 0 212 40 61 71 2,689 883 32.8 1,806 -13.5 1,798 (13.1)
22,910 18.5 105 23,015 18.4 19,390 3,625 0.7 15.8 855 2,770 0 424 44 0 0 2,390 789 33.0 1,601 -11.3 1,601 (10.9)
27,056 18.1 115 27,171 18.1 22,552 4,619 27.4 17.0 1,026 3,593 0 530 49 0 0 3,112 996 32.0 2,116 32.1 2,116 32.1

Sources of Funds Issued Equity Share Capital Reserves Net Worth Net Deferred Tax Total Loans Capital Employed Application of Funds Gross Fixed Assets Less: Depreciation Net Fixed Assets Capital WIP Total Net Fixed Assets Investments Curr.Assets, L & Adv. Inventory Sundry Debtors Cash & Bank Balances Loans & Advances Others Current Liab. & Prov. Sundry Creditors Other Liabilities Provisions Net Current Assets Application of Funds
193 4,485 4,678 524 4,728 9,930
193 6,414 6,608 548 4,643 11,799
194 8,102 8,296 548 5,643 14,488
194 9,577 9,771 548 8,393 18,713
194 11,542 11,736 548 10,243 22,527
7,388 2,042 5,346 747 6,093 322 6,309 1,223 2,191 111 2,783 1 2,793 611 236 1,946 3,515 9,930
8,715 2,566 6,149 589 6,738 807 8,173 2,031 2,403 42 3,696 0 3,918 843 306 2,769 4,254 11,799
11,715 3,316 8,399 0 8,399 807 9,681 2,755 3,179 50 3,696 0 4,399 1,325 306 2,769 5,282 14,488
16,715 4,171 12,543 0 12,543 807 10,320 3,138 3,452 33 3,696 0 4,958 1,883 306 2,769 5,362 18,713
20,715 5,198 15,517 0 15,517 807 11,502 3,706 4,077 22 3,696 0 5,299 2,224 306 2,769 6,203 22,527
95
22 February 2011

OP/(Loss) before Tax Interest/Div. Received Depreciation & Amort. Direct Taxes Paid (Inc)/Dec in Working Capital Other Items CF from Oper. Activity Extra-ordinary Items Other Items CF after EO Items (Inc)/Dec in FA+CWIP (Pur)/Sale of Invest. CF from Inv. Activity
1,405 49 565 -285 538 0 2,272 4 0 2,276 -1,139 19 -1,120 1,155 0 -620 -375 -136 -1,131 24 87 111
3,036 264 662 -1,024 -808 0 2,130 22 0 2,152 -1,307 -485 -1,792 360 0 -85 -187 -158 -429 -69 111 42
2,851 40 750 -883 -1,019 21 1,760 10 0 1,770 -2,411 0 -2,411 -641 1 1,000 -212 -140 649 8 42 50
2,770 44 855 -789 -98 0 2,782 0 0 2,782 -5,000 0 -5,000 -2,218 0 2,750 -424 -126 2,200 -17 50 33
3,593 49 1,026 -996 -852 0 2,820 0 0 2,820 -4,000 0 -4,000 -1,180 0 1,850 -530 -151 1,169 -11 33 22
Issue of Shares Inc/(Dec) in Debt Interest Paid Dividends Paid CF from Fin. Activity Inc/(Dec) in Cash Add: Beginning Balance Closing Balance

Basic (`) Diluted EPS EPS Growth (%) Cash EPS Book Value per Share DPS Payout (Incl. Div. Tax) % Valuation (x) P/E Cash P/E EV/EBITDA EV/Sales Price to Book Value Dividend Yield (%) Turnover Ratios Asset Turnover (x) Fixed Asset Turnover (x) Profitability Ratios (%) RoE RoCE Leverage Ratio Debt/Equity (x)
7.2 -32.9 13.1 48.4 1.2 19.4
21.3 195.5 28.4 68.4 1.4 7.6
18.5 -13.1 26.3 85.5 1.3 7.8
16.5 -10.9 25.3 100.7 1.1 7.9
21.8 32.1 32.4 121.0 1.4 7.1
17.6 9.7 8.4 1.3 2.6 0.9
6.0 4.5 4.4 1.2 1.9 1.1
6.9 4.8 4.8 0.9 1.5 1.0
7.7 5.0 5.5 0.9 1.3 0.9
5.8 3.9 4.7 0.8 1.1 1.1
1.3 1.7
1.2 1.6
1.3 1.7
1.2 1.4
1.2 1.3
15.0 14.6
31.3 28.0
21.7 20.0
16.4 15.0
18.0 16.2
1.0
0.7
0.7
0.9
0.9
96
22 February 2011
Company Background & Management

Balkrishna Industries is a leading manufacturer of a broad range of off road tyres for agriculture, construction, industrials, earthmovers and ATVs (all-terrain vehicles). It has three manufacturing plants and one die/tooling unit in Rajasthan and Maharashtra. Founded in 1988 to manufacture two- and three-wheeler tyres, Balkrishna shifted to the off-road tyre segment in 1993-94. It focuses on producing off-highway tires for agriculture, industry, materials-handling, forestry, lawns and gardens, construction and earthmovers. It has a worldwide distribution network, ensuring extensive reach and penetration. Balkrishnas plants:

Aurangabad: bias at 85-88 tpd; Bhiwadi: 80% radial and 20% bias; can go to 50-50 mix; 125 tpd; Chopankhi: 115 tpd. 30 OTR radial, balance bias; Dombivali: manufacturing own moulds; The upcoming Bhuj plant. Aurag Poddar is VC & MD. Rajeev Poddar is executive director. B K Bansal is CFO.
Management

97
Auto Components
India I Equities
Initiating Coverage
22 February 2011
Mahindra Forgings
Steady improvement; initiate with Buy
Mahindra Forgings is one of the leading forgings companies globally and is set to gain from the steady recovery in European auto demand. This would, in turn, drive a sustainable and profitable performance ahead. We initiate coverage on MFL with a Buy and a target price of `137.
Rohan Korde
Girish Solanki
Sound domestic demand. Domestic demand is good, especially in MFLs key segments, PVs and tractors, thereby benefiting its India operations. The transfer of dies from Europe in FY11, while resulting in short-term pain, would help improve production standards and capture additional demand ahead. Improved operations. Increased share of machined components at its India operations and greater operating leverage would lead to improved margins. Overseas performance to see steady improvement. Given the scale of its European operations, ~80% of MFLs revenue arises from outside India. Demand in the European auto market is expected to continue boosting steady recovery, which would benefit it both in terms of higher revenue and operating leverage. Valuation and risks. We value MFL at `137 (25x FY12e EPS of `5.5). Future re-rating is likely on: i) proven ability to sustain consolidated profitability and ii) likely restructuring of MFL as part of Mahindra Systech. We initiate coverage with a Buy. Risks: decline in domestic or overseas auto sales; currency fluctuations.
Key data
MFOL In/MAFR.BO `145/`63 18212 / 5459 US$0.2m `5.99bn/US$133.2m 87.9m 40.3% 50.7% 1.5% 11.1% 36.8%
Key financials - Consolidated


13,278 -1,492 -16.2 93.6 0.7 0.0 46.7 18,980 76 0.8 -105.1 78.4 0.8 1.0 4.0 0.0 45.1 24,316 506 5.5 565.2 11.8 0.7 6.0 8.5 0.0 44.0 29,334 878 9.5 73.4 6.8 0.6 9.4 11.9 0.0 40.8
Source: Bloomberg
22,434 -771 -8.4 -290.6 0.6 0.1 0.0 55.6
160 140 120 100 80 60 Aug-10 Jun-10 Feb-10 Oct-10 Apr-10
Sensex
MFOL Dec-10 Feb-11
22 February 2011
Mahindra Forgings - Steady improvement; initiate with Buy

Fig 4 Consolidated Price-to-Book Band

18,980 42.9 17,317 1,663 8.8 424 1,303 130 -10 76 76 -105.1 0.8 15.0 0.0 24,316 28.1 21,884 2,431 10.0 488 1,498 117 56 506 506 565.2 5.5 21.8 0.0 29,334 20.6 26,176 3,158 10.8 561 1,723 129 125 878 878 73.4 9.5 28.2 0.0
22,434 -3.3 21,148 1,286 5.7 704 1,494 223 80 -1,153 -771 -290.6 -8.4 10.6 0.0
13,278 -40.8 13,362 -84 -0.6 606 1,371 65 -504 -1,845 -1,492 93.6 -16.2 -1.4 0.0
480 440 400 360 320 280 240 200 160 120 80 40 0 Aug-06 Oct-07 Mar-07
Mahindra Forgings
3.2x 2.6x 2.0x 1.4x 0.8x 0.2x May-08 Jul-09 Feb-10 Sep-10 3.2x 2.6x 2.0x 1.4x 0.8x 0.2x May-08 Oct-07 Jul-09 Dec-08 Aug-06 Feb-10 Sep-10 Mar-07 Dec-08

Fig 5 Standalone Price-to-Book Band

879 7,064 7,943 6,536 -539 13,940 12,355 294 1,005 287 13,940 88 78.7 83.2 922 6,993 7,915 4,936 -539 12,312 11,570 294 318 130 12,312 92 60.7 45.0 922 7,499 8,421 4,536 -539 12,418 10,872 294 1,109 144 12,418 92 52.2 47.0 922 8,378 9,299 4,336 -539 13,096 10,549 294 1,755 498 13,096 92 41.3 47.0
480 440 400 360 320 280 240 200 160 120 80 40 0
686 6,762 7,448 8,740 -80 16,107 14,004 23 1,733 348 16,107 69 112.7 61.2
Mah Forgings

Fig 6 Mahindra Forgings vs. BSE Auto

76 1,303 1,379 -1,056 2,434 517 1,917 0 43 -1,600 0 516 -156 287 131 506 1,498 2,004 435 1,570 800 770 0 0 -400 0 356 14 130 144 878 1,723 2,601 278 2,322 1,400 922 0 0 -200 0 368 354 144 498
180 160 140 120 100 80 MFOL 60 Aug-10 Apr-10 Dec-10 Jun-10 Feb-10 Oct-10 Feb-11 BSE Auto
-1,153 1,494 341 -1,057 1,398 1,126 272 0 0 626 3 983 -88 437 348
-1,845 1,371 -474 -1,032 558 -278 836 0 193 -2,204 271 -1,384 -61 348 287
Source: Bloomberg
99
22 February 2011

One of the leading forgings companies globally, MFL would benefit from the steady recovery in European auto demand. This would, in turn, drive a sustainable and profitable performance. We initiate coverage on MFL with a Buy recommendation and a target price of `137. Sound domestic demand Domestic demand is sound, particularly in MFLs key segments of PVs and tractors. We expect the auto industry in India to see a 13.7% volume CAGR over FY11-13e. Auto volume growth in FY11 has been robust at 25.1% yoy, while the FY02-11 CAGR was 14%. Hence, MFLs domestic operations would benefit from the secular growth expected in PVs and tractors. Transfer of dies from Europe in FY11, while leading to short-term pain, would help improve production standards and capture additional demand ahead. Improved efficiencies Higher operating leverage, benefits of cost-reduction measures, completion of business restructuring and a greater proportion of machined forgings would drive MFLs EBITDA margin higher from FY12. Moreover, measures at its overseas operations to conserve cash, reduce costs and improve productivity, while helping in surviving the downturn, would also augur well for enhanced profitability ahead. Direct exports comprise a negligible proportion of MFLs consolidated revenue, but the scale of the European operations means that ~80% of revenue arises from outside India. Demand in the European auto market is expected to steadily recover from FY11, after bottoming out over CY08-10, thereby benefiting MFL. Turnaround With a host of global majors setting up car manufacturing plants in India, adequate capacity is a prime requisite for business growth. New machining and forgings lines being set up would help address this growing demand. We expect MFL to turn around its operations and register a profit CAGR of 239.6% over FY11-13e (from a very low base), together with a revenue CAGR of 24.3% and an EBITDA margin improvement of 200bps. Valuation Since listing, MFLs price performance has been hampered by organizational restructuring, operational restructuring and the impact of the demand downturn. Hence, past valuations are not too meaningful. Future re-rating is likely on two counts: proven ability to sustain profitability and benefits of re-organization with Mahindra Systech. We value MFL at `137 (25x FY12e EPS of `5.5). We initiate coverage on MFL with a Buy rating.
100
22 February 2011
Risks

Decline in auto demand Double-dip recession in Europe Currency fluctuations Delay in ramp-up in India machining capacity.
101
22 February 2011
Sound domestic growth

Domestic demand is sound, particularly in MFLs key segments of PVs and tractors. Domestic operations would benefit from the secular growth expected in these segments. In India, the key sources of revenues for MFL are the PV (both cars and UVs) and tractor segments. Other segments constitute a much smaller share of MFLs annual revenue. Domestically, MFL derives 41.5% of its revenue from passenger cars, 23.4% from MUVs, 12.8% from tractors, 9.5% from LCVs, 2.8% from HCVs and 9.9% from the non-auto segment. Non-M&M business accounts for more than 70% of MFLs sales.
Fig 7 - Mahindra Forgings India: Revenue breakup, segment-wise
MUVs 23% Passenger cars 41% Tractors 13% LCV 10%
Source: Company
HCV 3%
Non-auto 10%
India turning into a small car manufacturing hub, new capacities from global OEMs being set up in India, ramp-up in capacity of the Nano and increasing preference for UVs as a lifestyle product would lead to PVs seeing 13% volume CAGR over FY11-13e. On the other hand, the tractor segment would be more volatile, with seasonal vagaries of weather having a glaring influence on annual demand. PVs and tractors to continue doing well After two years of breakneck growth, the Indian auto sector has entered the secular growth phase in the current cycle. We expect an industry volume CAGR of 13.7% over FY11-13e, providing firm support to the sector. PVs India has emerged as a small car manufacturing hub as global giants General Motors (plant of 225,000-unit capacity annually set up at Talegaon near Pune), Volkswagen (plant at Pune), Nissan (upcoming plant at Chennai), and Renault (in partnership with Nissan) have joined the existing India old hands such as Suzuki and Hyundai. These companies not only cater to domestic demand but would also use India as an export base in the medium term. Tractors The tractor segment would benefit from the agri-friendly policies of the government and increased penetration in non-traditional tractor markets. An additional factor would be the increase in usage in non-traditional areas such as transportation and infrastructure. Tractor demand growth is expected to see a 9% CAGR over FY11-13e, subject to monsoon cycles.
102
22 February 2011
Fig 8 Industry: Volume growth expectation for PCs

(Nos.) 3,500,000 3,000,000 2,500,000 2,000,000 1,500,000 1,000,000 500,000 0 FY11e FY12e FY13e
(%) 30 25 20 15 10 5 0 -5 -10 -15 FY11e FY12e FY13e FY04 FY05 FY06 FY07 FY08 FY09 FY10
(%) 35 31 27 23 19 15 11 7 FY04 FY05 FY06 FY07 FY08 FY09 FY10
PC
yoy change (RHS)
Fig 9 Industry: Volume growth expectation for UVs

(Nos.) 450,000 400,000 350,000 300,000 250,000 200,000 150,000 100,000 50,000 0
UV
yoy change (RHS)
103
22 February 2011
Improved operations
Increased share of machined components and greater operating leverage would lead to improved margins for MFL. Higher operating leverage, benefits of cost reduction activities, completion of business restructuring and an increased proportion of machined forgings would drive MFLs EBITDA margin higher, from FY12 onwards. Moreover, measures at its overseas operations to conserve cash, reduce costs and improve productivity, while helping survive the downturn, would augur well for enhanced profitability ahead. Operating efficiencies at India operations Over FY09-10, MFLs India operations were impacted by a combination of factors adverse forex movement, breakdown of press, and auto demand slowdown. Ahead, we expect Mahindra Forgings India (MFI) to put behind this phase, and register sustainable improvement in its EBITDA margin, owing to:
1.
Increase in share of machined forgings in MFIs product mix MFI is setting up additional machining capacity. This would in turn do away with the need for MFI to outsource machining, or for OEMs to carry out machining in-house. As machining is a more value-added and hence profitable activity, an incremental share would drive up MFIs profitability.
Fig 10 Mahindra Forgings India: Increase in share of machined forgings

100%
75%
50%
25%
0% FY10e FY11e FY12e FY13e FY09
Machined Forgings
Non-machined forgings
2.
Operating leverage As production activity picks up, MFI would benefit increasingly from higher operating leverage. Current capacity utilization is ~60% (of actual usable capacity), which is expected to be scaled up to >80% by FY13e.
104
22 February 2011
Fig 11 Mahindra Forgings India: Trend in capacity utilization

90% 80% 70% 60% 50% 40% 30% 20% FY11e FY12e FY13e FY06 FY07 FY08 FY09 FY10
on rated capacity
on usable capacity
3.
Productivity and efficiency gains MFI has been able to improve its operational productivity by ~20% from FY09 levels. Among other steps to improve profitability, improvement in yield is expected to contribute ~4% savings on its raw-material costs. Lastly, focus on reduction in rejections would help save costs significantly. Current level of rejections is ~5%, which is lower than that in FY09 (~8%). Even a reduction to the level at which Bharat Forge operates (~4%) would result in considerable savings. The target for MFI is 2% rejections, which would bring it on par with its European operations. Transfer of dies from Europe carried out in FY11, while leading to short-term pain, would help improve production standards and capture additional demand.
(%) 16 14 12 10 8 6 4 2 0 FY11e FY12e FY13e FY06 FY07 FY08 FY09 FY10
4.
Fig 12 Mahindra Forgings India: Trend in EBITDA margin
Steps taken to improve MFE profitability With a significant downturn in the European CV market, Mahindra Forgings Europe (MFE) has trimmed expenditure and turned around its performance, owing to stringent steps including:
1.
Reduction of personnel expenses by 34% in FY10 vis--vis FY09. This included measures such as reduction of head count by 31% and up to 100% short-time-working. Stock reduction MFE has reduced WIP and finished goods worth 12m, while reducing raw-material inventory, by 8m, since Aug 08.
105
2.
22 February 2011
Hence, due to exhaustion of channel inventories, a pick-up in demand would lead to greater capacity utilization.
3.
Cost reduction MFE has been successful in reducing its fixed costs by ~40%. To ensure that costs do not significantly spiral up, further capacity expansion has been kept at an absolute minimum, with the focus being on cash-flow generation. Closure of the Walsall, UK, plant is also a step in this direction.
Key for European operations is that except for the 3-5% annual maintenance capex, no further investments are required to accommodate future growth. The companys co-development approach adopted with OEMs would continue to help forge long-term business relationships. Strong technological capabilities and an innovation culture would serve as a tool to garner incremental share of new business.
Fig 13 Mahindra Forgings Europe: Profitability improvement
(`m) 1,000 500 0 -500 -1,000 -1,500 -2,000 FY11e FY12e FY13e FY08 FY09 FY10
106
22 February 2011
Turnaround in financials
We expect MFL to record a turnaround in its operations and register a profit CAGR of 239.6% over FY11-13e. We expect a revenue CAGR of 24.3% and an EBITDA margin improvement of 200bps. Direct exports comprise a negligible proportion of MFLs consolidated revenue, but the scale of European operations means that ~80% of revenue arises from outside India. Demand in the European auto market is expected to steadily recover from FY11, after bottoming out over CY0810, thereby benefiting MFL. Anecdotal evidence suggests that European CV demand has slid ~60% in FY10 from FY09. We expect a 24.9% revenue CAGR over FY11-13e for MFE. This is after a compounded annual 36.4% decline in revenue over FY08-10. Ahead, growth would be driven by improvement in demand as well as commencement of supply for new orders. Increase in low-cost sourcing from India and diversification into non-autos and marines would open long-term growth avenues for MFL. With a host of global majors setting up car manufacturing plants in India, adequate capacity is a prime requisite for business growth. New machining and forgings lines being set up would help address this growing demand. We expect MFL to record a turnaround in its operations and register a profit CAGR of 239.6% over FY11-13e. We expect a revenue CAGR of 24.3% and an EBITDA margin improvement of 200bps.
Fig 14 - Trend in MFL standalone revenues and profitability
(`m) 5,500 5,000 4,500 4,000 3,500 3,000 2,500 2,000 FY10e FY11e FY12e FY13e FY08 FY09 (`m) 390 270 150 30 -90 -210 -330 -450
Total Income
Adj. PAT (RHS)
107
22 February 2011
Fig 15 - Trend in MFLs consolidated revenues and profitability

(`m) 30,000 26,000 22,000 18,000 14,000 10,000 FY11e FY12e FY13e FY08 FY09 FY10 (`m) 900 400 -100 -600 -1,100 -1,600
Total Income
Adj. PAT (RHS)
We expect 22.5% CAGR in MFLs (standalone) revenue over FY11-13e, backed by EBITDA margin improvement to 14% in FY13e from 10% in FY11e. The margin improvement is expected to be facilitated by a better product mix favoring machined products, higher capacity utilization and operational efficiencies. We expect a movement to adjusted profit from a loss in FY11e. We expect a 24.3% CAGR in (consolidated) revenue over FY11-13e, backed by an EBITDA margin improvement to 10.8% in FY13e from 8.8% in FY11e. In the past, MFLs overseas subsidiaries have had a higher EBITDA margin than the standalone operations. We expect the trend to change in favor of India operations (MFI) from FY10. Margin improvement in subsidiaries would be driven by higher capacity utilization and cost restructuring & reduction. We expect a 239.6% CAGR in the (consolidated) adjusted net profit over FY11-13e. Trend in India operations production tonnage Production tonnage growth CAGR in India operations is expected to be high for MFL due to:
1. 2.
Higher visibility of revenue growth since 78.1% of revenue is from the fast-growing PV and tractor segments; and Increased machining potential.
Reduction in debt MFL would steadily lower its debt over a period of time. The debt-equity ratio would be reduced to 0.5x in FY12e from 0.8x in FY10 and 1.2x in FY09. This would gradually lower the interest expense for MFL.
108
22 February 2011

Total Income Change (%) Expenditure EBITDA Change (%) % of Net Sales Depreciation Goodwill amortization EBIT Provision for contingency Interest & Fin. Charges Other Income Non-recurring Expense Non-recurring Income PBT PBT margin (%) Tax Effective Rate (%) Rep. PAT Change (%) Adj. PAT Change (%)
22,434 -3.3 21,148 1,286 -34.6 5.7 1,494 -209 0 704 223 383 -1,073 -4.8 80 -7.5 -1,153 -800.9 -771 -290.6
13,278 -40.8 13,362 -84 -106.5 -0.6 1,371 -1,455 0 606 65 353 -2,349 -17.7 (504) 21.5 -1,845 60.0 -1,492 93.6
18,980 42.9 17,317 1,663 -2,077.1 8.8 1,303 360 0 424 130 66 0.3 (10) -15.0 76 -104.1 76 -105.1
24,316 28.1 21,884 2,431 46.2 10.0 1,498 934 0 488 117 563 2.3 56 10.0 506 565.2 506 565.2
29,334 20.6 26,176 3,158 29.9 10.8 1,723 1,436 0 561 129 1,003 3.4 125 12.5 878 73.4 878 73.4
Fig 17 - Balance sheet (`m)

Sources of Funds Equity Share Capital Reserves ESOPs outstanding / Others Net Worth Loans Secured Loans Unsecured loans Deferred Tax Liability Minority Interest Capital Employed Application of Funds Gross Fixed Assets Less: Depreciation Net Fixed Assets Capital WIP Investments Curr.Assets, L & Adv. Inventory Sundry Debtors Cash & Bank Balances Loans & Advances Current Liab. & Prov. Sundry Creditors Other Liabilities Provisions Net Current Assets Application of Funds
686 6,730 32 7,448 8,740 7,742 998 (79) (1) 16,107
879 7,024 40 7,943 6,536 5,677 859 (539) 13,940
922 6,953 40 7,915 4,936 4,277 659 (539) 12,312
922 7,459 40 8,421 4,536 3,877 659 (539) 12,418
922 8,337 40 9,299 4,336 3,677 659 (539) 13,096
28,048 14,580 13,469 535 23 6,748 3,275 1,955 348 1,171 4,667 1,469 2,087 1,110 2,081 16,107
25,748 13,876 11,872 483 294 5,114 2,559 1,974 287 295 3,823 1,507 979 1,337 1,291 13,940
26,748 15,178 11,570 294 5,105 2,600 2,080 130 295 4,656 2,340 979 1,337 449 12,312
27,548 16,676 10,872 294 6,434 3,330 2,664 144 295 5,181 2,864 979 1,337 1,253 12,418
28,948 18,399 10,549 294 8,025 4,018 3,214 498 295 5,772 3,455 979 1,337 2,254 13,096
109
22 February 2011
Fig 18 - Cash flow statement (`m)

OP/(Loss) before Tax Interest/Dividends Received Depreciation & Amortisation Direct Taxes Paid (Inc)/Dec in Working Capital Other Items CF from Oper. Activity Extra-ordinary Items Other Items CF after EO Items (Inc)/Dec in FA+CWIP (Pur)/Sale of Invest. CF from Inv. Activity Issue of Shares Inc/(Dec) in Debt Interest Rec./(Paid) Dividends Paid CF from Fin. Activity Inc/(Dec) in Cash Add: Beginning Balance Closing Balance
-209 223 1,494 -18 834 -1,045 1,279 -383 897 -1,126 -3 -1,129 0 626 -481 0 145 -88 437 348
-1,455 65 1,371 44 967 1,843 2,836 -353 2,483 278 -271 7 193 -2,204 -541 0 -2,552 -62 348 286
360 130 1,303 10 926 -516 2,212 0 2,212 -517 0 -517 43 -1,600 -294 0 -1,851 -156 287 130
934 117 1,498 -56 -552 -356 1,584 0 1,584 -800 0 -800 0 -400 -371 0 -771 14 130 144
1,436 129 1,723 -125 -407 -368 2,387 0 2,387 -1,400 0 -1,400 0 -200 -432 0 -632 354 144 498
Fig 19 - Ratio analysis @ `65

Basic (`) EPS EPS Fully Diluted Cash EPS EPS Growth (%) Book Value per Share DPS Payout (Incl. Div. Tax) % Valuation (x) P/E Cash P/E EV/EBITDA EV/Sales Price to Book Value Dividend Yield (%) Profitability Ratios (%) RoE RoCE Turnover Ratios Asset Turnover (x) Leverage Ratio Debt/Equity (x)
-11.2 -8.4 10.6 -290.6 108.6 0.0 0.0 6.1 10.0 0.6 0.6 0.0 0.1 1.4 1.2
-17.0 -16.2 -1.4 93.6 90.4 0.0 0.0 0.9 0.7 0.0 1.0 0.8
0.8 0.8 15.0 -105.1 85.9 0.0 0.0 78.4 4.3 6.3 0.6 0.8 0.0 1.0 4.0 1.5 0.6
5.5 5.5 21.8 565.2 91.4 0.0 0.0 11.8 3.0 4.1 0.4 0.7 0.0 6.0 8.5 2.0 0.5
9.5 9.5 28.2 73.4 100.9 0.0 0.0 6.8 2.3 3.0 0.3 0.6 0.0 9.4 11.9 2.2 0.5
110
22 February 2011

MFL is part of Mahindra Systech, which is the Art to Part business arm of the M&M Group. MFL focuses on forgings, with operations in India and Europe. The company has a diversified revenue stream, with ~70% of European revenues arising from the truck segment; India operations focus more on PVs and tractors. MFL is part of the Systech business of the Mahindra Group. Systech comprises various businesses, offering customers full services, from designing to delivery. The Systech division is made up of three segments:
1. 2. 3.
Contract sourcing for sourcing of components at competitive prices; Mahindra Engineering Services for design solutions (revenue of US$34m); and Auto-components business unit (ACBU) the manufacturing and main revenue generating arm, which consists of plants manufacturing forgings, castings, stampings, gears, steel and composites.
Annualized revenue of the Systech division in FY09 stood at ~US$850m. Among all segments of the ACBU, the forgings segment is the biggest, with revenue of ~US$400m.
Fig 20 Current Mahindra Systech: organisational chart
PE1 PE1 Mahindra & Mahindra Mahindra &
53%
PE2 PE2
47%
35%
65%
51%
53%
47%
India
Mahindra Mahindra Castings Castings

(Urse) (Urse)
Mahindra Forgings Mahindra Forgings Limited Limited

(Chakan) (Chakan)
Mahindra Gears Mahindra Gears ** (Rajkot )) (Rajkot
Europe Mahindra Mahindra Forgings Europe Forgings Europe MetalCastello MetalCastello
Source: Company
Fig 21 Mahindra Systech businesses
Mahindra Systech
Forgings
Mahindra Forgings
Castings
Mahindra Hinoday
Gears
Mahindra Gears and
Stampings & Steel

MUSCO (Listed)
Engineering Services
Mahindra Engineering
Composites
Mahindra
Key Businesses
(Listed)
(with PE partner)
Transmission Pvt. Ltd. Metalcastello S.r.l. (with PE partner)

150,000 gears every Alloy steel and
Design and Development Co Engines Engineering
Composites (Listed)
One of the leading
HPDC, Induction
Brief Description
forgings company in the world*
Melting, Auto Pour, Computerized Sand Mixing
month
critical stamping parts required for auto & non-auto
Automotive (inc.
Polymer composites
motorcycles), aerospace & engineering
Source: Company
111
22 February 2011
Creation of a global forgings capacity Mahindra Forgings is a leading manufacturer of forgings, with plants in three countries, India, Germany and the UK. Its product portfolio includes a range of forged components for cars, tractors, trucks as well as the non-auto segment. In FY06-07, several acquisitions were made by M&M and group companies in the forgings business, to build its manufacturing capacity, product portfolio, technological abilities and add clients. Some acquisitions are:
1. 2. 3. 4.
Apr 05 100% stake in Amforge, Chakan unit, India, subsequently renamed Mahindra Forgings Jan 06 99.5% stake in Stokes, UK Nov 06 67.9% stake in Jeco Holdings, Germany Dec 06 90.47% stake in Schoeneweiss, Germany
Consequent on these acquisitions, the European companies became subsidiaries of MFL during the subsequent restructuring. Post consolidation and restructuring, MFL is one of the biggest forgings companies globally, with forgings capacity comparable with that of Sumitomo and Hirschvogel. Key management personnel:

Mr. Anand Mahindra - Chairman Mr. Hemant Luthra: President - Systech Sector Mr. Sanjay Joglekar: CFO - Systech Sector Mr. Deepak Dheer MD Mahindra Forgings
112
Auto Components
India I Equities
Initiating Coverage
22 February 2011
NRB Bearings
The leader in needle roller bearings; initiate at Buy
We initiate coverage on NRB, the leading manufacturer of needle bearings in India, with a Buy rating and a target of `68. The huge rise in number of vehicles in India, NRBs sharper focus on exports and the replacement market, and its expansion are likely to lead to a 29% earnings CAGR over FY11-13e.
Girish Solanki
Rohan Korde
+9122 66266733 rohankorde@rathi.com
Market leader in needle bearings, with a ~10% share in the organised bearings sector. The bearings sector is split equally between organised and unorganised companies. NRB has a ~10% market share in the organised sector; in needle bearings it has a commanding 70% market share. Sharper focus on exports and replacement market. As exports and replacement markets command higher margins, the company is increasing its focus on these markets. In the next three years exports would rise to 20% of sales. Adding capacities to satisfy stable auto demand. As most of NRBs revenue comes from the auto segment, robust demand for automobiles would benefit it. To cater to this roaring demand, NRB is investing `0.6bn to double its needle bearings capacity by Jul 11. Valuations and risks. At our target of `68, the stock would trade at 11x 12-month-forward earnings and an EV/EBITDA of 5.7x. Risks: fragmentation in the sector, spurious products in after-sales market, threat of cheap imports from China, increase in prices of raw materials.
Key data
NRBBR IN / NBEA.BO `65/`29 18212 / 5459 US$0.1m `4.4bn/US$96m 97m 26.2% 73.8% 8.0% 4.5% 13.7%
Key financials
Year end Mar FY09 FY10 FY11e FY12e FY13e

2,968 26 0.3 -92.2 168.4 2.5 1.4 6.2 1.8 76.8 3,568 217 2.2 727.6 20.4 2.3 11.8 15.0 2.2 47.0 4,797 497 5.1 128.8 8.9 1.9 23.4 27.3 2.6 42.8 6,135 602 6.2 21.1 7.3 1.6 23.4 27.6 3.2 41.1 7,900 831 8.6 38.2 5.3 1.3 26.8 32.2 3.8 29.6
Source: Bloomberg
Sales (`m) Adj. Net profit (`m) EPS (`) Growth (%) PE (x) P/BV (x) RoE (%) RoCE (%) Dividend yield (%) Net gearing (%)
70 60 50 40 30 20 Aug-10 Jun-10 Oct-10 Apr-10 Feb-10 Dec-10 Feb-11 Sensex NRBBR
22 February 2011
NRB Bearings The leader in needle roller bearings; initiate at Buy

Fig 4 PE Band
4,797 34.4 3,736 1,062 22.1 95 240 37 266 497 128.8 497 5.1 7.6 1.2 6,135 27.9 4,871 1,264 20.6 108 270 40 326 602 21.1 602 6.2 9.0 1.4 7,900 28.8 6,271 1,629 20.6 112 288 45 442 831 38.2 831 8.6 11.5 1.7
(`) 90 80 70 60 50 40 30 20 10 0 Sep-05 Aug-08 Sep-10 Sep-10 Apr-05 Mar-08 Feb-06 Apr-10 Dec-06 May-07 Nov-09 Feb-11 2.0x 1.5x 1.0x 0.5x 10 0 Sep-05 Aug-08 Apr-05 Mar-08 Feb-06 Apr-10 May-07 Dec-06 Nov-09 Feb-11 Jan-09 Jun-09 Oct-07 Jul-06 Jan-09 Jun-09 Oct-07 Jul-06 5x NRB 8x 14x 11x
Net sales Sales growth (%) - Op. expenses EBIDTA EBITDA margins (%) - Interest - Depreciation + Other income - Tax PAT PAT growth (%) Consolidated PAT FDEPS (`/share) CEPS (`/share) DPS (`/share)
2,968 -11.0 2,585 383 12.9 106 202 9 55 29 -92.2 26 0.3 2.4 0.8
3,568 20.2 2,962 607 17.0 105 206 50 128 217 727.6 217 2.2 4.4 1.0

Fig 5 P/BV Band

97 1,667 1,891 943 -14 2,821 1,690 1 1,075 55 2,821 96.9 47.0 124.9 194 2,026 2,349 1,143 -14 3,478 1,836 1 1,504 138 3,478 96.9 42.8 98.1 194 2,462 2,787 1,243 -14 4,017 1,966 1 1,952 98 4,017 96.9 41.1 102.8 194 3,095 3,423 1,193 -14 4,602 1,879 1 2,542 181 4,602 96.9 29.6 103.8
70 NRB 60 50 40 30 20 c
Share capital Reserves & surplus Shareholders fund Debt Minority interests Capital employed Fixed assets Investments Working capital Cash Capital deployed No. of shares (m) Net Debt/Equity (%) W C turn (days)
97 1,563 1,785 1,416 -14 3,187 1,775 1 1,366 45 3,187 96.9 76.8 155.7

Fig 6 NRB V/s Auto Index

497 240 739 428 310 386 (76) 136 0 200 0 (95) 83 55 138 602 270 873 448 425 400 25 163 0 100 0 2 (40) 138 98 831 288 1,121 590 531 200 331 196 0 (50) 0 2 83 98 181
70 60 50 40 30 20 Aug-10 Apr-10 Dec-10 Feb-10 Jun-10 Oct-10 Feb-11 BSE Auto NRBBR
Consolidated PAT + Depreciation Cash profit - Incr/(Decr) in WC Operating cash flow - Capex Free cash flow - Dividend + Equity raised + Debt raised - Investments - Misc. items Net cash flow + Opening cash Closing cash
26 202 235 200 35 279 (244) 91 0 325 0 9 (16) 62 45
217 206 426 (291) 716 121 596 113 0 (473) 0 0 10 45 55
Source: Bloomberg
114
22 February 2011

We initiate coverage on NRB, a leader in needle roller bearings, with a Buy rating and a target price of `68. Its dominance in needle roller bearings, the vast rise in vehicle volumes, the sharper focus on exports and replacements, and its expansion are likely to lead to a 29% earnings CAGR over FY11-13e. Market leader in needle bearings, with a ~10% overall share in the organised bearings sector The bearings sector is split equally between organised and unorganised companies. In the organised space, the company has a ~10% market share; it leads in needle bearings, with a commanding 70% market share. The Indian bearings industry was worth `120bn-130bn in 2010, and has seen a healthy growth rate. The domestic industry satisfies 75% of that demand, the balance 25% is met through imports. A number of global bearings manufacturers have established units in India through joint ventures or 100% ownership.
Fig 7 Structure of the bearings industry
Imported, 25% Organised, 37.50%
Unorganised, 37.50%
Sharper focus on exports and the replacement market NRB plans to leverage its leading position in needle roller bearings by concentrating on furthering exports. It aims at a consistent 20-25% growth pa in the next five years, largely from mounting exports. We expect the exports share in sales to rise from 8% in FY10 to 20% in FY13e. Adding capacities, to satisfy stable automobile demand As a huge 93% of demand for NRBs bearings in India arises from the automobile segment (both OEM and replacement), stable demand prospects in this segment are a positive for the company. As many of NRBs products are in the R&D stage, and with new product launches planned for OEMs, we expect healthy volume off-take for NRB. The fourth largest in the bearings segment, dominated by SKF, FAG and NEC (unlisted), NRBs market share has stagnated at around 10% since FY04. For growth, NRB has chalked out a capacity expansion plan, at its present plant at Waluj where it has sufficient land. It has already ordered machinery. It is doubling its needle roller bearings capacity by Jul 11 (the benefits would show from 2HFY12). When this expansion goes on stream, its market share would improve to ~13-14%.
115
22 February 2011
Outlook and Valuation We value NRB at 11x 12-monthforward earnings; target price: `68 We expect the domestic automobile industry to grow 13.7% over FY1113e, boosting demand for bearings. Hence the domestic bearings sector would see a 15-20% CAGR over FY11-13e. NRB would benefit from this emerging domestic demand and increased export opportunity. On all valuation parametersP/E, P/BV, MCap/salesNRB is available at a discount to FAG and SKF. Also, both SKF India and FAG Bearings have trading revenues; NRBs revenues arise only from its products. The industry is characterized by high-end technology and the amount of capital required (raising entry barriers to others). Hence, organised domestic bearings companies, mainly global players, have a dominant share through their tie-ups. SKF India has a 37% market share, FAG 19%, NRB Bearings ~10%. NRBs enhanced capacity would help satisfy the booming demand and boost sales volumes. Its profitability would rise owing to its operating leverage, rising exports and after-sales share. Given the better long-term growth prospects for bearings, we expect healthy return ratios for NRB. At our target price of `68, the stock would trade at 11x 12-month-forward earnings. NRBs one-year-forward PBV in the past five years has ranged between 0.7x and 3.8x. At `46, NRB trades at PE of 8.9x and 7.3x FY11e and FY12e earnings, respectively, and EV/EBITDA of 4.8x and 4x.
Fig 8 12-month-forward P/BV Mean and standard deviations
4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 -2SD 0.5 0.0 Apr-05 Feb-06 Apr-10 Sep-05 Aug-08 May-07 Sep-10 Dec-06 Nov-09 Feb-11 Jan-09 Mar-08 Jun-09 Jul-06 Oct-07 +2SD +1SD Mean -1SD
Risks to our valuation
Increase in prices of raw materials. Steel, constituting almost 35% of net sales, has a significant impact on margins. Any increase in steel prices would result in pricing and margin pressures if NRB is not able to pass on the higher costs. Spurious products. Spurious products are a significant part of the Indian bearings market, mainly in the price-sensitive replacement market. This market uses inferior materials, which are relatively unsafe and unreliable. Threats from imports. Customs duty on imported bearings was reduced from 30% in FY03 to nil. This has attracted more imports, catering mainly to the replacement market. Major imports of ball bearings are from China and have been rising.
116
22 February 2011
Leading in needle roller bearings

NRB Bearings manufactures almost all types of bearings: needle roller bearings, spherical roller bearings, cylindrical roller bearings, tapered roller bearings, ball bearings, crank pins and wide inner-ring bearings. It is a leader in the domestic needle roller bearings markets, with a commanding 70% market share. Its strength lies in customising bearings to meet the needs of its clients. NRB has well-established relationships with some major OEMs. Its topfive customers are Tata Motors, Hero Honda, Ashok Leyland, Mahindra & Mahindra, and Bajaj Auto, bringing in 35-40% of its revenues. But no single customer accounts for >10%, resulting in a suitably diversified client portfolio. Its global clientele isare Daimler, Volvo and Volkswagen. Its non-automobile clients are TAFE, Siemens, ABB, Lucas and LMW.
Fig 9 NRB's client-wise percentage sales break-up (FY09 and FY10)
Company FY09 FY10
Tata Motors Hero Honda Ashok Leyland M&M Bajaj HMSI Maruti
Source: Company
7.8 7.1 4.2 4.6 5 2.1 2
9.9 6.5 5 5.5 5 2 1.5
The roaring prospects in the automobile sector augur well for demand for bearings, and we expect all segments of the automobile industry to report robust growth in coming years. We expect the bearings sector to continue seeing good times, riding on the auto sector boom and export growth. However, we expect NRB, the market leader in needle roller bearings to report a better performance in the next two years, as demand growth in key user industries is expected to rise sharply. The automobile industry, which is the primary client of NRB Bearings (93% of its sales go to auto companies) grew 25% yoy in FY10 and registered 28% yoy growth till Jan 11. The Indian bearings industry is estimated at `120bn-130bn. Domestic manufacturers address almost 75% of that demand. Imports cater to the rest of that demand (25%), essentially for industrial applications and special purpose.
Fig 10 Bearings industry structure Bearing Industry (~`120bn-130bn)
Organised ~37.5%
Unorganised ~37.5%
Imported ~25%
OEM (Auto, Rail & Industrial)

Replacement
Special Purpose Bearing
117
22 February 2011
Demand for bearings is derived from demand in two key user segments, automobiles and industrial sector growth. The automobile industry is the largest growth driver as it accounts for almost 47% of the bearings market. The industrial sector makes up the rest. Since the bearings industry is technology-intensive, most Indian manufacturers have collaborated as joint-venture partners with other more established global players. The largest user segments of bearings in India are the auto industry, the industrial OEM segment, and the replacement market. Leaders in this market are SKF in ball bearings (with a 41% market share), FAG in spherical roller bearings (60%), NBC in tapered roller bearings (23%) and NRB in needle roller bearings (70%).
Fig 11 User-segment demand for bearings
Industrial 53%
Auto 47%
118
22 February 2011
Capacity expansion, a growth driver

In order to cater to mounting demand in the auto segment, NRB has chalked out an expansion programme. This would help it raise its market share. On account of slowdown in the auto industry in FY09, NRB had not increased its capacity for ball and roller bearings in FY09, but its utilization levels fell considerably, from 76% in FY08 to 60% in FY09. In FY10, on the revival in the automobile industry, NRBs production improved 40%, utilization levels improved to 76% on 10% higher capacities. At present, NRBs average utilization levels are 80-85%. In order to grow at more than 20%, it has been undertaking regular capacity expansions at its main plants at Waluj and Jalna, by 20-25% in course of time. A further ramp-up in capacity would take place as and when demand from its customers increases. Demand from the automobile sector makes up 47% of demand for bearings. Over FY05-10, bearings have seen an 8-10% CAGR. If the industry has to grow at 20% pa, with greater preference for branded products, there is need for capacity ramp-ups and product development to meet the new-age user requirements. In order to grow, NRB has chalked out a capacity expansion plan. It is doubling its needle roller bearings capacity by Jul 11, and such benefits would be reflected from 2HFY12. Its market share has stagnated at around 10% since FY04, and when this expansion goes on stream its market share would rise to 13-14%. The expansion would take place at its present plant at Waluj, where it has enough land. It has already ordered machinery. The rationale behind establishing this plant (involving capital outlay of `0.6bn) is to cater to the swelling demand from auto companies and from exports. The Thailand subsidiary formed at an investment of `200m would cater to the ASEAN and SAARC markets, 70% would be exported and 30% sold in the Thai market. Manufacturing at this subsidiary is likely to go on stream from Q4FY11. It would have capacity to produce 32m pieces yearly. According to us, a key trigger for NRB would be the execution of its capacity expansion plans as that would place it in an ideal situation to gain market share.
Expansion in needle bearings in 2QFY12 would drive growth. The full impact of the enhanced capacity would be seen in FY12
Auto industry to drive demand
119
22 February 2011
Focus on exports and replacements

NRB plans to leverage its leading position in needle roller bearings by focusing on furthering exports. It aims at a consistent 20-25% growth pa in the next five years, chiefly from rising exports. We expect the exports share in sales to rise from 8% in FY10 to 20% in FY13. Since exports and the replacement market command higher margins, the company is increasing its focus in these segments. Its exports, which were 8% of its sales, would rise to 20% in the next three years. NRB focuses on non-commoditised bearings, i.e., it customises bearings for important clients. It has come a long way from manufacturing only needle-roller bearings. Today, it has diversified into cylindrical, tapered, roller, spherical and ball bearings, and is making a concentrated effort to boost exports by focusing on its research and development centre. This centre has churned out 1,500 products so far. NRB has old customers in Renault, Volvo and the UK-based ZF Group. This is a technology-intensive industry and there is a significant difference in the quality of products manufactured by others. This works in India's favour. Dumping by Chinese companies (selling in India under fake brand names) is common. As the Indian auto components industry is doing well, this has a direct effect on demand for bearings of quality. These are certainly good times for many Indian manufacturers. Ahead, there will not be adequate capacity to satisfy the vast and growing demand. NRB is hence looking at widening its global footprint and proposes to focus on exports. In the next three years, we estimate the share of exports to sales would increase from 8% now to 20%. The company has sensed outsourcing opportunities and has initiated the process to produce a range of bearings to meet the requirements of the parent or of other global customers. NRB has already entered into talks with some major OEMs. It is also exploring the possibility of tapping replacement markets in Asia and Europe. It plans to develop new products to satisfy the requirements of the international market. Technical collaboration with Nadella, France, would prove significant in achieving export targets.
Fig 12 Trend in exports over the years
(`m) 1,600 1,400 1,200 1,000 800 600 400 200 0 FY11e FY12e FY13e FY05 FY06 FY07 FY08 FY09 FY10 (%) 21 19 17 15 13 11 9 7 5
Forex earnings on exports

% of sales (RHS)
120
22 February 2011
Also, the sharper and greater focus on the replacement market would help safeguard NRB in a slowdown, which could lead to lower growth in the OEM segment and higher growth in replacement demand. NRB has been concentrating on improving its share in the replacement market, and is set to garner a higher share there. In order to deepen its penetration into the replacement market it is focusing on developing the market. It is also widening its dealer network in the lucrative semi-urban and rural markets. This initiative would help it penetrate further into such lucrative areas. Margins in the replacement market being higher would translate into higher overall margins.
121
22 February 2011
Financials
Roaring demand in the auto sector coupled with NRBs capacity expansion to satisfy this demand offers assurance of revenue for the next two years. We expect NRB to register CAGRs of 28% in revenue and 29% in net profit over FY11-13e. A 28% CAGR in revenue expected over FY11-13e We expect a 28% CAGR in revenue from FY11 to FY13 Following expansion in needle bearings capacity on the increase in demand, we expect a robust revenue performance from NRB. Capex planned for FY11-12 is `0.8bn. We expect a 28% CAGR in revenue from FY11 to FY13. We believe the share of exports as well as of the after-sales market would rise in the next two years.
Fig 13 Revenue and revenue growth
(`m) 9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 FY11e FY12e FY13e FY09 FY10 (%) 35 30 25 20 15 10 5 0 -5 -10 -15
Net sales
Sales growth (RHS)
Margins to be stable We expect the EBITDA margin over FY11-13 to be around 20-21%. This strong EBITDA performance would stem from the healthy growth in export and replacement sales. We expect the EBITDA margin over FY11-13 to be around 20-21%
Fig 14 EBITDA and EBITDA margin
(`m) 1,800 1,600 1,400 1,200 1,000 800 600 400 200 0 FY09 FY10 FY11e FY12e FY13e (%) 23 21 19 17 15 13 11
EBIDTA
EBITDA margins (RHS)
122
22 February 2011
We expect NRB to post a 29% CAGR in net profit over FY11-13
A 29% CAGR in net profit expected over FY11-13 We expect NRB to post a 29% CAGR in net profit over FY11-13. The growth in net profit would be reflected in expanded return ratios. Over FY11-13, we expect the RoE to rise from 23.4% to 26.8% and the RoCE from 27.3% to 32.2%.
Fig 16 Return ratios
(%) 12 10 8 6
15
Fig 15 Net profit and Net-profit margin

(`m) 900 800 700 600 500 400 300 200 100 0 FY11e FY12e FY13e FY09 FY10
(%) 35
30 25 20
4 2 0
10 5 0 FY09 FY10 FY11e FY12e FY13e

(%) 81 74 67 60 53 46 39 32 25 FY11e FY12e FY13e FY09 FY10
PAT
PAT margin (RHS)
RoE
RoCE
Comfortable balance sheet The FY10 net debt-equity ratio holds at a manageable 0.5x and falls within the industry range of 0.2x to 2x. We expect it to gradually slip to around 0.3x in FY13. Working capital days are also at manageable levels of around 98 days. Over FY11-13, this is expected to be maintained around FY11 levels. The company has capex plans for the next two years, of ` 0.8bn, which would be met by internal accruals and debt. Its FY10 debt-equity ratio is 0.5x. This implies that it is in a comfortable position to raise debt, if required.
Fig 17 Working capital days

(Days) 160
Fig 18 Debt and Net-debt-to-equity ratio

(`m) 1,600 1,400
120
1,200 1,000
80
800 600 400
40
200 0
0 FY11e FY12e FY13e FY09 FY10
Debt
Net Debt/Equity (RHS)
123
22 February 2011

Gross sales -Excise duty Net sales -COGS Gross profit -Operating costs Operating profit +Other recurring income EBITDA -Depreciation/Amortisation EBIT -Interest expense PBT -Tax PAT +Share of profits in associates -Minority interests PAT +Extra-ordinary income/(expense) Net profit -Preference dividend -Dividend paid -Dividend tax Transferred to reserves
3,311 343 2,968 1,278 1,690 1,307 383 9 392 202 190 106 84 55 29 0 3 26 0 26 0 78 13 -65
3,843 274 3,568 1,551 2,018 1,411 607 50 657 206 450 105 345 128 217 0 0 217 0 217 0 97 16 104
5,240 443 4,797 2,099 2,699 1,637 1,062 37 1,098 240 858 95 763 266 497 0 0 497 0 497 0 116 20 361
6,703 567 6,135 2,788 3,347 2,083 1,264 40 1,305 270 1,035 108 927 326 602 0 0 602 0 602 0 140 24 438
8,641 740 7,900 3,584 4,317 2,687 1,629 45 1,674 288 1,386 112 1,274 442 831 0 0 831 0 831 0 167 28 636

Equity Reserves Deferred tax liability -Miscellaneous expenses Networth Working capital loans Long term debt Preference equity Total debt Minority interests Capital employed Gross block -Accumulated depreciation Net block +CWIP Fixed assets Financial investments Investments Debtors Inventory Loans & advances Other current assets -Creditors -Provisions -Other curent liabilities Working capital +Cash & cash equivalents Net current assets Capital deployed
97 1,563 126 1,785 966 451 1,416 (14) 3,187 3,707 1,947 1,760 15 1,775 1 1 743 956 157 348 125 16 1,366 45 1,411 3,187
97 1,667 128 1,891 435 508 943 (14) 2,821 3,826 2,150 1,676 14 1,690 1 1 746 866 200 545 167 25 1,075 55 1,130 2,821
194 2,026 130 2,349 1,143 1,143 (14) 3,478 4,226 2,390 1,836 1,836 1 1 1,026 1,169 215 715 167 25 1,504 138 1,642 3,478
194 2,462 132 2,787 1,243 1,243 (14) 4,017 4,626 2,659 1,966 1,966 1 1 1,331 1,481 230 899 167 25 1,952 98 2,050 4,017
194 3,095 134 3,423 1,193 1,193 (14) 4,602 4,826 2,947 1,879 1,879 1 1 1,738 1,888 245 1,137 167 25 2,542 181 2,723 4,602
124
22 February 2011

PAT +Depreciation +Deferred tax Cash profit -Increase/(Decrease) in WC Operating cash flow -Capex Free cash flow -Dividend +Equity raised +Debt raised +Minority interests -Investments -Miscellaneous items Net cash flow +Opening cash Closing cash
26 202 7 235 200 35 279 (244) 91 325 3 9 (16) 62 45
217 206 2 426 (291) 716 121 596 113 (473) 0 10 45 55
497 240 2 739 428 310 386 (76) 136 0 200 (95) 83 55 138
602 270 2 873 448 425 400 25 163 100 2 (40) 138 98
831 288 2 1,121 590 531 200 331 196 (50) 2 83 98 181

Basic (`) EPS Fully Diluted Cash EPS EPS Growth (%) Book Value per Share DPS Valuation (x) P/E Cash P/E EV/EBITDA EV/Sales Price to Book Value Dividend Yield (%) Profitability Ratios (%) RoE RoCE Turnover Ratios Debtors (Days) Inventory (Days) Creditors (Days) Working Capital (Days) Asset Turnover (x) Leverage Ratio Debt/Equity (x)
0.3 2.4 (92.2) 18.4 0.8 168.4 19.4 13.5 1.8 2.5 1.8 1.4 6.2 99.1 112.4 52.8 155.7 1.2 0.8
2.2 4.4 727.6 19.5 1.0 20.4 10.4 8.0 1.5 2.3 2.2 11.8 15.0 76.1 93.2 45.7 124.9 1.0 0.5
5.1 7.6 128.8 24.2 1.2 8.9 6.0 4.8 1.1 1.9 2.6 23.4 27.3 67.4 77.4 47.9 98.1 0.8 0.5
6.2 9.0 21.1 28.8 1.4 7.3 5.1 4.0 0.9 1.6 3.2 23.4 27.6 70.1 78.8 48.0 102.8 0.8 0.4
8.6 11.5 38.2 35.3 1.7 5.3 3.9 3.2 0.7 1.3 3.8 26.8 32.2 70.9 77.8 47.0 103.8 0.7 0.3
125
22 February 2011

NRB manufactures ball and roller bearings and is the only one in India to make all types of bearings: ball, needle, cylindrical, spherical, tapered, thrust, roller. It is a market leader (70% share) in needle roller bearings, which bring in ~55% of its revenues, and has a notable 16% market share in cylindrical roller bearings. Besides, it has also taken up manufacturing ball and tapered roller bearings. Over FY05-10, NRB had a 9% revenue CAGR. Brief history and business Incorporated in 1966, The Needle Roller Bearing Co. a joint venture with Nadella, France, was the first in India to manufacture needle roller bearings. In view of its diversified range and types of bearings, it was renamed NRB Bearings. It manufactures over 600 types of bearings at its plants at Thane, Jalna, Waluj and Pantnagar. It has two subsidiaries, the profitable SNL Bearings in Ranchi (in which it holds a 69% equity stake) and the loss-making 100% subsidiary in Thailand. NRB supplies all types of bearings and is dominant in needle roller bearings. It also supplies lightweight bearings where the load is low, as in automobiles: for gears, clutches and brakes.
Fig 23 Key management
Key Person Designation Background
Trilochan Singh Executive M.A.; CEO. Executive chairman since 1 Oct 10; till then, managing director; Sahney Chairman member, Governing Council, and VP, Indo-French Chamber of Commerce & Industry. Was non-executive director, Punjab Tractors. P D Ojha Director B.A (Econ) M.A (Advanced Econ), Ph.D (Economics) 56 years experience; retired as Deputy Governor of The Reserve Bank of India Kala S Pant Director B.Sc., M.Sc. (Stats.) for Economics and Industry. Doctoral research work in quantitative methods in banking and transport. 42 years experience in management and research methodologies; research in the problems of transport, ports, infrastructure cost-benefit analysis, both macro and micro Harshbeena S Managing 23 years in industry, in planning, purchase & imports, and marketing. Since Zaveri Director January, responsible for entire operations Is also on the Board of SNL Bearings. Director 16 years experience. B.A. (Business Administration & Economics), Richmond Devesh S College, London, and MBA (general management), Asian Institute of Sahney Management (Philippines) K M Elavia Director B.Com (Hons), FCA; 39 years post-qualification experience. Former partner, Kalyaniwalla & Mistry; on the Boards of many listed and unlisted Indian companies Anand N Desai Additional LL.B., Bombay University, LLM (International Law), University of Edinburgh, Director Scotland. Managing partner, DSK Legal. Has extensive experience in banking and financial services law, intellectual property rights, among others
Source: Company
126
Auto Components
India I Equities
Initiating Coverage
22 February 2011
Setco Automotive
M&HCV clutch leader; initiate with a Buy
We initiate coverage on Setco Automotive, the leader in M&HCV clutches, with a Buy and a target of `182. Setcos unique business model, expansion and upswing in vehicle volumes would lead to 29% earnings CAGR over FY11-13e.
Girish Solanki
Domestic leader in M&HCV clutches. While Setco is one of the top-five clutch manufacturers globally, it is the largest in India. It caters to the OEM and replacement markets, meeting ~75% of the M&HCV OEM clutch demand in the country. Unique business model. Setco is one of the largest clutch suppliers to the after-sales segment via the distribution networks of Tata Motors, Ashok Leyland and Eicher. Its after-market sales saw a 29% CAGR over FY03-10, and growth even during the economic downturn. Expansion to cater to the growing demand. Setco caters to the strong sustainable demand from the clutch replacement and OEM markets that we believe would continue. The company plans setting up a unit in an SEZ to cater to rising exports; the unit would be completed by FY12-13. Valuation and risks. At our target price, the stock would trade at 9x 12-month forward earnings and EV/EBITDA of 5.1x. The target PE is in line with the three-year average. Key risks: low volume offtake from OEMs and rising raw material prices.
Key data
Rohan Korde
SETC IN / SETC.BO `143/`77 18212 / 5459 US$0.1m `2.1bn/US$46m 17.64m 36.4% 63.6% 18.6% 0% 17.8%
Key financials
Year end Mar FY09 FY10 FY11e FY12e FY13e

2,320 160 9.1 17.6 12.9 3.5 30.4 18.0 1.1 192.8 2,559 143 8.1 -10.4 14.4 3.0 22.2 17.2 1.3 164.9 3,230 264 15.0 84.4 7.8 2.2 32.6 23.3 1.5 123.8 4,169 357 20.2 35.3 5.8 1.7 33.1 25.0 1.8 105.4 4,912 442 25.0 23.6 4.7 1.3 30.9 24.8 2.2 81.0
Source: Bloomberg
140 130 120 110 100 90 80 Aug-10 Jun-10 Feb-10 Oct-10 Apr-10
SETC
Sensex
Dec-10
Feb-11
22 February 2011
Setco Automotive M&HCV clutch leader; initiate with a Buy

YE 31 March FY09 FY10 FY11e FY12e FY13e
Fig 4 PE Band
3,230 26.2 2,682 548 17.0 121 98 23 87 264 84.4 264 15.0 20.5 1.8 4,169 29.1 3,458 711 17.1 138 123 26 119 357 35.3 357 20.2 27.2 2.2 4,912 17.8 4,059 853 17.4 150 142 28 147 442 23.6 442 25.0 33.1 2.6
( ) 210 190 170 150 130 110 90 70 50 30 Aug-06 Aug-07 Aug-08 Aug-09 May-07 May-08 May-09 May-10 Aug-10 Nov-06 Nov-07 Nov-08 Nov-09 Nov-10 Feb-07 Feb-08 Feb-09 Feb-10 Feb-11 5x Setco 7x 9x
2,320 10.4 2,005 315 13.6 91 44 12 33 160 17.6 160 9.1 11.5 1.3
2,559 10.3 2,187 371 14.5 114 84 24 54 143 -10.4 143 8.1 12.9 1.5
11x

Fig 5 P/BV Band

88 579 696 1,171 0 1,866 938 10 896 23 1,866 18 165 121 176 717 922 1,271 0 2,193 939 10 1,115 129 2,193 18 124 114 176 1,030 1,236 1,471 0 2,706 1,066 10 1,462 169 2,706 18 105 113 176 1,418 1,623 1,621 0 3,244 1,174 10 1,755 305 3,244 18 81 119
180 160 140 120 100 80 60 40 20 0 May-07 Nov-06 May-08 Nov-07 May-09 Nov-08 May-10 Nov-09 Nov-10 Feb-07 Feb-08 Feb-09 Feb-10 Aug-06 Aug-07 Aug-08 Aug-09 Aug-10 Feb-11 1.0x 1.5x 2.5x 2.0x
88 485 594 1,157 0 1,751 935 0 804 12 1,751 18 193 117

Fig 6 Setco vs. Auto sector index

264 98 362 220 143 100 43 37 0 100 0 0 106 23 129 357 123 480 346 134 250 (116) 45 0 200 0 0 39 129 169 442 142 584 293 291 250 41 54 0 150 0 0 137 169 305
140 130 120 110 BSE Auto 100 90 80 Aug-10 Jun-10 Oct-10 Dec-10 Feb-10 Apr-10 Feb-11
160 44 216 118 98 278 (180) 26 0 214 (3) 9 1 11 12
143 84 233 91 142 87 55 31 0 14 10 17 11 12 23
SETC
Source: Bloomberg
128
22 February 2011

We initiate coverage on Setco, the leader in M&HCV clutches, with a Buy recommendation and a target price of `182. The companys unique business model, expansions to cater to exports and healthy growth in the automobile sector would lead to 29% earnings CAGR over FY11-13e, in our view. Domestic leader in M&HCV clutches Setco meets 75% of Indias M&HCV OEM clutch demand and is among the top-five (in volumes) globally. Eaton is #1 internationally (but does not operate in India), followed by Fisher & Facs, a part of the ZF Group. LUK is #3 and is part of the Scaefller Group. Valeo, which caters to the car and LCV clutch segments in India, is #4. Setco commands a 40% share of the domestic industry and saw 26% revenue CAGR through FY06-10. It expects a similar growth rate in the next five years. Setco is the largest supplier of M&HCV clutches to Tata Motors, Ashok Leyland, Eicher and Asia Motor Works. Also, it is an approved source for Daimler India. Robust growth in the M&HCV business and the shift to higher value-added new-generation CVs would boost its growth. Its strength in the after-sales market and the recognition of its LIPE brand give it added penetration. Unique business model Setco is one of the largest suppliers of clutches to the after-sales market, through the distribution networks of Tata Motors, Ashok Leyland and Eicher Motors. Its after-market sales have seen a 29% CAGR through FY03-10. Even in the severe economic downturn, it saw growth. It has tie-ups with OEMs for their distribution networks to cater to the replacement markets (where Setco supplies ~56% of its products). Expansion to cater to the growing domestic and export demand Setco caters to the clutch replacement market (clutches need replacement every 2-2.5 years on average) and to OEMs. The strong demand growth in OEMs and in the replacement market would continue. To cater to rising exports, Setco plans to set up a `0.7bn unit in an SEZ, to be complete by FY13 and to be funded via debt and internal accruals. Access to international CV players through acquisitions in the US and UK has enhanced its customer portfolio. The lower cost of production in India would continue to help it gain international clients. At present, its plants run on two shifts, and can be increased to three if demand increases. Outlook and valuations The domestic automobile industry grew a strong 14% through FY02-11. We expect the growth to continue, boosting demand for clutches in the OEM and replacement markets. Consequently, we estimate that domestic clutch volumes would see a 20-25% CAGR over FY10-13e. Setco would benefit from the emerging domestic demand and increased export opportunity. We believe that the stock would be re-rated owing to Setcos leading position, strong OEM clients, unique business model and a breakeven in its international business operations. We expect the enhanced capacity to
22 February 2011
cater to the growing demand and to boost sales volumes. Profitability would improve on account of the operating leverage, rising exports and after-sales contribution. At the current market price, the stock trades at FY11e and FY12e EPS of 7.8x and 5.8x respectively. At present valuations, it appears inexpensive. We initiate coverage on Setco with a Buy rating and a target price of `182. The stock would trade at 9x 12-month-forward earnings and an EV/EBITDA of 5.1x. The target PE is in line with the three-year average.
Fig 7 Twelve-month forward PE: Mean and standard deviations
16 14 12 10 8 6 4 2 0 Aug-06 Aug-07 Aug-08 Aug-09 Aug-10 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Apr-07 Apr-08 Apr-09 Apr-10 -1SD +1SD +2SD
We value Setco at 9x FY12e earnings, with a target price of `182
Mean
Source: Bloomberg
Risks
OEM risk. The replacement market comprises 56% of Setcos sales; OEMs constitute nearly 37%. Low volume growth in OEMs would directly affect the companys revenue. Interest-rate risk. Many vehicles are purchased through auto finance. Higher interest rates would raise the cost of auto loans and curb volume growth of auto players, thereby affecting Setcos growth. High raw-material prices. Raw material costs, as high as 55% of sales, affect pricing and margins. Steel, aluminium and ceramic buttons are key raw materials. Any rise in prices would erode margins. Risk of economic slowdown. A slowdown in the economy would affect demand for M&HCVs, curtailing Setcos revenue.
130
22 February 2011
Domestic leader in M&HCV clutches

Setco is leveraging its strong brand, market leadership and marquee clientele to ride on the strong auto demand. The prevailing macro-economic scenario is benefiting the auto sector and, in turn, the auto clutch segment. Setco manufactures new-technology clutches under the LIPE brand, with over 90% of its sales coming from clutches. It is a market leader in the OEM segment (sales to OEMs constitute ~37% of sales) and one of the largest suppliers of clutches to the after-sales segment (56% of sales).
Fig 8 Plant details
Plant Year of Area commencement (acres) Facility Comment
Kalol, Gujarat
1984
24
Sitarganj, Uttarakhand UK subsidiary
2008 2006
1.5 1 44
Integrated unit: press shop, heat treatment, machining, assembly and R&D Assembly Clutch assembly and R&D Clutch assembly, hydraulics
Capacity utilization: 75-80%
Capacity utilization: ~65% Clients added to Setco: Daimler, BMC and after-sales market Clients added to Setco: Caterpillar, Terex and after-sales market
USA subsidiary 2007
Source: Company
The companys domestic unit at Kalol, Gujarat, manufactures all clutches for original-equipment-manufacturer (OEM) sales. The export-oriented unit (EOU) at Kalol caters to international demand. Setco has set up a new press shop at the Kalol unit, at ~`320m. Commercial production commenced in FY10. In FY08, Setco set up a new assembly line at Sitarganj, Uttarakhand (for its tax incentives, entailing exponential growth potential), especially for the replacement market, for ~`80m. The Sitarganj unit, which mainly caters to the after-sales market, has the flexibility to meet increasing demand. Setco also has the option to purchase components and assemble them, since it can set up an additional assembly line quickly, without high capital costs. Setco is a manufacturer of new-technology clutches, which it markets globally under the LIPE brand. It is a pioneer in cera-metallic friction technology clutches in India and a tier-I supplier to Tata Motors, its largest customer. MCV clutches supplied to Tata Motors average `4,000 and HCV clutches range from `6,000 to `11,000. Strong in the OEM market Healthy growth in CVs and its business strategy have helped Setco establish itself as a strong player. This trend is expected to continue. We expect M&HCV demand to see an 11.5% CAGR through FY11-13e. Setco enjoys a strong clientele, including major OEMs Tata Motors, Ashok Leyland and Eicher Motors in India and others in Europe and the US. Setco meets ~80% of Tata Motors M&HCV clutch requirement, 100% of Eicher Motors and 65% of Ashok Leylands. It has added global clients Caterpillar, General Motors, Daimler-Benz, Chrysler and Hitachi to its elite client list. Also, Setco is the approved vendor for some global OEMs which have entered India; this would help it service such global markets. It boasts of a loyal client base, attributable to timely delivery, robust and simple clutch designs and an effective cost structure.
22 February 2011
Fig 9 Domestic business opportunities

M&HCV opportunity `5.5bn-6bn p.a. 2m vehicles added in the last 10 years. 1m clutches replaced every year @ `4,400 each Replacement ~`4.5bn-4.9bn Setcos 30% share `1.3bn
OEM `1.1bn Setcos 75% share `790m

Fig 10 Demand drivers for clutches
Fig 11 Factors affecting clutch life
Massive investment in road sector
Increasing Freight Capacity
Driver
Condition of roads
Huge replacement demand
Application Ban on Overloading Distance Travelled
Overloading
We believe Setco would cater to clutches for new-age trucks. These have higher realizations for their higher value addition. Its R&D facility in the UK is continually improvising clutch designs. Future demand for higher capacity trucks also augurs well for Setcos growth potential.
132
22 February 2011
Unique business model

Setco is one of the largest suppliers of clutches to the after-market sales, through the distribution networks of Tata Motors, Ashok Leyland and Eicher Motors. Its after-market sales has thus seen a 29% revenue CAGR through FY03-10. Hence, the cyclical effect in the automobile sector is mitigated by the strong after- market sales, as even during the severe downturn in the CV cycle, Setco continued to grow. In the Indian market, Setco supplies to OEMs and original equipment suppliers (OESs), who cater to the M&HCV segment. Others such as Clutch Auto cater to the MCV, LCV and passenger-car segments, marketing products through OEMs, OESs and the after-market sales. Exide India (erstwhile Ceekay Daikin) supplies only to LCVs and passenger cars via OEMs, OESs and the after-sales market. There are two others, LUK Clutch and Amalgamations Valeo Clutch, in the organised space. Amalgamations Valeo competes with Clutch Auto in the segments it operates in, while LUK caters to the farm-equipment segment only. On account of its customer profile and nature of the segment (M&HCVs) it caters to, Setco would always have a high replacement market. Also, realizations and margins for Setcos clutches are very high. The company caters to the replacement market mainly via OEMs spare-parts divisions (i.e., OES), which contribute ~56% to its turnover. We believe Setco is well placed to cater to the rising demand as it is the largest manufacturer of M&HCV clutches in India, where it enjoys a ~40% market share. Setcos clutch realization per piece is much higher than that of its peers (Fig 12-13) on account of its thrust into higher value-added products.
Fig 12 Average realization, clutch cover assembly

(`/unit) 5,000 4,000 3,000 2,000 1,000 0 FY05 FY06 FY07 FY08 FY09 FY10
Fig 13 Average realization, clutch plate/disc

(`/unit) 2,500 2,000 1,500 1,000 500 0 FY05 FY06 FY07 FY08 FY09 FY10
Setco
Clutch auto
Exedy India
Setco
Clutch auto
Exedy India
Source: Company
Source: Company
With the increasing number of new-generation CVs on Indian roads, the market for branded clutches is rising. Setco deals in OE as well the aftersales market, giving it a hedge in any downturn in the automobile industry and providing a steady sales pipeline. Clutches need frequent replacement owing to wear & tear in M&HCVs. With more advanced and costly M&HCVs nowadays, demand for clutches being used by OEMs has increased in the after-sales market as well.
22 February 2011
In addition to India, Setco caters to the US, Europe, the Middle East, South Asia and African markets. It plans to expand its client base in the after-sales segment in the aforementioned markets, especially West Africa and Iran. The typical validation period for a clutch, with major OEMs, is 2-3 years. Setco follows the cost-plus pricing formula with customers, thereby largely insulating itself from the change in base prices as well as exchange-rate risks. Growth in after-market sales is expected to translate into a higher profit margin, since margins in this market are higher than those in OE products. We believe that the size of the Indian M&HCV clutch segment is `5.5bn6bn, where the organized sector caters to OEM demand and the unorganized sector serves the replacement market only. Wear and tear requires replacement of a clutch every two years or after 200,000km for M&HCVs. The cover assembly needs to be replaced every 4-5 years. Demand in the replacement market is largely catered to by unorganized manufacturers. Owing to quality and technology issues, the trend is slowly reversing. OEM measures to promote genuine products, customer awareness programmes and tie-ups with local mechanics have helped the organised sector. There has been healthy volume growth in OEMs in the past decade, leading to more vehicles on the road, stimulating replacement demand for clutches. Setcos cost-efficient business model enables clients (OEMs) to offer quality spares to end-users and create a sustainable source of revenue. Hence, it has clocked growth through FY09, the worst year for the auto sector. Superior new-age trucks are coming into the market, shifting to organised manufacturers offering premium, branded clutches. M&HCVs produced in the past decade use Setco-manufactured, new-technology clutches.
Fig 14 Sales trend: segment-wise
(%) 100
75
32
35
43 63 56
50
25
60
57
50 29 36
0 FY06 FY07 FY08 FY09 FY10
OEM
Aftermarket
Export
Source: Company
At present, there are +6m CVs in India. In the past decade, more than 2m M&HCVs were produced. Higher growth rates are expected in future. The after-sales market for clutches, which command a higher margin, has significant potential. We expect sales during FY11-13e (in terms of replacement demand for clutches) to grow 25-30%. Also, exports, which command a higher margin, contribute 8% to the companys revenue and are expected to increase to 15% by FY12e.
134
22 February 2011
Expansion to meet rising demand

In order to meet the increasing demand, Setco has chalked out an expansion strategy, which would help it increase market share. It is also aggressively looking at exports. Setco caters to the clutch replacement market and OEMs, where demand drivers are strong. Strong demand revival from OEMs and the replacement market would continue. The company has tie-ups with OEMs for their distribution networks to cater to the replacement markets (where Setco supplies ~56% of its products). Its strength in the after-sales market and high LIPE-brand recognition provide high penetration. Growing demand Strong demand revival from OEMs and the replacement market would continue through FY12-13. With these markets booming, Setco is set to see further gains. Access to international CV players through acquisitions in the US and UK has enhanced the companys customer portfolio. The lower cost of production in India would help the company gain international clients. Robust growth in M&HCVs and the shift to higher value-added new generation CVs would boost growth. The companys strength in the after-sales segment and brand recognition through its LIPE brand provide high penetration. Expansion plans Utilization at Setcos plants is high. To capitalise on expected growth, the company plans to set up capacity at its Kalol SEZ, at `0.7bn, to cater to rising exports. The unit would be complete by FY13 and funded through debt and internal accruals. Setco also plans to set up an SEZ and R&D centre. These expansion projects would support additional demand and assure a strong revenue stream in future. Ahead, Setco is looking at increasing its global footprint and plans sharpening its focus on exports. In the next two years, we estimate exports share in sales to increase, from 8% at present to 15% by FY13. The company has doubled capacity in the past two years, and continues to increase it, to meet the growing demand for clutches. Product and research capabilities. Setco has the ability to produce new-generation ceramic clutches. It acquired two companies to add to its abilities and obtain technology, brands and access to the US and European markets. It has dedicated R&D centres, which help improve customization for export markets In Jan 06, Setco acquired the LIPE clutch division from Dana Corporation, UK, along with the latters manufacturing and R&D centre. The facility is now known as Setco Automotive, UK. The company has an agreement since CY00 to use the LIPE brand and has been paying royalty to Dana Corp. In addition, it acquired the engineering designing capabilities as well as technical competencies and 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-purchase deal. It became the sole owner of the LIPE brand globally. The acquisition aimed to add important OE customers, especially in the US. Setco has already added Caterpillar and Terex in the US for hydraulics sale.
22 February 2011
Exports As exports are a high-margin business, we expect Setco to increase them, from 8% of sales at present to 15% by FY13e. Manufacturing costs in India are 25-30% lower than in the West. The expected entry of major global auto companies Navistar, Mann and Daimler into India, to set up low-cost manufacturing bases would open up fresh opportunities. Supplying the Indian arm of global majors would throw up opportunities to tap demand from other areas for auto components. Other opportunities The company has the ability to manufacture clutches for LCVs. It proposes to enter the segment early next fiscal. Technological advances such as hydraulics manufacturing being introduced from the US to India would help gain more international clients. Strong products, R&D capital and the ability to provide a low-cost base for international markets are key ingredients in tapping the vast export opportunities.
136
22 February 2011
Financials
Robust demand in the auto sector coupled with Setcos capacity expansion to cater to such demand gives assurance of revenue for the next two years. We expect CAGRs of 23% in revenue and 29% in net profit over FY11-13. We believe that the company would see increased volumes along with better margins. 23% revenue CAGR expected over FY11-13e We expect a 23% CAGR in revenue during FY11-13 With increased demand, we expect a robust revenue performance from Setco. We expect a 23% revenue CAGR over FY11-13. We believe the contribution from exports as well as from the after-sales market would rise in the next two years. The company has seen a 19% revenue CAGR in the past three years despite a recession in the auto industry.
(`m) 6,000 5,000 4,000 3,000 2,000 1,000 0 FY09 FY10 FY11e FY12e FY13e (%) 36 30 24 18 12 6 0
Revenue
Revenue growth (RHS)
On account of mounting demand, OEM sales (as percent of total sales) increased in FY10. Exports (as percent of sales) decreased, but are expected to rise in future.
Fig 16 Revenue breakdown (FY09)
Export 8% OEM 29%
Fig 17 Revenue breakdown (FY10)

Export 6%
OEM 37%
Aftermarket 63%
Aftermarket 57%
Source: Company
Source: Company
137
22 February 2011
Increase in margins due to operating leverage We expect the EBITDA margin to increase to 17.4% in FY13, from 14.5% in FY10 We expect Setcos EBITDA margin to increase to 17.4% in FY13, mainly on account of the healthy margin in the India operations and improvement in the foreign subsidiaries. In the past few quarters, the company has improved its profit margin. PAT margin has improved from 7.9% in 9MFY10 to 10.2% in 9MFY11. The EBIDTA margin rose from 18.6% to 19.4% in the same period. 9MFY11 performance Revenue stood at `1,925m (34.8% yoy growth); EBITDA was `373m (40.4% yoy growth) and PAT was `19.6m (73.7% yoy growth).
(`m) 900 720 540 360 180 0 FY09 FY10 FY11e FY12e FY13e (%) 18 17 16 15 14 13
EBIDTA
EBITDA margins (RHS)
We expect Setco to post a 29% CAGR in net profit over FY11-13
29% CAGR in net profit expected over FY11-13e We expect Setco to see a 29% CAGR in net profit over FY11-13e. The growth in net profit would be reflected in expanded return ratios. Over FY11-13, we expect the RoE to be 32.6% in FY11e and 30.9% in FY13e, and the RoCE to increase from 23.3.2% to 24.8%.
(%) 9 (%) 35 31 27
Fig 19 Net profit and net-profit margin

(`m) 600
450
300
7 23
150
19 15 FY11e FY12e FY13e FY09 FY10
0 FY11e FY12e FY13e FY09 FY10
PAT
PAT Margin (RHS)
RoE
RoCE
138
22 February 2011
Balance sheet improving Setcos FY10 net debt-equity ratio was 1.65x and would fall to 0.9x in FY13e. Its working capital days would remain in the 120-day range from FY11-13.
(Days) 122 120 118 116 114 112 110 108 FY11e FY12e FY13e FY09 FY10
Fig 22 Debt and Net debt-to-equity ratio

(`m) 1,800 1,600 1,400 1,200 1,000 800 600 400 FY09 FY10 FY11e FY12e FY13e (%) 210 190 170 150 130 110 90 70
Debt
Net Debt/ Equity (RHS)
139
22 February 2011

2,446 126 2,320 1,492 828 513 315 12 328 44 284 91 192 33 160 0 0 160 -27 133 0 22 4 107
2,704 145 2,559 1,708 851 480 371 24 395 84 311 114 197 54 143 0 0 143 0 143 0 26 4 112
3,372 143 3,230 2,174 1,056 508 548 23 571 98 473 121 351 87 264 0 0 264 0 264 0 32 5 227
4,358 189 4,169 2,823 1,346 635 711 26 737 123 613 138 476 119 357 0 0 357 0 357 0 38 6 313
5,138 226 4,912 3,321 1,591 738 853 28 881 142 738 150 589 147 442 0 0 442 0 442 0 46 8 388

Equity Reserves Deferred tax liability -Miscellaneous expenses Networth Working capital loans Long term debt Preference equity Total debt Minority interests Capital employed Gross block -Accumulated depreciation Net block +CWIP Fixed assets Subsidiary Strategic investments Financial investments Investments Debtors Inventory Loans & advances Other current assets -Creditors -Provisions -Other curent liabilities Working capital +Cash & cash equivalents Net current assets Capital deployed
88 485 25 5 594 550 607 1,157 1,751 839 181 658 277 935 0 0 347 537 151 173 39 19 804 12 816 1,751
88 579 31 2 696 682 489 1,171 1,866 1,193 256 938 938 10 10 363 600 188 188 49 19 896 23 919 1,866
176 717 31 2 922 1,271 1,271 2,193 1,293 354 939 939 10 10 459 758 188 221 49 19 1,115 129 1,244 2,193
176 1,030 31 2 1,236 1,471 1,471 2,706 1,543 477 1,066 1,066 10 10 592 978 188 228 49 19 1,462 169 1,630 2,706
176 1,418 31 2 1,623 1,621 1,621 3,244 1,793 620 1,174 1,174 10 10 698 1,152 188 215 49 19 1,755 306 2,060 3,244
140
22 February 2011

160 44 12 216 118 98 278 (180) 26 214 (3) 9 1 11 12
143 84 6 233 91 142 87 55 31 14 10 17 11 12 23
264 98 0 362 220 143 100 43 37 100 106 23 129
357 123 0 480 346 134 250 (116) 45 200 39 129 169
442 142 0 584 293 291 250 41 54 150 137 169 306

Year-end 31 Mar FY09 FY10 FY11e FY12e FY13e
9.1 11.5 17.6 33.7 1 12.9 10.1 7.9 1.1 3.5 1.1 30.4 18.0 54.6 83.6 31.7 117.2 0.8 1.9
8.1 12.9 (10.4) 39.4 2 14.4 9.1 6.5 1.0 3.0 1.3 22.2 17.2 50.7 81.1 25.8 121.2 0.8 1.7
15.0 20.5 84.4 52.3 2 7.8 5.7 4.5 0.8 2.2 1.5 32.6 23.3 46.5 76.7 23.1 113.6 0.7 1.4
20.2 27.2 35.3 70.0 2 5.8 4.3 3.5 0.6 1.7 1.8 33.1 25.0 46.0 76.0 19.7 112.8 0.7 1.2
25.0 33.1 23.6 92.0 3 4.7 3.5 2.9 0.5 1.3 2.2 30.9 24.8 47.9 79.1 16.5 119.5 0.7 1.0
141
Auto Components
India I Equities
Initiating Coverage
22 February 2011
Banco Products, India

Temporary dip, bright prospects; initiate with Buy
Banco Products, India, is a leading manufacturer of radiators and primed to benefit from steady auto growth at home as well as better demand globally. Strong ties with OEMs, de-risked business and inexpensive valuations make the stock attractive. We initiate with a Buy and a target of `103.
Rating: Buy Target Price: `103 Share Price: `71 Rohan Korde
Girish Solanki
+9122 6626 6712 girishslanki@rathi.com
Well placed in the auto segment. Being a leading manufacturer of automobile radiators in India, particularly in the heavy vehicle & equipment segment, Banco is set to benefit from the sustained automobile growth (a 13.7% demand CAGR over FY11-13e). Diversification benefits. Besides benefiting from demand from OEMs, increased penetration in the non-auto space would de-risk revenue concentration in autos. The acquisition of NRF, Holland, would provide Banco better access to the European market. Growth to recover. Despite a disappointing FY11, we expect Banco to see a strong recovery in FY12 and register standalone CAGRs of 21.3% in revenue and 26.4% in profit over FY11e-13e. Valuation and risks. We value the stock at `103, based on 9x FY12e EPS of `11.5. It trades at an attractive 6.2x FY12e standalone PE. After a disappointing FY11, we expect the PE multiple to be re-rated, given stable growth ahead. We initiate with a Buy. Risks: decline in auto demand; negative surprises from a cement venture in Tanzania and rise in commodity prices.
Key data
BNCO IN/BNCO.BO `139/`66 18212 / 5459 US$0.1m `5.1bn/US$113.8m 71.5m 32.8% 67.2% 0.4% 2.6% 29.8%
Key standalone financials


2,928 415 5.8 -4.2 12.3 3.0 24.5 27.0 2.1 13.4 4,131 786 11.0 89.6 6.5 2.2 34.0 29.9 2.8 35.1 4,592 642 9.0 -18.3 7.9 1.8 22.7 21.5 2.2 35.1 5,647 820 11.5 27.8 6.2 1.5 23.5 23.2 2.5 34.4 6,759 1,026 14.3 25.1 5.0 1.2 23.5 24.4 2.7 24.6
Source: Bloomberg
140 130 120 110 100 90 80 70 60 Aug-10 Jun-10 Feb-10 Oct-10 Apr-10
Sensex
BNCO Dec-10 Feb-11
22 February 2011
Banco Products (India) - Temporary dip, bright prospects; initiate with Buy

Fig 1 Standalone Income statement (`m)
Fig 4 PE Band
5,647 23.0 4,362 1,285 22.8 145 151 37 205 820 820 27.8 11.5 13.6 1.8 6,759 19.7 5,181 1,578 23.4 160 177 40 256 1,026 1,026 25.1 14.3 16.8 1.9
200
Net sales Sales growth (%) - Op. expenses EBIDTA EBITDA margins (%) - Interest - Depreciation + Other income - Tax Reported PAT Adjusted PAT Adj PAT growth (%) FDEPS (`/share) CEPS (`/share) DPS (`/share)
2,928 -2.0 2,354 574 19.6 26 88 19 64 415 415 -4.2 5.8 7.0 1.5
4,131 41.1 3,071 1,060 25.7 22 95 42 199 786 786 89.6 11.0 12.3 2.0
4,592 11.2 3,598 994 21.7 97 129 33 160 642 642 -18.3 9.0 10.8 1.6
150
14.0x 11.5x
100 Banco Products 50
9.0x 6.5x 4.0x 1.5x
0 Aug-07 May-09 Nov-05 Dec-09 Feb-11 Mar-08 Apr-05 Jun-06 Jan-07 Oct-08 Jul-10
Fig 2 Standalone Balance Sheet (`m)


143 3,353 3,496 1,464 90 5,050 1,130 2,205 1,644 71 5,050 72 39.8 122 143 4,219 4,362 1,464 90 5,916 1,253 2,205 2,011 448 5,916 72 23.3 122
150 3.0x 2.5x 100 2.0x 1.5x
143 1,550 1,694 93 86 1,873 798 55 915 106 1,873 72 -0.7 126
143 2,168 2,311 964 90 3,364 859 1,305 1,146 55 3,364 72 39.3 122
143 2,678 2,821 1,264 90 4,175 981 1,805 1,296 92 4,175 72 41.5 122
50
Banco Products
1.0x 2.5x
0 Aug-07 Apr-05 Mar-08 May-09 Nov-05 Dec-09 Feb-11 Jun-06 Jan-07 Oct-08 Jul-10

Fig 6 Banco vs. Sensex

866 129 994 -475 1,469 251 1,218 132 0 300 500 850 37 55 92 1,133 151 1,285 -278 1,563 300 1,263 145 0 200 400 939 -21 92 71 1,401 177 1,578 -259 1,838 300 1,538 159 0 0 0 1,002 376 71 448
140 130 120 110 100 90 80 70 60 Aug-10 Apr-10 Dec-10 Jun-10 Feb-10 Oct-10 Feb-11 BNCO BSE Auto
PBT + Depreciation Cash profit - Incr/(Decr) in WC Operating cash flow - Capex Free cash flow - Dividend + Equity raised + Debt raised - Investments - Misc. items Net cash flow + Opening cash Closing cash
486 88 574 -285 859 221 638 126 1 -123 -28 328 91 15 106
965 95 1,060 -203 1,263 149 1,114 167 0 871 1,250 618 -50 106 55
Source: Bloomberg
143
22 February 2011

Banco is Indias leading manufacturer of radiators and is poised to benefit from the steady automobile growth at home as well as the better demand overseas. A less-regulated competition and strong ties with OEMs coupled with inexpensive valuations make the stock attractive. We initiate coverage on Banco with a Buy and a target price of `103. Banco is a leading supplier of engine-cooling components and all types of gaskets in addition to radiators, intercoolers, oil-coolers, etc. Its products are used in the auto and non-auto segments: auto (55% of off-take), earthmoving equipment and construction (20%), industrial engines and others (30%). In FY10, 78% of Banco revenue came from radiators, 22% from gaskets. Key customers for gaskets were Maruti Suzuki, Tata Motors, Hero Honda and TVS Motors; for radiators, Tata Motors, Ashok Leyland, M&M, BEML, TAFE and the Indian Railways were the main clients. The companys operations are well-diversified: no customer contributes more than ~10-12% to revenue. Well placed in the auto segment Being a leading manufacturer of auto radiators, Banco would continue to benefit from the sustained auto growth ahead, especially as it caters to the heavier vehicle segment (India M&HCV CAGR expected at 11.5% and LCV CAGR at 14.4% over FY11-13e). The automotive sector is a key customer, contributing ~55% to Bancos sales. Of this, two-thirds arise at home, the balance from exports. In the CV segment, Banco has a significant 30-35% market share. The engine-cooling segment is concentrated among the large regulated manufacturers. Stringent design and performance requirements of OEMs and a less active replacement market limit the scope for unregulated players of lower quality. With the Indian automotive industry seeing robust growth (~25.1% in FY11, and expecting a 13.7% CAGR over FY11-13e), the domestic growth potential for Banco is upbeat. Higher off-take for the non-auto segment would help faster growth than in the auto industry. The share of exports slipped from 37% in FY08-09 to 33% in FY10, attributable to the robust domestic growth and relatively subdued overseas markets. Diversification benefits In addition to benefiting from demand from OEMs, increased penetration in the non-auto space would serve towards de-risking revenue. The share of non-auto radiators has risen to ~45-50% of Bancos revenue (from 2530% in the past few years). Even after such fast growth, the industrial segment still has the potential to be a major growth driver, with user industries Railways and Power adding mass to the present business owing to huge spending. The Railways contribute 4-5% of domestic radiator sales; in view of the aggressive targeted capex by the Railways, its share has the potential to rise to 8-10% in the medium term (even on the expanded auto base).
Good presence in the automotive segment and increased presence in the non-auto segment over the past few years augurs well for Bancos growth ahead
144
22 February 2011
Acquisition gives access to overseas market The acquisition of NRF, Holland, would give Banco better access to the European market. Further, it would help in product diversification into the non-auto segment, with NRFs area of expertise being in the quicksupply business as well as in end-products utilised in industries (air-coolers and air-conditioners). Recovery from the lows for the European auto market (EU regions being major customers) and continuing replacement demand on a further buildup in the automotive base would benefit Banco. (In exports, most of its sales are in the replacement market.) Valuation We value the stock at `103, based on 9x FY12e EPS of `11.5. At present, it trades at an attractive 6.2x FY12e standalone PE. After a disappointing FY11, we expect the PE multiple to be re-rated, given the stable growth expected. We initiate with a Buy. Risks
Banco is looking at new business opportunities in Europe as well as new customers through its acquisition. It would target OEMs in the marine sub-segment. However, this would take at least two years to start contributing to revenue. Upward trend in commodity prices. Delay in ramp-up at the acquired company. Domestic or international auto demand slowdown. Cement venture in Tanzania may provide negative surprises. With 33% of revenue from exports, Banco would be subject to a currency-fluctuation risk.
145
22 February 2011
Well placed in the auto segment

Being a leading manufacturer of auto radiators, particularly catering to the heavier vehicle sub-segment, Banco would continue to benefit from the sustained auto growth (13.7% demand CAGR over FY1113e). To benefit from auto industry growth The automotive industry is a key customer, with ~55% of Bancos sales going to this segment. Of this, two-thirds come from the home markets, the rest from exports. With the Indian automotive industry in the midst of robust growth (~25.1% yoy growth in FY11e, and 13.7% demand CAGR expected in the next two years), the domestic growth potential for Banco is good. The share of exports has declined from 37% in FY08-09 to 33% in FY10, attributable to the robust domestic growth and relatively subdued overseas markets. Most of the growth in FY10 net sales was driven by better volumes, introduction of value-added products and competitive pricing. With the rapid transition in technology norms and increase in efficiency standards in the automotive industry, the company has to cater to the much more complex and demanding gaskets and radiators sub-segments of Indian OEMs. The engine-cooling segment is concentrated among large organised manufacturers. Stringent design and performance requirements of OEMs and a less active replacement market limit the scope for unorganised players of lower quality. Four decades of experience have resulted in Bancos better understanding of the business. The company is one of the largest in the organised radiator business, offering a wide range of products and innovative processes. Tata Motors, M&M and Ashok Leyland are some of its major clients, the first two contributing ~11% each. Bancos market share in the CV segment ranges from 30% to 35%.
Fig 7 Comparison of BPILs revenue growth and auto industry growth
(%) 60 50 40 30 20 10 0 -10 -20 -30 FY11e FY12e FY13e FY04 FY05 FY06 FY07 FY08 FY09 FY10
Bancos revenue growth trend till FY10 largely mirrored the Indian CV sectors. Ahead, we expect its increased non-auto presence and higher exports to help de-risk operations
Banco's revenues
CV volumes
Auto volumes
146
22 February 2011
Diversification benefits
Besides benefiting from demand from OEMs and exports, increased penetration in the non-auto space would effectively de-risk revenue. Non-auto share has increased The industrial segment would be a major growth driver, with user industries Railways and Power adding to the existing business owing to the vast expenditure expected in those sectors. The Railways contribute ~57% of domestic radiator sales; ahead, this could rise to 8-10% in the medium term. Bancos penetration in the OTR/construction engines sub-segment would boost growth, as these have high sensitivity to capex and infrastructure cycles. The slow and steady foray into the Railways and other heavy engines would be a key growth driver for high-value components and ensure that incremental revenue has a higher EBITDA margin. In the next 2-3 years, Banco expects to benefit from NRFs marinecomponents-supply business and diversify its Indian revenue streams through this vertical. It looks forward to monetize the technology and market access that it would gain through this acquisition. Cement foray More controversial in nature is Bancos decision to venture into the African cement market via setting up a 500,000-ton plant in Tanzania. At present, this has not been factored into our estimates. Some highlights of the project are:
The project cost is US$70m. Of this, equity would be US$24m. Bancos investment in the cement venture would be US$12.3m. The rest would be borrowed. Banco would have a 51% stake in the venture; the balance would be with local companies. The payback period is expected to be three years, with project breakeven predicted at 28% capacity utilisation. On full production, this plant would cater to 10% of Tanzanias demand. However, competition would include large players such as Lafarge. Lake Cements would be run by professionals appointed from India, and would be financed by local banks in Tanzania.
As this is a venture into an unrelated field for the company, we reserve our judgement on the project while factoring in the execution risk as one that might impair financial performance ahead.
147
22 February 2011
NRF gives access to global markets

The acquisition of NRF, Holland, would give Banco better access to European markets through a local base. As NRF specializes in nonauto heat exchanges, this acquisition would help de-risk Bancos operations. Exports, overseas presence to increase The acquisition of NRF, Holland, would give Banco better access to European markets through a local base. NRF has been operating in the business for more than 80 years. Though it specializes in the marine/shipbuilding industry, 50% of its revenue comes from the automotive segment, 25% from Marine and 25% from others. Replacement demand accounts for +50% of sales. Banco acquired Nederlandse Radiateuren Fabriek B.V. (NRF), which was incorporated in the Netherlands and manufactures heat transfer products. NRF was owned by a US company, now undergoing Chapter 11 proceedings. Banco acquired NRF without any liabilities, for 17.70m, funded via debt and equity. The European auto market recovering from its lows (EU regions being major customers) and the continuing replacement demand owing to a further build-up in the automotive base would benefit Banco. (In exports, most of its sales come from the replacement market.) Banco is looking at new business opportunities in the European markets as well as new customers through this acquisition. NRF has subsidiaries all over Europe and a main warehouse in Holland. Banco aims to improve NRFs product line and business, though 2-3 years would be required for that. Similarly, NRF would benefit from Bancos cost-cutting measures, synergies, and management initiatives.
148
22 February 2011
Financials
Growth ahead would be driven by growth in user industries such as the automobile sector, marine requirements, the Railways, construction equipment and other industrials. The acquisition of NRF would contribute to growth by increasing operations in Europe, North America and other areas. Most of Bancos FY10 sales growth was driven by better volumes, new value-added products and competitive pricing. With the rapid transition in technology norms and the increase in efficiency standards in the automotive industry, Banco has to cater to the complex and demanding gaskets and radiator segments of Indian OEMs. Banco now operates at ~70-75% utilization. Despite a disappointing FY11, we expect it to recover in FY12 and register standalone CAGRs of 21.3% in revenue and 26.4% in profit over FY11e-13e. The continuing good performance of OEMs would augur well for Banco, in terms of sustained revenue growth. Growth opportunities from the Railways and Power have further potential for revenue. Additional positives are Bancos adapting to changes in technology via investing in R&D and following globally competitive pricing and timely delivery.
Fig 8 Trend in revenue and profit growth
(%) 100.0 80.0 60.0 40.0 20.0 0.0 -20.0 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e
FY12e
Revenues
Profit
Fig 9 Trend in EBITDA margins

(%) 30
26 22 18 14 10 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY13e
EBITDA Margin
FY13e
149
22 February 2011

Net Sales Change (%) Expenditure EBITDA Change (%) % of Net Sales Depreciation EBIT Deferred Revenue Exp. Interest & Finance Charges % of Debt Other Income Non-recurring Expense Non-recurring Income PBT Tax Effective Rate (%) Rep. PAT Change (%) % of Net Sales Adj. PAT Change (%)
2,879 -3.7 2,354 574 3.6 19.6 88 486 0 26 16.9 19 0 0 479 64 13.4 415 -4.2 14.2 415 (4.2)
4,071 41.4 3,071 1,060 84.7 25.7 95 965 0 22 4.1 42 0 0 985 199 20.2 786 89.6 19.0 786 89.6
4,524 11.1 3,598 994 -6.2 21.7 129 866 0 97 8.7 33 0 0 802 160 20.0 642 -18.3 14.0 642 (18.3)
5,568 23.1 4,362 1,285 29.2 22.8 151 1,133 0 145 10.7 37 0 0 1,025 205 20.0 820 27.8 14.5 820 27.8
6,669 19.8 5,181 1,578 22.9 23.4 177 1,401 0 160 10.9 40 0 0 1,282 256 20.0 1,026 25.1 15.2 1,026 25.1

Sources of Funds Share Capital Reserves Net Worth Net Deferred Tax Total Loans Capital Employed Application of Funds Gross Fixed Assets Less: Depreciation Net Fixed Assets Capital WIP Total Net Fixed Assets Investments Curr.Assets, L & Adv. Inventory Sundry Debtors Cash & Bank Balances Loans & Advances Others Current Liab. & Prov. Sundry Creditors Other Liabilities Provisions Net Current Assets Application of Funds
143 1,550 1,694 86 93 1,873
143 2,168 2,311 90 964 3,364
143 2,678 2,821 90 1,264 4,175
143 3,353 3,496 90 1,464 5,050
143 4,219 4,362 90 1,464 5,916
1,273 479 795 3 798 55 1,442 552 646 106 138 0 421 204 66 151 1,021 1,873
1,376 566 810 49 859 1,305 1,796 759 879 55 102 0 595 282 118 195 1,201 3,364
1,676 695 981 0 981 1,805 2,015 844 977 92 102 0 626 314 118 195 1,388 4,175
1,976 846 1,130 0 1,130 2,205 2,414 1,038 1,202 71 102 0 699 386 118 195 1,715 5,050
2,276 1,023 1,253 0 1,253 2,205 3,233 1,244 1,440 448 102 0 775 462 118 195 2,458 5,916
150
22 February 2011

OP/(Loss) before Tax Interest/Div. Received Depreciation & Amort. Direct Taxes Paid (Inc)/Dec in Working Capital Other Items CF from Oper. Activity Extra-ordinary Items Other Items CF after EO Items (Inc)/Dec in FA+CWIP (Pur)/Sale of Invest. CF from Inv. Activity Issue of Shares Inc/(Dec) in Debt Interest Paid Dividends Paid CF from Fin. Activity Inc/(Dec) in Cash Add: Beginning Balance Closing Balance
486 19 88 -45 -26 46 568 0 0 568 -231 28 -203 1 -123 -26 -126 -274 91 15 106
965 42 95 -195 -231 -2 674 0 0 674 -157 -1,250 -1,407 0 871 -22 -167 682 -51 106 55
866 33 129 -160 -151 0 717 0 0 717 -251 -500 -751 0 300 -97 -132 72 37 55 92
1,133 37 151 -205 -348 0 769 0 0 769 -300 -400 -700 0 200 -145 -145 -90 -21 92 71
1,401 40 177 -256 -367 0 996 0 0 996 -300 0 -300 0 0 -160 -159 -319 377 71 448

Basic (`) Diluted EPS EPS Growth (%) Cash EPS Book Value per Share DPS Payout (Incl. Div. Tax) % Valuation (x) P/E Cash P/E EV/EBITDA EV/Sales Price to Book Value Dividend Yield (%) Turnover Ratios Asset Turnover (x) Fixed Asset Turnover (x) Profitability Ratios (%) RoE RoCE Leverage Ratio Debt/Equity (x)
5.8 -4.2 7.0 23.7 1.5 30.3 12.3 10.1 8.7 1.7 3.0 2.1 1.5 2.3 24.5 27.0 0.1
11.0 89.6 12.3 32.3 2.0 21.2 6.5 5.8 4.4 1.2 2.2 2.8 1.2 3.0 34.0 29.9 0.4
9.0 -18.3 10.8 39.4 1.6 20.5 7.9 6.6 4.5 1.0 1.8 2.2 1.1 2.7 22.7 21.5 0.4
11.5 27.8 13.6 48.9 1.8 17.7 6.2 5.2 3.3 0.8 1.5 2.5 1.1 2.8 23.5 23.2 0.4
14.3 25.1 16.8 61.0 1.9 15.5 5.0 4.2 2.5 0.6 1.2 2.7 1.1 2.9 23.5 24.4 0.3
151
22 February 2011

Banco supplies engine-cooling components and all types of engine gaskets, besides radiators, inter-coolers, oil-coolers, etc. Its products are used across auto and non-auto segments. Banco started in 1962. It has four modern manufacturing plants at Baroda, with state-of-the-art facilities. It collaborates with Elring Klinger, Germany and Japan Metal Gaskets for the Indian market. It has ~600 employees. Promoter and chairman Vimal Patel has an M.Sc. (Economics) from the London School of Economics and wide experience in automotive components. Shailesh Thakker is the executive director and CFO. Copromoter Mehul K Patel is a post graduate in engineering from England. The promoter holding in Banco is 69.5%. Product range
1. 2.
Gaskets: The company manufactures and exports a wide range of gaskets for diesel engines (automotive and agriculture). Radiator: It also manufactures and exports radiators for all sorts of applications (automotive, industry, agriculture). It supplies radiators and air coolers to all major OEMs in India and some leading companies in Europe. It also addresses the replacement market, with an extensive range covering popular German, French and Japanese cars. Compressed Fibre Jointing Sheets (CFJS): It manufactures compressed jointing sheets using non-asbestos raw materials, exporting many varieties, covering a range of automotive and industrial applications world-wide.
3.
152
Auto Components
India I Equities
Initiating Coverage
22 February 2011
Gabriel India
A leading shock-absorber manufacturer; initiate with Buy
We initiate coverage on Gabriel, with a Buy recommendation and a target of `62. Gabriel is one of the leading manufacturers of shock absorbers and likely to see a 42% earnings CAGR over FY11-13e supported by a strong brand catering to stable demand, its location advantage and expansion.
Girish Solanki
Rohan Korde
Stable auto demand. Indias auto sector is likely to see a 13.7% volume CAGR over FY11-13e, boosted by two-wheelers and cars. The country is already one of the worlds largest two-wheeler markets and an established small-car global manufacturing hub. We expect the nascent recovery in export demand to gather steam as US/EU auto demand recovers in FY11 after hitting bottom in CY08/CY09. Strategic plant location; timely delivery. Gabriels plants are strategically located, in proximity to original equipment manufacturers (OEMs). This results in timely delivery to clients at lower costs. Adding capacities. The boom in the automobile industry has led to Gabriel investing `1.5bn-2bn in the next 3-4 years to enhance capacity to cater to the booming demand. Valuation and risks. At our target price of `62, the stock would trade at 11x FY12e earnings and EV/EBITDA of 4.9x. The target PE is at a slight discount to the stocks five-year average PE. Key risks: higher interest rates and rise in raw material prices
Key data
GABR IN / GABR.BO `74/`29 18212 / 5459 US$0.1m `3.2bn/US$71m 71.8m 45.4% 54.6% 6.0% 0.7% 38.7%
Key financials

5,267 56 0.8 -26.7 54.2 2.1 3.9 8.3 1.7 103.4 7,031 240 3.3 329.1 12.6 1.9 15.7 16.7 2.0 82.9 9,500 282 3.9 17.2 10.8 1.7 16.3 15.4 2.4 81.9 12,221 407 5.7 44.6 7.5 1.4 20.6 20.2 2.9 77.2 15,112 566 7.9 39.1 5.4 1.2 24.1 23.1 3.5 63.5
Source: Bloomberg
75 70 65 60 55 50 45 40 35 30 Feb-10 Jun-10 Oct-10 Apr-10 Aug-10
GABR
Sensex Dec-10 Feb-11
22 February 2011
Gabriel A leading shock-absorber manufacturer; initiate with Buy

Fig 4 PE Band
9,500 35.1 8,778 722 7.6 127 216 7 104 282 17.2 282 3.9 6.9 1.0 12,221 28.6 11,215 1,006 8.2 197 251 7 158 407 44.6 407 5.7 9.2 1.2 15,112 23.7 13,833 1,279 8.5 219 281 8 220 566 39.1 566 7.9 11.8 1.5
(`) 100 90 80 70 60 50 8x 40 30 20 10 0 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Gabriel 4x 12x 16x
5,267 10.4 4,978 290 5.5 171 153 107 16 56 -26.7 56 0.8 2.9 0.7
7,031 33.5 6,385 647 9.2 160 202 68 112 240 328.5 240 3.3 6.2 0.9

Fig 5 P/BV Band

72 1,421 1,633 1,488 0 3,122 1,965 133 889 134 3,122 71.8 82.9 45.9 72 1,617 1,829 1,688 0 3,517 2,127 133 1,068 189 3,517 71.8 81.9 37.6 72 1,921 2,134 1,888 0 4,022 2,377 133 1,270 242 4,022 71.8 77.2 34.9 72 2,364 2,577 2,088 0 4,665 2,596 133 1,485 451 4,665 71.8 63.5 33.3
80 70 60 50 Gabriel 40 1.5x 1.0x 0.5x 10 0 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 2.0x
72 1,252 1,430 1,569 0 2,999 1,896 133 878 91 2,999 71.9 103.4 66.3
30 20

YE 31 March FY09 FY10 FY11 FY12 FY13
Fig 6 Gabriel Vs Auto sector index

282 216 498 179 319 379 (59) 86 0 200 0 0 55 134 189 407 251 658 202 456 500 (44) 103 0 200 0 0 53 189 242 566 281 848 215 633 500 133 123 0 200 0 0 209 242 451
80 GABR 70 60 50 BSE Auto 40 30 20 Aug-10 Apr-10 Dec-10 Jun-10 Feb-10 Oct-10 Feb-11
56 153 211 (156) 367 456 (89) 59 0 108 (10) 0 (31) 122 91
240 202 477 11 466 271 196 71 (0) (81) 0 0 43 91 134
Source: Bloomberg
154
22 February 2011

We initiate coverage on Gabriel India with a Buy and a target price of `62. Gabriel is one of the leading manufacturers of shock absorbers and likely to see a 42% earnings CAGR over FY11-13e on the back of a strong brand catering to the stable demand, locational advantage and expansion. Stable auto demand positive for Gabriel Most of the domestic demand for shock absorbers comes from the OEM market; 80% stems from fresh demand in case of Gabriel. With the revival in the auto sector, prospects for the shock-absorber segment seem bright. Indias auto sector is likely to see a 13.7% volume CAGR over FY11-13e, boosted by two-wheelers and cars. Various launches in the past year have attracted a healthy response; with OEMs likely to see further launches, we expect healthy volume off-take for the company. India is already one of the worlds largest two-wheeler markets and an established small-car global manufacturing hub. We expect the nascent recovery in export demand to gather steam as US/EU auto demand recovers in FY11 after hitting bottom in CY08/CY09. Leveraging its strategic plant location for timely delivery Gabriels largest plant, at Hasur (Tamil Nadu) supplies suspension products to OEMs Suzuki, Yamaha and TVS Motors. Its plant at Nashik supplies front forks and shock absorbers to Bajaj Auto and Yamaha. Marutis plant at Mansesar is being supplied shock absorbers by Gabriels Khandsa plant; similarly, Tata Motors, Bajaj Auto, Renault, Volkswagen and the Indian Railways are being served struts and shock absorbers from the companys Chakan plant at Pune. Gabriels plants are strategically located, in proximity to OEMs. Hence, it boasts of timely delivery at lower costs. Adding capacities Gabriel plans to leverage its strong brand by targeting more exports. (Gabriel is Indias most recognized shock-absorber brand.) The company has, through its long experience in shock absorbers, built units to further strengthen its product range. It is #2 in shock absorbers (dominated by Munjal Showa, which primarily supplies Hero Honda), with a 30% share of the organized set-up and a past five-year CAGR of 11-12% (largely volume-driven). It aims at a consistent 25% annual growth in the next three years, mainly via increased domestic volumes and improved exports. In the past three years, Gabriel has added three plants: Parwanoo, Khandsa and Sanand. This expansion in shock-absorber capacity has driven growth (ytd FY11 revenue up 35% yoy). The boom in the automobile industry has resulted in the company planning investment of `1.5bn-2bn in the next 3-4 years to enhance capacity to cater to the rising demand.
155
22 February 2011
We value Gabriel at 11x 12-month-forward earnings; Target price: `62
Outlook and Valuation The domestic automobile industry saw a strong 12.7% growth over FY0210 (against a slight decline in FY08). We expect the trend to continue, boosting demand for shock absorbers in OEM and replacement markets. Consequently, we estimate the domestic shock absorber sector to see a 2025% CAGR over FY10-13e. Gabriel would benefit from the emerging domestic demand and increased exports opportunity. Gabriels leading position, proximity to OEM clients and capacity expansions lead us to believe that there is substantial upside to the stock. Also, it has bagged orders and increased capacities to cater to the rising demand. This would boost its sales volumes. Profitability would improve on account of the operating leverage, increased exports and after-sales contribution. Given the better long-term growth prospects for shock absorbers, we expect healthy return ratios. At our target price of `62, the stock would trade at 11x FY12 earnings and EV/EBITDA of 4.6x. We assign some discount to the stocks five-year average multiple. Gabriels one-year-forward PE in the past five years has largely ranged between 2x and 40x. P/BV has ranged between 0.3x and 2.4x. At the current market price of `42, the stock trades at PE of 10.8x and 7.5x FY11e and FY12e earnings respectively and EV/EBITDA of 5.1x and 3.6x. We initiate coverage with a Buy recommendation and a target price of `62.
Fig 7 Twelve-month forward PE: Mean and standard deviations
45 40 35 30 25 20 15 10 5 0 -5 Feb-06 Dec-06 Nov-09 May-07 Sep-05 Aug-08 Sep-10 Feb-11 Jan-09 Jun-09 Apr-05 Oct-07 Mar-08 Apr-10 Jul-06 -1SD -2SD +2SD +1SD Mean
Risks
OEM risk. Nearly 80% of Gabriels sales are to OEMs, while only 20% to the replacement market (original equipment suppliers). Hence, low volume growth for OEMs would trim the companys revenue. Interest-rate risk. A substantially high percentage of vehicles is purchased through auto finance; as such, with an increase in interest rates, cost of financing rises. This affects volume growth of auto manufacturers, thereby impacting Gabriels growth. High raw-material prices. Raw material costs being as high as 7075% of sales play a large part in pricing and margins. Steel, aluminium, rubber and oil are key raw materials. Any adverse movement in prices would lead to eroded margins.
156
22 February 2011
Stable auto demand

Indias auto sector is likely to see a 13.7% volume CAGR over FY1113e, boosted by two-wheelers and cars. Demand for shock absorbers in India largely comes from the OEM market; 80% from fresh demand in case of GIL. With the auto revival, prospects for the shock-absorber segment look bright. The launch of many vehicles last year has seen a good response; also, based on further launches in the pipeline for OEMs, we expect healthy volume offtake for Gabriel. Gabriel is the most recognized shock-absorber brand Catering to the booming OEM and replacement markets. The domestic automobile industry has been growing rapidly. The replacement market has broadened, with the number of old vehicles in India increasing (average life of ride-control products is 4-5 years). In such an everincreasing replacement market, where Gabriel supplies ~20% (including supplies to OES) of its products, it could see 30% revenue growth in the next two years. In the replacement market, it commands higher margins.
Fig 8 - Demand drivers in place
The company has a healthy market share in all segments it operates in. The market size of the ride-control-equipment segment is `23.5bn, of which Gabriels market share is 29.7%. It has the lions share of 84% in the commercial-vehicle (CV) segment and 44% in the passenger-car segment. Even in the two- and three-wheeler segments, it has an 18% market share, despite not supplying to Hero Honda, the market leader. (Munjal Showa is Hero Hondas sole supplier.)
157
22 February 2011
Fig 9 Commercial-vehicle segment: market share (FY10)

Others, 7% Tenneco, 8% Endurance, 1% Showa, 0%
Fig 10 Two-wheeler segment: market share (FY10)

Others, 7% Tenneco, 3% Gabriel, 18%
Endurance, 17%
Gabriel, 84%
Source: Company Source: Company
Showa, 55%
Fig 11 Passenger-car segment: market share (FY10)

Others, 24%
Gabriel, 44%
Tenneco, 19%
Showa, 13%
Source: Company
Further, with fresh orders from CV OEMs Mahindra Navistar, Tata Motors, Ashok Leyland and Daimler Commercial Vehicles, Gabriel has secured good business. Also, it is bidding for new products from passenger-car manufacturers Tata Motors and Maruti Suzuki. Gabriel expects 25-30% growth in the next two years, mainly through volumes. It has already secured new business for FY11 worth `1.97bn, and `3.16bn for FY12.
Fig 12 Secured business
Revenue (`m) Segment FY11e FY12e
Two-wheelers Passenger cars Commercial vehicles Exports Total

Source: Company
1,121 438 316 99 1,973
1,720 739 549 153 3,161
158
22 February 2011
Strategic plant location; timely delivery

Gabriels plants are strategically located, in proximity to OEMs, resulting in timely delivery to clients at lower costs. Gabriel has established strong relationships with major OEMs Maruti Suzuki, Ashok Leyland, Tata Motors, TVS Motors, Yamaha, Bajaj Auto and M&M. Diverse clients in various segments mitigates the impact of a slowdown in one segment or a single client.
Fig 13 Key OEM customers (percentage of FY10 revenue)
HMSI, 1% M & M, 4% SMIL, 5% Maruti Suzuki, 16%
Bajaj Auto, 11%
TVS motors, 18% Yamaha, 11% TATA motors ltd, 10%
Source: Company
Gabriels plants are strategically located in proximity to marquee clients, thereby achieving timely delivery at lower transportation costs. Its largest plant, at Hasur (Tamil Nadu), supplies suspension products to OEMs Suzuki, Yamaha and TVS Motors. The plant at Nashik supplies front forks and shock absorbers to Bajaj Auto and Yamaha. Marutis plant at Mansesar is being supplied shock absorbers by Gabriels Khandsa plant; similarly, Tata Motors, Bajaj Auto, Renault, Volkswagen and the Indian Railways are being served struts and shock absorbers from its Chakan plant at Pune.
Fig 14 Plant location
pieces (m) Location (client) Capacity (FY10) Production (FY10)
Khandsa (PC: Maruti Suzuki) Nashik (Bajaj, M&M, Piaggio, Yamaha) Chakan (PC: Tata Motors, Hyundai, Renault, GM, Ford, Maruti, and Volkswagen) Parwanoo (TVS, Tata Motors, M&M and after-sales market) Dewas (CV: Tata Motors, Eicher, Ashok Leyland, Force Motors, Nano, exports and after-sales market) Hosur (TVS, Suzuki, HMSI, Yamaha) Sanand, (Tata Nano)
Source: Company
2.4 3 3.6 5.18 4 4.68
1.56 2.58 2.17 1.98 2.44 3.83
159
22 February 2011
Consistently superior margins to Munjal Showa On account of its diversified clientele, Gabriel has always enjoyed superior margins to Munjal Showa, which obtains 70% of its revenue from Hero Honda.
Fig 15 Competitive margin profile
(%) 12
10 8 6 4 2 0 FY05 FY06 FY07 FY08 FY09 FY10
Munjal Showa
Gabriel India
Source: Company
160
22 February 2011
Adding capacities
The boom in the automobile industry has resulted in the company planning investment of `1.5bn-2bn in the next 3-4 years to enhance capacities to cater to the rising demand. Gabriel plans to leverage its strong brand by increasing its focus on exports. It built units to further strengthen its product range. It is the second-largest manufacturer of shock absorbers (dominated by Munjal Showa, which is the chief supplier to Hero Honda) and commands a 30% share of the organized set-up. It has seen an 11-12% annual growth for the past five years, largely driven by volumes. It aims at a consistent 25% annual growth for the next three years, chiefly via increased domestic volumes and improved exports. In the past three years, Gabriel has added three plants (Parwanoo, Khandsa and Sanand); this expansion in shock-absorber capacity has driven growth (ytd FY11 revenue up 35% yoy). The boom in the automobile industry has resulted in Gabriel planning investment of `1.5bn-2bn for the next 3-4 years to enhance capacities to cater to the booming demand. A just-in-time approach is vital to contain freight costs, critical in the auto sector. To tap the vast and mounting demand from OEMs, the company has strategically set up its plants in proximity to its clients. New factory to come up in Gurgaon; expansion at Hosur The company is setting up a factory at Gurgaon to cater to the swelling demand from Maruti there. Utilization at Gabriels present plants is ~90%. To capitalise on expected growth, the company plans to expand capacity at both plants (Gurgaon and Hosur). It aims to increase capacity at all its plants by 15% every year for the next three years. Gabriel plans to invest `1.5bn-2bn in the next 3-4 years on expanding capacity and R&D. The growth in the industry would entail new plant launches and capacity expansions. Current capacity utilization being significantly high, in line with the high market demand, the company aims at increasing annual capacity by 45% in the next three years to meet the increasing demand from automakers. It is looking to set up a new plant in the Gurgaon region for one of its biggest customers, Maruti Suzuki. Also, it plans expanding capacity at its Hosur plant, which is a supplier to twowheeler companies. Of the investment, `0.4bn-0.5bn has been earmarked for R&D, while the bulk is for fresh capacity additions. In FY11, the company invested `0.6bn-0.7bn. The expansion would be funded through both internal accruals and debt. Increasing focus on exports and after-market sales Ahead, Gabriel is looking to increase its global footprint and increase focus on exports. In the next two years, we estimate the share of exports-to-sales to increase to 5% in FY13e from 2% at present. In the exports market, Gabriel supplies to the OEM and replacement segments. It supplies to Renault in Iran as well as to North America and an OEM motorcycle manufacturer in Bangladesh. Also, the company supplies replacement
Expansion in shock absorbers to drive growth. Full impact of enhanced capacity would be seen in FY13
Auto industry to drive demand
161
22 February 2011
equipment (shock absorbers) to most Indian vehicles exported.

Fig 16 Growth in share of exports
(`m) 700 600 500 400 300 200 100 0 FY05 FY06 FY07 FY08 FY09 FY10 FY11e FY12e FY13e (%) 5 4 4 3 2 1 1 0
Exports
% of sales (RHS)
162
22 February 2011
Financials
Robust demand from the auto sector coupled with Gabriels capacity expansion to cater to this demand offer assurance of revenue for the next two years. We expect the company to see CAGRs of 26% in revenue and 42% in net profit over FY11-13e. We believe volumes would increase, with slightly better margins. 26% revenue CAGR over FY11-13e We expect a 26% CAGR in revenue from FY11 to FY13e Following expansion in its shock-absorber capacity on escalating demand, we expect Gabriel to register a robust revenue performance. We expect a 26% revenue CAGR over FY11-13e. We believe the share of exports as well as that of the after-sales market would increase in the next two years.
(`m) 16,000 (%) 45
12,000
30
8,000
15
4,000
0 FY08 FY09 FY10 FY11e FY12e FY13e
-15
Revenue
Revenue Growth % (RHS)
Slight increase in margins due to operating leverage We expect EBITDA margins at a strong 8.2-8.5% over FY11-13e We expect an FY11-13e EBITDA margin at a strong 8.2-8.5%, owing to healthy margins in new orders and revenue increases in the replacement and exports segments.
(`m)
1,400 1,200 1,000 800 600 400 200 0 FY09 FY10 FY11e FY12e FY13e
(%)
11.2 9.6 8.0 6.4 4.8 3.2 1.6 0.0
EBITDA
EBITDA margin (RHS)
163
22 February 2011
42% CAGR in net profit over FY11-13e We expect Gabriel to post a 42% CAGR in net profit over FY11-13e
(`m) 600 500 400 300 200 100 0 FY11e FY12e FY13e FY09 FY10 (%) 4.20 3.50 2.80 15 2.10 10 1.40 0.70 0.00 5 0 FY11e FY12e FY13e (%) 120 100 80 1,500 40 30 20 10 0 FY11e FY12e FY13e FY09 FY10 1,000 40 500 0 FY11e FY12e FY13e FY09 FY10 20 0 60 FY09 FY10
We expect Gabriel to post a 42% CAGR in net profit over FY11-13e. This growth would be reflected in expanded return ratios. We expect RoE to rise to 24.1% (from 16.3%) and RoCE to 23.1% (from 15.4%) over FY11-13e.
(%)
25 20
PAT
PAT Margin (RHS)
RoE
RoCE
Comfortable balance sheet The FY10 net debt-to-equity holds at a manageable 0.8x and falls within the industry range of 0.2x to 2x. We expect it to gradually slip to ~0.6x in FY13e. Working capital days are also lower than peers (70-120). Over FY12-13e, this is expected to further fall below FY10 levels.
(days) 70 60 50
Fig 22 Debt and net debt-to-equity

(`m) 2,500 2,000
Debt
Net Debt/Equity (RHS)
164
22 February 2011

5,882 615 5,267 4,522 745 456 290 107 396 153 244 171 72 16 56 0 0 56 0 56 0 50 9 -3
7,580 549 7,031 5,865 1,166 520 647 68 714 202 512 160 352 112 240 0 0 240 0 240 0 61 10 169
10,093 593 9,500 8,179 1,321 599 722 7 729 216 513 127 386 104 282 0 0 282 0 282 0 73 12 196
13,271 1,050 12,221 10,311 1,910 904 1,006 7 1,013 251 762 197 566 158 407 0 0 407 0 407 0 88 15 304
16,412 1,300 15,112 12,624 2,488 1,209 1,279 8 1,287 281 1,005 219 787 220 566 0 0 566 0 566 0 105 18 443
Fig 24 - Balance Sheet (`m)

Equity Reserves Deferred tax liability Networth Working capital loans Long term debt Total debt Capital employed Gross block -Accumulated depreciation Net block +CWIP Fixed assets Strategic investments Financial investments Investments Debtors Inventory Loans & advances -Creditors -Provisions -Other curent liabilities Working capital +Cash & cash equivalents Net current assets Capital deployed
72 1,252 106 1,430 501 1,068 1,569 2,999 3,062 1,315 1,747 149 1,896 133 0 133 823 672 605 1,048 121 53 878 91 969 2,999
72 1,421 141 1,633 641 847 1,488 3,122 3,358 1,514 1,844 121 1,965 133 0 133 773 800 633 1,052 122 142 889 134 1,023 3,122
72 1,617 141 1,829 1,688 1,688 3,518 3,858 1,730 2,127 2,127 133 133 1,039 1,075 633 1,414 122 142 1,068 189 1,257 3,518
72 1,921 141 2,134 1,888 1,888 4,022 4,358 1,981 2,377 2,377 133 133 1,339 1,385 633 1,823 122 142 1,270 242 1,512 4,022
72 2,364 141 2,577 2,088 2,088 4,665 4,858 2,262 2,596 2,596 133 133 1,658 1,715 633 2,257 122 142 1,485 451 1,936 4,665
165
22 February 2011

PAT +Depreciation +Deferred tax Cash profit -Increase/(Decrease) in WC Operating cash flow -Capex Free cash flow -Dividend +Equity raised +Debt raised +Minority interests -Investments -Miscellaneous items Net cash flow +Opening cash
Closing cash
56 153 2 211 (156) 367 456 (89) 59 108 (10) (31) 122
91
240 202 35 477 11 466 271 196 71 (0) (81) 43 91

134
282 216 498 179 319 379 (59) 86 200 0 55 134

189
407 251 658 202 456 500 (44) 103 200 53 189
242
566 281 848 215 633 500 133 123 200 209 242
451

Basic (`)
EPS Fully Diluted Cash EPS EPS Growth (%) Book Value per Share DPS
Valuation (x)
0.8 2.9 (26.7) 19.9 0.7 54.2 14.6 9.0 0.7 2.1 1.7 3.9 8.3 53.6 38.8 58.4 66.3 0.8 1.1
3.3 6.2 329.1 22.8 0.9 12.6 6.9 5.0 0.5 1.9 2.0 15.7 16.7 41.4 38.2 54.5 45.9 0.6 0.9
3.9 6.9 17.2 25.5 1.0 10.8 6.1 4.9 0.4 1.7 2.4 16.3 15.4 34.8 36.0 47.4 37.6 0.5 0.9
5.7 9.2 44.6 29.7 1.2 7.5 4.6 3.5 0.3 1.4 2.9 20.6 20.2 35.5 36.7 48.3 34.9 0.5 0.9
7.9 11.8 39.1 35.9 1.5 5.4 3.6 2.8 0.2 1.2 3.5 24.1 23.1 36.2 37.4 49.3 33.3 0.4 0.8
P/E Cash P/E EV/EBITDA EV/Sales Price to Book Value Dividend Yield (%)
Profitability Ratios (%)
RoE RoCE
Turnover Ratios
Debtors (Days) Inventory (Days) Creditors (Days) Working Capital (Days) Asset Turnover (x)
Leverage Ratio
Debt/Equity (x)
166
22 February 2011

Gabriel India is one of the leaders in shock absorbers, struts and front forks (ride-control products) in India. Operating in all subsegments of automobiles: commercial vehicles, two- and threewheelers, passenger cars and utility vehicles All its six plants are strategically located, in proximity to OEM units, thereby leading to just-in-time delivery of products and spares. To benefit from the present robust automobile volumes, the company has expanded capacities of its products. Brief history and business Established in 1961, the flagship company of the Anand Group and the market leader in the four-wheeler shock-absorber sub-segment, Gabriel India has six plants manufacturing over 20m shock absorbers, struts and front forks. It caters to the booming auto industry (two-, three- and fourwheelers) as well as to the Indian Railways. Shock absorbers and struts constitute the bulk of its sales. Over FY06-10, Gabriel saw CAGRs of 9% in revenue and 28% in net profit. The promoters have raised their stake by 10% through acquiring, in two tranches, Gabriel Internationals stake.
Fig 27 Key management
Key Person Designation Background
Prakash Kulkarni
Executive Chairman
Arvind Walia
Managing Director
Deepak Chopra
Director
Russi Jal Taraporewala
Independent Director
Padmini Khare Kaicker
Rajeev Vasudeva
Gurdeep Singh
Mechanical engineer; 37 years experience in operations and project management. Was MD, Thermax; director, Sulzer India and Praj Industries CA, 30 years experience in finance, tax, operations, legal matters and project management. Has been associated with Gabriel since 2006. Also associated with Anfilco, Anchemco and Henkel Teroson India. Member, ICAI, and The Institute of Company Secretaries of India, New Delhi. Elevated as Anand Group CEO. Has been associated with the company since 2008. Specializes in finance and serves as director in many companies. An eminent economist. Has been associated with Gabriel since 1962. 48 years experience in economics, finance, management. Also serves as chairman of the Investor Grievance Committee of Gabriel and Stanrose Mafatlal Investments & Finance and the Remuneration Committee of Standard Industries. She is a CA and a Certified Public Accountant from USA. She is a partner in M/s B. K. Khare & Co., a reputed CA firm in Mumbai. She has 17 years of rich experience in Auditing, Company Law and Taxation. She has also served as a Chairperson of the Audit Committee of IndusInd Bank. She is associated with GIL since 2005 and is the Chairman of the Audit Committee of Gabriel India Limited. CA with MBA and LLB degrees. Specializes in recruitment and assessment of CEOs, COOs and critical leadership talent in the technology and private equity sectors. Has been associated with Gabriel since 2008. B.Tech, Chemical Engineering, IIT, Delhi. Has been associated with Unilever for over 38 years holding key positions. Specializes in project implementation, HR & industrial relations, business development and technical support. Has been associated with the company since 2009. Serves as director of Blue Star, Halonix, Tecnova India Pvt. Ltd., Everest Kanto Cylinders and Gateway Rail Freight.
Source: Company, as of Dec 10
167
22 February 2011
Fig 28 Shareholding pattern

Public, 31.1%
Promoter, 54.6% other corporate bodies, 7.8% Indian Institutions, 0.6% Foreign holding, 5.9%
Source: Company, as of December 10
168
Chemicals
India I Equities
Update
22 February 2011
Phillips Carbon Black

Powering ahead; maintain Buy
We maintain a Buy on Phillips Carbon Black, with a revised target of `246 (from `261). We are upbeat about the company, given its healthy volume growth and improving high-margin power division. We expect a 23% net profit CAGR over FY11-13e.
Girish Solanki
Benefiting from rising demand. Demand for tyres would continue rising, in line with the buoyant auto industry. Hence, PCB is likely to benefit from economies of scale. To sustain its leadership and benefit from mounting demand, both domestically and globally, PCB is further expanding capacity. Capacity expansion to fuel volume growth. PCBs 360,000tpa expanded capacity now runs at 90% utilization. Another 50,000tpa would be operational by end-1QFY12. Given rising demand, we see the capex as suitably timed. Power reduces commodity risk. PCB generates 60.5MW, of which 10.5MW is utilized internally, the rest sold at ~`3/unit. It plans to set up two more plants of 16MW (total) by 2QFY12. We expect this to boost earnings, given the divisions high margin, of up to 80%. Further, PCB plans to tie up some of its spare power capacity through PPAs. Valuation and risks. At our target of `246, the stock trades at FY12e PE of 5.6x and EV/EBITDA of 4x. We value PCB at FY12e P/BV of 1.25x. Key risks: Volatility in key raw material prices and capacity under-utilization.
Key data
PHCB IN/PHIL.BO `242/ `113 18212 / 5459 US$0.3m `4.4bn/US$97m 33.2m 54.2% 45.8% 15.4% 25.3% 13.5%
Key financials
Year Ending 31 Mar FY09 FY10 FY11e FY12e FY13e

11,633 (648) (24) 1.7 (28.4) (6.0) 191.8 12,326 1,227 43 3.1 1.2 45.2 19.9 3.7 161.0 16,853 1,161 34 (22.4) 4.0 0.8 26.7 14.9 3.7 74.7 19,030 1,541 45 32.7 3.0 0.7 25.2 16.8 3.7 47.0 20,443 1,764 51 14.5 2.6 0.6 23.3 17.3 3.7 21.6
Source: Bloomberg
260 240 220 200 180 160 140 120 100 Feb-10 Oct-10 Apr-10 Aug-10 Jun-10
Sensex
PHCB
Dec-10
Feb-11
22 February 2011
Phillips Carbon Black Powering ahead; maintain Buy

Fig 4 EV/sales Band

16,853 37 14,669 2,184 16 13 333 411 108 387 1,161 (5) 34 41 5 19,030 13 16,359 2,671 22 14 294 448 98 487 1,541 33 45 53 5 20,443 7 17,506 2,937 10 14 243 491 118 557 1,764 14 51 60 5
(`m) 18,000
16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 Nov-02 Dec-06 Aug-04 Nov-09 Sep-08 Feb-08 Apr-02 Oct-05 Apr-09 Jun-10 Jun-03 Jan-04 Mar-05 May-06 Jan-11 Jul-07 0 0.4x PCB 0.6x 1.0x 0.8x
Net sales Sales growth (%) - Op. expenses EBITDA EBITDA growth (%) EBITDA margins (%) - Interest - Depreciation + Other income - Tax PAT PAT growth (%) FDEPS (`/share) CEPS (`/share) DPS (`/share)
11,633 13 12,279 (646) (6) 294 196 163 (325) (648) (24) (28) -
12,326 6 10,447 1,879 15 289 312 28 79 1,227 43 52 5


283 2,962 3,244 5555 96 8,895 6,855 378 1,332 330 8,895 28.3 161.0 18.1 345 5,096 5,441 4755 96 10,291 6,971 378 2,255 688 10,291 34.5 74.7 38.8 345 6,435 6,780 4055 96 10,931 7,323 378 2,361 869 10,931 34.5 47.0 44.3 345 7,998 8,343 3355 96 11,794 7,332 378 2,535 1,550 11,794 34.5 21.6 43.7
450 400 350 300 250 200 150 100 50 0 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 0.5x 1.0x PCB 2.0x 1.5x
Share capital Reserves & surplus Shareholders fund Debt Deferred Tax/ others Capital employed Fixed assets Investments Working capital Cash Capital deployed No. of shares (m) Net Debt/Equity (%) W C turn (days)
283 1,899 2,182 4256 10 6,447 6,107 378 (109) 71 6,447 28.3 191.8 21.7

Fig 6 PCBL vs. Auto index

1,161 411 1,572 (923) 649 527 122 201.6 1,237 (800) 0 (0) 358 330 688 1,541 448 1,989 (106) 1,883 800 1083 201.6 (700) 181 688 869 1,764 491 2,255 (127) 2,128 500 1628 201.6 (700) (45) 681 869 1,550
300 280 260 240 220 200 180 160 140 120 100 Aug-10 Jun-10 Oct-10 Dec-10 Feb-10 Apr-10 Feb-11 PHCB BSE Auto
Reported PAT + Depreciation Cash profit - (Incr)/Decr in WC Operating cash flow - Capex Free cash flow - Dividend + Equity raised + Debt raised - Investments - Misc. items Net cash flow + Opening cash Closing cash
(648) 196 (452) 1,793 1,341 2424 (1,083) 117.2 402 1,327 14 (1,377) (99) 151 71
1,227 312 1,538 (1,092) 446 939 (493) 0.4 1,311 (69) 922 437 71 330
Source: Bloomberg
170
22 February 2011

We maintain our Buy recommendation on Phillips Carbon Black, the leader in carbon black production. We revise our target price to `246 and re-iterate our bullish stance, given the companys capacity expansion and growing high-margin power division. We estimate PCB to register a 23% net profit CAGR over FY11-13e. Benefiting from mounting demand Being the market leader, PCB enjoys economies of scale In step with the buoyant demand for automobiles, demand for tyres is set to continue rising. Economies of scale would allow PCB to benefit from the upswing in the tyre sector. To retain its dominance in carbon black production and to benefit from rising demand globally and domestically, PCB is further expanding capacity.
Fig 7 Domestic ranking (FY10)
Players Capacity '000 tons Production '000 tons Production share % Exports '000 tons
PCBL Hi-Tech Continental Himadri Chemicals Cabot Total
360 230 65 50 52 757.0
258.4 233.4 55 26 44 617.2
42 38 9 4 7 100.0
41 43 0 0 84
Source: Industry, Company, Anand Rathi Research
Note: The Himadri plant commenced in the Jul 09 quarter
Capacity expansion to fuel volume growth PCBs 360,000-tpa carbon black capacity is running at 90%, and another 50,000tpa would be operational by FY12. Given the buoyant demand, the capacity expansion is suitably timed.
Fig 8 PCBL: Production and utilization trend
(MT) 450,000 (%) 95
400,000 350,000 300,000
91 87 83
250,000 200,000 150,000 100,000 FY06 FY07 FY08 Capacity FY09 FY10 FY11e FY12e FY13e 79 75 71
Production
Utilisation (RHS)
Power reduces commodity risks PCB plans to set up two more power plants of 16MW (total) by 2QFY12 Utilizing waste heat, PCB generates 60.5MW, of which 10.5MW is used internally and the rest sold to exchanges/traders at ~`3/unit. It plans to set up two more power plants by 2QFY12, of total capacity of 16MW. Given that the division generates margins as high as 80% (with negligible costs), we expect such expansion to be earnings-accretive.
171
22 February 2011
Change in Estimates and Valuation On interaction with the management, we have trimmed our EBITDA estimates for FY11 and FY12 by 3.5% and 5.7% respectively, to factor in the increase in costs. We have also reduced our power tariff (`3.2/unit in FY11 and `3.5 from FY12). We lower our target price to `246 from `261 earlier.
(`m) Previous FY11e Revised % Chg Previous FY12e Revised % Chg
Net Sales EBITDA EBITDA Margins (%) Depreciation Interest Other income Tax PAT FDEPS (`)
16,933 2,264 13.4 411 333 108 407 1,221 35
16,853 2,184 13.0 411 333 108 387 1,161 34
(0.5) (3.5) (41.0)bp (0.0) (4.9) (4.9) (4.9)
18,312 2,832 15 448 294 98 525 1,663 48
19,030 2,671 14 448 294 98 487 1,541 45
3.9 (5.7) (143)bp (0.0) (7.4) (7.4) (7.4)
During 9MFY11, PCBs domestic volumes grew 12.7%. At our target of `246, the stock would trade at FY12e PE of 5.6x and EV/EBITDA of 4x. We value PCB at target multiple of 1.25x one-year-forward P/BV, in line with the past four-year average. At the current market price of `134, the stock trades at FY11e and FY12e PE of 4x and 3x and an EV/EBITDA of 3.5x and 2.9x respectively.
Fig 10 Twelve-month forward P/BV: Mean and standard deviations
4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 -1SD -2SD Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10
+2SD +1SD Mean
Risks
Volatility in key raw material prices. PCB imports most of its key raw material (carbon black feed-stock, CBFS) requirement. Prices of CBFS strongly co-relate with those of crude. Though a pricing mechanism is in place, any sharp increase in CBFS would affect PCBs margin if not passed on to end-customers. Capacity utilization. PCBs greenfield 90,000tpa plant at Mundra has commenced production. If unable to optimally utilize capacity, profitability would be substantially affected. Forex fluctuation. PCB imports ~90% of its raw material; hence, any depreciation in exchange rates may squeeze margins.
172
22 February 2011
To benefit from strong industry outlook

In step with the buoyant demand for automobiles, demand for tyres is set to continue rising. Its economies of scale would allow PCB to benefit from the upswing in the tyre sector. To retain its dominance in carbon black production and benefit from rising demand globally and domestically, the company is further expanding capacity. Carbon black is ~25% (by weight) and 16% (by value) of the raw materials used in manufacturing automobile tyres Through FY04-08, the domestic carbon black sector saw a 5% CAGR in capacities added. Yet by FY07, the industry was flooded with excess demand; hence, major players planned capacity expansions. Over FY09-12, capacity additions are expected at ~10.8%. Of all domestic players, only PCB has planned expansions, 50,000tpa at Mundra, to commence in 3-4 months. On the other hand, in Jun10, Cabot India closed its 50,000tpa Thane plant. Setting up a carbon black plant involves a gestation period of 18-24 months. Hence, overall effective capacity addition in the next two years would be only 85,000tpa. The domestic automobile industry is expected to post a 13.7% volume CAGR over FY11-13e following the 25% growth in FY10 and FY11. Based on this, we estimate the carbon black sector to again see 90% capacity utilization by FY13. Further, the domestic carbon black sector would export the surplus to neighboring countries, at a 26% CAGR over FY10-12e. Growth in carbon black production has followed the trend in tyres and automobiles. Rise in tyre offtake to propel carbon-black growth The buoyant domestic automobile sector has triggered off capex programs, both greenfield and brownfield, in the tyre sector (the principal consumer of carbon black). Most tyre companies are expected to commence production at their greenfield units in the next three years. Planned capex by tyre companies is `110bn-120bn. Further, expansions in the AsiaPacific region would trigger demand for carbon black, both in the OEM and replacement markets.
PCBs fortunes are directly linked to growth in the auto sector domestically. Automobiles have seen a quick recovery in demand. We expect a 13.7% CAGR in auto sales in the next two years
173
22 February 2011
Capacity expansion likely to fuel volume growth

PCB, the domestic market leader in carbon black, would be a key beneficiary of the revival in tyre sales in India. Its 360,000tpa carbon black capacity is running at 90%. The Mundra plant is being expanded by 50,000 tons, scheduled to be operational by end1QFY12. Given the better demand scenario, this capacity addition is opportune. We expect PCBs carbon black sales volumes to grow 25.4% in FY11 and another 9% in FY12. We believe the expansion would further strengthen its dominance.
Fig 11 Quarterly carbon-black volumes
('000 tons) 90 Improving trend 80 70 60 50 40 30 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 FY07 FY08 FY09 FY10 FY11 60 60 63 63 60 63 65 67 62 61 58 48 44 61 58 69 75 75 81
Source: Company
Expansion boosts volumes; focus on gaining strong global foothold We expect an 8-9% demand CAGR over FY11-13 in the domestic carbon black sector, based on demand increasing in OEM and replacement markets. To address this, PCB embarked on aggressive capacity expansion. In Oct 09, it commissioned phase-1 of its 90,000-tpa greenfield Mundra plant, boosting carbon-black capacity to 360,000tpa. It is further expanding capacity at Mundra by 50,000 tons, to be commissioned by end-1QFY12. PCBs 50,000-ton expansion at Mundra is likely to be commissioned by end 1QFY12and would raise plant capacity to 410,000 tons The capacity addition would enhance economies of scale and bolster sales (by volume) by 25.4% in FY11e and a further 9% in FY12e. Moreover, with carbon black plants shifting from developed to developing countries, the export potential has substantially risen. On expansion, PCB would be able to fortify its global footprint by leveraging its established brand and leading position vs. earlier being largely restricted to its home market. Revenue from the expansions would start flowing in from FY12. PCB has already incurred capex of `1.8bn on phase-1 of the Mundra capacity augmentation; the next 50,000 tons would entail `750m-800m, funded by debt-equity of 2:1. Capacity addition at Mundra to boost export volume PCBs new 90,000-tpa carbon black plant, which commenced in FY10, has arrested the volume decline in carbon black exports, which was due to rising domestic demand and capacity constraints. With the Mundra capacity addition, we expect exports to rise to 22% (as percent of sales) in FY11e and ~31% in FY12e (from 16% in FY10).
174
22 February 2011
Fig 12 Exports (as percent of volumes)

(%) 38 34 30 26 22 18 14 Export Volumes
FY07
FY08
FY09
FY10
FY11e
FY12e
Export Volumes
Carbon black exports (by volume) have improved manifold (Fig 22). In 1HFY10, exports were only 10,200 tons. On the commissioning of the Mundra plant in 2HFY10, exports more than tripled to 30,947 tons and have shown a positive trend after four consecutive quarters of volume declines. Now, quarterly exports have moved to the 17-18,000tpa range.
Fig 13 Pick-up in exports on commissioning of Mundra plant
('000 tons) 25 20 16 15 10 5 0 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 FY07 FY08 FY09 FY10 FY11 16 17 17 15 14 15 12 10 5 5 16 15 23 19 17 14
Exports show a positive trend after four consecutive quarters of volume declines
Source: Company
Fig 14 Proposed carbon-black capacity expansion

Current capacity Location Carbon Black (tons/annum) Commencement
Durgapur Baroda Kochi Mundra Total Expansion Mundra Domestic capacity after expansions Vietnam International (phase-1)
140,000 90,000 40,000 90,000 360,000 50,000 410,000 55,000 (not factored in calculations) June11
FY13e
175
22 February 2011
Power reduces commodity risk

PCB generates 60.5MW (via waste-heat recovery), of which 10.5MW is utilized in house with the rest sold to exchanges at ~`3/unit. It plans to set up two more plants of 16MW (total) by 2QFY12. We expect such expansions to be earnings-accretive, given that the division generates margins as high as 80%. PCB has considerably reduced power costs by converting waste gases released during carbon-black production into steam (used as fuel) against releasing/flaring such hazardous gases. Its power generation capacity is now 60.5MW. Of this, 10.5MW is utilized in-house and the rest sold to exchanges. Production cost for PCB is only `0.3/unit (mainly for O&M; no raw material costs). It plans to set up two more power plants: 6MW at Mundra (to be operational by 2QFY12) and 10MW at Kochi (to be operational from 1QFY12). The expansions would boost capacity to 74MW. Of this, it is likely to sell 53MW and 58MW in FY12 and FY13 at ~`3.5/unit respectively. PCBs further forward integration into power would expand its margins, mainly from revenue in power percolating to the net profit, leading to a ~80% EBIT margin, given that there are no raw material costs. Hence, besides stabilizing earnings, the sale of power would shore up margins. Not merely into commodities; Power to drive profitability, reduce volatility PCB is no more only a carbon-black (commodities) story. It is also a play on Power, which would drive profitability. Over the years, it has improved its performance. Price volatility in CBFS as well as slow off-take of carbon black (with the auto sector slowing down, compounded by global dumping of carbon black in India) hit earnings in 2HFY09. Hence, it has prudently shifted focus to power. With additional power capacity coming up, its earnings potential has improved as the share of power in EBIT is likely to rise, from 27% in FY10 to 36% in FY12e. During 2QFY11 and 3QFY11, its revenue from power declined as realizations from exchanges were low, at `2.5/unit. In 4QFY11, though, we expect it to be `3/unit and, from FY12, we expect realizations to improve further to `3.5/unit as the company is looking at entering into a short-term PPA.
PCB is setting up two more power plants:6MW at Mundra (to be operational by 2QFY12) and 10MW at Kochi (to be operational from 1QFY12), taking its power capacity to 74MW
176
22 February 2011
Financials
PCBs capacity expansion in carbon black coupled with rising demand offers assurance of decent revenue in the next two years. We expect it to register revenue and net profit CAGRs of 10% and 23% over FY11-13e. Revenue CAGR of 10% over FY11-13e With the carbon black capacity expansions and rising demand from the auto industry, we expect robust revenue growth in PCB, underpinned chiefly by 7% volume CAGR through FY11-13e to 366,536 tons. The utilization level is likely to improve to 90% in FY13e from an estimated 72% in FY10. We expect a 10% revenue CAGR over FY11-13e. We believe the revenue mix would be tilted towards carbon black, but in the next two years the share from Power could inch up to 7-8% of sales.
(Rsm) 22,000 20,000 18,000 16,000 (%) 40 35 30 25 20 15 10 5 0 FY07 FY08 FY09 FY10 FY11e FY12e FY13e
We expect a 10% revenue CAGR over FY11-13e
14,000 12,000 10,000 8,000 6,000
Revenue
Revenue growth (RHS)
Fig 16 Revenue breakup (FY10)

Power 4%
Fig 17 PBIT breakup (FY10)
Power 27%
Carbon black 73%
Carbon black 96%
Revenue from the high-margin power segment is set to grow exponentially, from `545m in FY10 to ~`1.4bn in FY13e as operations at Kochi and Mundra gather steam.
177
22 February 2011
Stable margins We expect the EBITDA margin over FY12-13e to be 14% With the contribution from Power, we expect a healthy EBITDA margin of 14% over FY12-13e.
(Rsm) 3,500 3,000 2,500 2,000 1,500 1,000 500 0 -500 -1,000 FY07 FY08 FY09 FY10 FY11e FY12e FY13e
FY11e
(%) 20 15 10 5 0 (5) (10)
EBITDA
EBITDA Margins (RHS)
Net profit CAGR of 23% expected over FY11-13e We expect PCB to report a 23% net profit CAGR over FY11-13e We expect PCB to report a 23% net profit CAGR over FY11-13e. Growth in net profit would be reflected in healthy return ratios. From negative return ratios in FY09, we expect the RoE in FY13 at a healthy 23.3%, with RoCE at 17.3%.

(Rsm) 2,000 1,500 1,000 5 500 0 0 -500 -1,000 FY07 FY08 FY09 FY10 FY11e FY12e FY13e (5) (10) (%) 15 10

(%) 50 40 30 20 10 0 (10) (20) (30) FY12e FY13e FY07 FY08 FY09 FY10 RoE RoCE
PAT
PAT Margin (RHS)
Comfortable balance sheet The high FY10 net debt-to-equity of 1.7x would fall to 0.9x in FY11. We expect the ratio to gradually slip to ~0.6x in FY12. As most of the capacity expansion is complete and funds for future expansion tied up, we expect debt to fall.
178
22 February 2011

(Days) 50 45 40 35 30 25 20 15 10 5 0 FY08 FY09 FY10 FY11e FY12e FY13e
Fig 22 Debt and net-debt-to-equity

(Rsm) 6,000 5,000 4,000 1.1x 3,000 0.8x 2,000 1,000 FY07 FY08 FY09 FY10e FY11e FY12e FY13e 0.5x 0.2x 2.0x 1.7x 1.4x
Debt
debt - to- equity ratio (RHS)
179
22 February 2011

Gross sales -Excise duty Net sales -COGS Gross profit -Operating costs Operating profit +Other recurring income -Depreciation/Amortisation -Interest expense PBT -Tax PAT +Share of profits in associates -Minority interests PAT +Extra-ordinary income/(expense) Net profit -Preference dividend -Dividend paid -Dividend tax Transferred to reserves
12,875.9 1,243.1 11,632.8 10,116.8 1,516.0 2,051.0 -534.9 51.9 196.4 293.6 -973.0 -324.6 -648.4 0.0 0.0 -648.4 0.0 -648.4 0.0 0.0 0.0 -648.4
13,380.7 1,118.0 12,325.7 9,058.9 3,266.8 1,388.3 1,878.5 28.2 311.5 289.4 1,305.8 78.9 1,226.9 0.0 0.0 1,226.9 0.0 1,226.9 0.0 141.3 23.5 1,062.2
18,631.4 1,778.1 16,853.3 11,891.4 4,961.9 2,777.8 2,184.1 108.4 411.1 332.8 1,548.6 387.1 1,161.4 0.0 0.0 1,161.4 0.0 1,161.4 0.0 172.3 29.3 959.8
21,009.8 1,980.0 19,029.9 13,251.6 5,778.2 3,107.4 2,670.8 98.4 447.9 294.0 2,027.4 486.6 1,540.8 0.0 0.0 1,540.8 0.0 1,540.8 0.0 172.3 29.3 1,339.2
22,557.6 2,114.8 20,442.9 14,177.1 6,265.7 3,328.9 2,936.9 118.1 490.6 243.2 2,321.1 557.1 1,764.1 0.0 0.0 1,764.1 0.0 1,764.1 0.0 172.3 29.3 1,562.5
Fig 24 Balance Sheet (`m)

Equity Reserves Deferred tax liability -Miscellaneous expenses Networth Working capital loans Long term debt Preference equity Total debt Minority interests Capital employed Gross block -Accumulated depreciation Net block +CWIP Fixed assets Subsidiary Strategic investments Financial investments Investments Debtors Inventory Loans & advances Other current assets -Creditors -Provisions -Other curent liabilities Working capital +Cash & cash equivalents Net current assets Capital deployed
283 1,900 17 7 2,192 130 4,126 4,256 6,447 4,405 2,125 2,280 3,828 6,107 375 3 378 1,808 1,210 365 478 3,917 53 (109) 71 (38) 6,447
283 2,962 96 3,340 595 4,959 5,555 8,895 8,279 2,348 5,932 923 6,855 375 3 378 2,950 1,966 1,328 166 4,876 202 1,332 330 1,662 8,895
345 5,096 96 5,536 595 4,159 4,755 10,291 9,029 2,759 6,271 700 6,971 375 3 378 3,694 2,255 531 600 4,570 202 53 2,255 688 2,943 10,291
345 6,435 96 6,876 595 3,459 4,055 10,931 9,829 3,206 6,623 700 7,323 375 3 378 3,910 2,364 626 782 5,065 202 53 2,361 869 3,230 10,931
345 7,998 96 8,438 595 2,759 3,355 11,793 10,829 3,697 7,132 200 7,332 375 3 378 4,201 2,526 672 840 5,449 202 53 2,535 1,550 4,085 11,793
180
22 February 2011

(648) 196 (336) (788) (1,600) 812 2,550 (1,738) 402 1,351 97 (2) (79) 151 72
1,227 312 79 1,617 1,441 176 1,059 (882) 165 1 1,299 0 (7) 259 72 331
1,161 411 1,572 923 649 527 122 202 1,236 (800) (0) 357 331 688
1,541 448 1,989 106 1,883 800 1,083 202 (0) (700) 181 688 869
1,764 491 2,255 173 2,081 500 1,581 202 0 (700) 680 869 1,550
Fig 26 Ratio @`134

(24) (28) 77 (4.8) (13.6) 0.8 1.7 (28) (6) 62 43 130 22 2.4 1.9
43 52 115 5 3.1 2.6 5.2 0.8 1.2 3.7 45 20 70 47 185 18 1.9 1.7
34 41 (22.4) 158 5 4.0 3.3 4.0 0.5 0.8 3.7 27 15 72 46 157 39 2.4 0.9
45 53 32.7 197 5 3.0 2.5 2.9 0.4 0.7 3.7 25 17 73 44 143 44 2.7 0.6
51 60 14.5 242 5 2.6 2.2 2.2 0.3 0.6 3.7 23 17 72 44 146 44 2.8 0.4
181
Appendix 1
Analyst Certification The views expressed in this research report accurately reflect the personal views of the analyst(s) about the subject securities or issuers and no part of the compensation of the research analyst(s) was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst(s) in this report. The research analysts, strategists, or research associates principally responsible for the preparation of Anand Rathi Research have received compensation based upon various factors, including quality of research, investor client feedback, stock picking, competitive factors, firm revenues and overall investment banking revenues. Anand Rathi Ratings Definitions Analysts ratings and the corresponding expected returns take into account our definitions of Large Caps (>US$1bn) and Mid/Small Caps (<US$1bn) as described in the Ratings Table below. Ratings Guide Large Caps (>US$1bn) Mid/Small Caps (<US$1bn) Buy >20% >30% Hold 5-20% 10-30% Sell <5% <10%
Anand Rathi Research Ratings Distribution (as of 6 December 10) Buy Anand Rathi Research stock coverage (138) 69% % who are investment banking clients 5%
Hold 17% 4%
Sell 14% 0%
Other Disclosures This report has been issued by Anand Rathi Financial Services Limited (ARFSL), which is regulated by SEBI. The information herein was obtained from various sources; we do not guarantee its accuracy or completeness. Neither the information nor any opinion expressed constitutes an offer, or an invitation to make an offer, to buy or sell any securities or any options, futures or other derivatives related to such securities ("related investments"). ARFSL and its affiliates may trade for their own accounts as market maker / jobber and/or arbitrageur in any securities of this issuer(s) or in related investments, and may be on the opposite side of public orders. ARFSL, its affiliates, directors, officers, and employees may have a long or short position in any securities of this issuer(s) or in related investments. ARFSL or its affiliates may from time to time perform investment banking or other services for, or solicit investment banking or other business from, any entity mentioned in this report. This research report is prepared for private circulation. It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Investors should note that income from such securities, if any, may fluctuate and that each security's price or value may rise or fall. Past performance is not necessarily a guide to future performance. Foreign currency rates of exchange may adversely affect the value, price or income of any security or related investment mentioned in this report. This document is intended only for professional investors as defined under the relevant laws of Hong Kong and is not intended for the public in Hong Kong. The contents of this document have not been reviewed by any regulatory authority in Hong Kong. No action has been taken in Hong Kong to permit the distribution of this document. This document is distributed on a confidential basis. This document may not be reproduced in any form or transmitted to any person other than the person to whom it is addressed. If this report is made available in Hong Kong by, or on behalf of, Anand Rathi Financial Services (HK) Limited., it is attributable to Anand Rathi Financial Services (HK) Limited., Unit 1211, Bank of America Tower, 12 Harcourt Road, Central, Hong Kong. Anand Rathi Financial Services (HK) Limited. is regulated by the Hong Kong Securities and Futures Commission. Anand Rathi Financial Services Limited and Anand Rathi Share & Stock Brokers Limited are members of The Stock Exchange, Mumbai, and the National Stock Exchange of India. 2010 Anand Rathi Financial Services Limited. All rights reserved. This report or any portion hereof may not be reprinted, sold or redistributed without the written consent of Anand Rathi Financial Services Limited. Additional information on recommended securities/instruments is available on request.

AND Feb 22 2011 16 25 19

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

AND Feb 22 2011 16 25 19

Uploaded by

Copyright:

Available Formats

India I Equities

Auto Components Sector Report

India Auto Components

Overweight Nifty/Sensex: 5459 / 18212

Auto Components Sector Report

India Auto Components

Overweight Nifty/Sensex: 5459 / 18212

Auto sector vs Sensex

150 140 130 120 110 100 90

Valuation matrix - India auto components

Buy 71 103 113.8 26.4 6.2 3.3 23.5 23.2 1.1

Buy 42 62 71.1 41.8 7.5 3.5 20.6 20.2 0.5

Buy 65 137 133.2 239.6 11.8 4.2 6.0 8.5 2.0

Buy 46 68 97.1 18.7 7.3 4.0 23.4 27.6 0.8

45.8 29.3 5.8 3.5 33.1 25.0 0.7

Source: Company, Anand Rathi Research;

Note: Ratios are based upon FY12e earnings, * consolidated

Prices as on 18 February 2011

Buy 117 182

India Auto Components Overseas sales Paving growth

India Auto Components

Overseas sales to strengthen .......................................................7

Steady domestic growth..............................................................11

Company Profiles ........................................................................16

Anand Rathi Research

India Auto Components Overseas sales Paving growth

Investment Argument and Valuation

Overseas sales to strengthen

Note: on a scale of 1 to 100;m

Steady domestic auto growth

Anand Rathi Research

India Auto Components Overseas sales Paving growth

Fig 2 Auto sector: volume CAGR over FY02-11

Improved efficiencies, diversification

Anand Rathi Research

India Auto Components Overseas sales Paving growth

Fig 3 Improvement in companies RoE (FY09-13e)

Balkrishna Inds Motherson Sumi*

Bharat Forge* NRB Bearings*

Source: Company, Anand Rathi Research, Note: * consolidated

Anand Rathi Research

India Auto Components Overseas sales Paving growth

Fig 4 Auto component sector: Valuation matrix

Buy 71 103 113.8 26.4 6.2 3.3 23.5 23.2 1.1

Buy 42 62 71.1 41.8 7.5 3.5 20.6 20.2 0.5

Buy 65 137 133.2 239.6 11.8 4.2 6.0 8.5 2.0

Buy 46 68 97.1 18.7 7.3 4.0 23.4 27.6 0.8

Prices as on 18 February 2011

Anand Rathi Research

India Auto Components Overseas sales Paving growth

Overseas sales to strengthen

Fig 5 CSM global light vehicle production summary

18,732 14,791 13,162 2,105 11,943 4,140 6,709 71,582

19,042 16,268 12,793 2,159 12,944 4,376 7,653 75,237

19,715 18,139 13,524 2,406 13,919 4,623 8,614 80,940

20,776 19,689 13,965 2,334 14,743 5,055 9,525 86,087

21,956 20,997 13,966 2,409 15,493 5,332 10,129 90,280

22,753 22,003 14,180 2,486 16,078 5,595 10,802 93,897

23,334 22,919 14,181 2,573 16,147 5,786 11,515 96,453

23,867 23,775 14,046 2,665 16,265 6,006 12,101 98,725

3.5 10.0 2.0 3.5 7.3 6.9 12.4 6.3

2.9 6.6 3.0 2.6 4.4 4.9 7.6 4.6