Bharat Gears Ltd LKP Small Cap Pick

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					     Jan 20, 2012
                                                                                                                                                                            Bharat Gears Ltd.
     Bharat Gears Ltd.
     Industry: Auto Ancillaries                         View : Positive                                                                          Small Cap Pick
    “ Gearing up for the big leap”
Investment Rationale                                                          Stock Data
                                                                              Current Market Price (`)                                                                                                                     50
   Bharat Gears Ltd (BGL) is India”s largest non OEM producer of Crown Target Price (`)                                                                                                                              125
    Wheel Pinion – CWP gears or bevel gears manufactured using Gleason & Potential upside (%)                                                                                                      150
    Oerlilon systems. It has a dominant position in the domestic CWP gears in BSE Code                                                                                                         505688
    the after market for ring gears and pinions. The After Market segment Auditors                                                                                             Deloitte Haskins & Sells
    accounts for about 20% of its revenues.                                      Key Data
                                                                                 Market Cap (`mn )                                                                                                                     400
   The `4bn BGL is a leading player in the Tractor gear segment and this
                                                                                 52-Week Range (`)                                                                                                                   82 /39
    segment accounts for about 50% of its revenues.                              Dividend Yield                                                                                                                         3%
   BGL with two manufacturing facilities (Mumbai & Delhi) is now putting up its Promoters – Dr. Raunaq Singh (%)                                                                                                        50
    third facility at Satara in Maharashtra and shall be spending `650mn in 3 Public & Others Holding (%)                                                                                                                50
    phases financed through debt and internal accruals.
                                                                             Fiscal Year Ended
   BGL‟s main customers are original equipment manufacturers (OEMs) in the  Y/E March                                             FY10                     FY11                        FY12E                   FY13E
    tractor and commercial vehicle (CV) industry. The surge in the volume    Net sales (`mn)                                     2,499.7                  3,305.1                      4,150.4                  5,250.4
    growth for these OEMs would derive demand growth for BGL‟s products.     EBITDA (`mn)                                          272.6                    321.2                        399.0                    516.7
    BGL has marquee customers which include Tata Motors, Mahindra, Ashok     PAT (` mn)                                             61.4                     97.2                        120.0                    181.1
    Leyland, TAFE, Escorts, VST Tillers Tractors, John Deere, New Holland    EPS (`)                                                 6.2                     11.0                         13.5                     20.4
    Tractors, Carraro India, JCB among others.                               P/E (x)                                                 8.1                      4.6                          3.7                      2.4
                                                                             P/BV (x)                                                0.9                      0.7                          0.6                      0.5
   Shifting from diesel to PNG at its Faridabad unit and converting furnace EV/EBITDA (x)                                           3.1                      2.8                          2.5                      1.9
    based on Propane to PNG would in our view reduce power cost next fiscal ROCE (%)                                                18.6                     19.4                         21.8                     25.6
    and improve margins.                                                     ROE (%)                                                11.8                     16.4                         17.3                     21.1

                                                                                           Relative Price Performance
The `4bn BGL is the largest independent gear producer in India and its present             150
market capitalisation of `400mn is less than even the market value of spare
land at its Mumbai facility.                                                               100
                                                                                                  22,000                                                                                                             270
BGL spent over `500mn during the past three years to increase capacities and                 50                                                                                                                      220
upgrade technology and this was funded largely through cash accruals of                           20,000
`450mn over this period.                                                                       0 18,000







A dominant player like BGL in a business which is both capital intensive and                      16,000                                                                                                             70
working capital intensive trades at 0.6x book and we believe that with ROCE of
over 20% and compelling valuations makes it an excellent small cap pick with
                                                                                                                                                BGL                  Nifty
an 18 month target price of `125.
                                                                                                                                                Sensex                      VGIL
                                                                                          One Year Indexed
                                                                                          (%)                                           1 Month                         3 Months                           6 Months

                                                                                          BGL                                                  20.9                          4.9                            (18.4)

                                                                                          Nifty                                                7.0                           (1.8)                              4.2

     S.Ranganathan                   Kunal Bothra                         The information in this document has been printed on the basis of publicly available information, internal data                     and other reliable sources believed to be true and are for general guidance only. While every effort is made to
                                                                          ensure the accuracy and completeness of information contained, the company makes no guarantee and
     +91 22 6635 1270                +91 22 6635 1213                     assumes no liability for any errors or omissions of the information. No one can use the information as the basis
                                                                          for any claim, demand or cause of action. LKP Securities Ltd., and affiliates, including the analyst who have
                                                                          issued this report, may, on the date of this report, and from time to time, have long or short positions in, and buy
                                                                          or sell the securities of the companies mentioned herein or engage in any other transaction involving such
                                                                          securities and earn brokerage or compensation or act as advisor or have other potential conflict of interest with
      LKP Advisory                                                        respect to company/ies mentioned herein or inconsistent with any recommendation and related information and                                1
                                                                          opinions. LKP Securities Ltd., and affiliates may seek to provide or have engaged in providing corporate finance,
                                                                          investment banking or other advisory services in a merger or specific transaction to the companies referred to in
                                                                          this report, as on the date of this report or in the past.
                                                                                                                                                      Bharat Gears Ltd.

  Strong Q2FY12 net earnings powered by higher net sales

  During the second quarter ended September 2011, the net profit of BGL stood at `24.8 million, registering an impressive growth of 57.0%
  on yoy basis, respectively. The robust bottom-line of the company is mainly fuelled by the significant growth of 25.4% (yoy) in the net
  sales of BGL at `982.0 million as compared to `782.9 million in Q2‟FY11. Total income from operations during the quarter increased
  27.2% to `1,008.3 million, which included other operating income of `26.3 million. Further, operating margins of the company improved
  during the quarter to 9.3% from 8.6% in the corresponding quarter of the previous year as operating profit rises to `93.5 million from `68.2
  million. Further, interest expenses and depreciation cost appreciated to `30.5 million and `25.9 million from `22.7 million and `21.6 million
  in the corresponding quarter ended September 2010. The Net profit margins of the company stood at 2.45%, resulting into an increase of
  45bps, as against 1.99% in the corresponding period of the last fiscal year. BGL also enhances focus to reduce cost by converting the
  energy source for power in Faridabad from Diesel to Piped Natural Gas (PNG). The company is also in the process of converting its
  furnaces from being based on Propane to the lower cost PNG. While, some of the benefits would be evident this fiscal, we believe the real
  savings will kick in during the next financial year.

                                                    Consistent increase in top-line and EBITDA

            1200                                                        14                 120                                                                                    14

                                                                        12                                                                                                        12
            1000                                                                           100
                                        13.3                                                                            11.8
                                                                        10                                                                                                        10
             800                                                                               80
                                                                                                                                        9.3                         9.3
` million

                                                                        8                                                                                                         8
                               8.4                                                                                                                     8.4
             600                                                                               60
                                                               1.9                                         8.6
                                                                        6                                                                                                         6

             400                                     1.7                                       40
                                                                        4                                                                                                         4

             200                                                                               20
                                                                        2                                                                                                         2

               0                                                        0                      0                                                                                  0
                   Q2'FY11   Q3'FY11   Q4'FY11    Q1'FY12     Q2'FY12                                 Q2'FY11       Q3'FY11           Q4'FY11        Q1'FY12    Q2'FY12
                                                                                                                   EBIDTA                EBIDTA Margin (%)
                             Sales               Growth (%)

      Improving Capacity Utilization                                                                        Capacity Utilization Rate (in %)

      The capacity utilization level for automotive gear manufacturing has       100
      been remained in the trajectory of 75-80%. For FY‟11 BGL has                                                                                           90.5          90.5
                                                                                   90                               89.4
      achieved capacity utilization of over 80% and aims to achieve over
      90% in FY‟12E, which is the most efficient level of capacity utilization                         73.9                                             82.2
                                                                                   70                                                         75.7
      rate for any player in the gear manufacturing business.                                                                  72.6
      The company is holding a robust order backlog for FY‟12E and                 50
      based on strong estimated automotive growth, the management is               40
      confident to achieve over 90% of utilization rate.                           30
                                                                                                    FY07         FY08    FY09          FY10      FY11        FY12E        FY13E

 LKP Advisory                                                                                                                                                                     2
                                                                                                                  Bharat Gears Ltd.
Leading Gear supplier to automobile industry

Bharat Gears is the leading Gear manufacturer in India. BGL supplies gears to major OEMs in India and Overseas for different
automobile industry, like, Heavy, Medium & Light Trucks, Utility Vehicles, Tractors & Off Highway. The company‟s strength encompasses
world class quality, excellence in customer responsiveness right from metallurgical quality control of basic steel to precision of gear
cutting, HT and post HT operation along with state of art machinery.

It supplies a wide array of automotive parts which includes, Automotive Clutch and components, Turbo Chargers and components,
Driveline Products, Axle Shafts , Fly Wheel Assemblies & Rings, Propeller Shaft components, U-J Cross, Steering Components,
Differential Cages and Steel Wheel Rims.

                                                   BGL’s Business Divisions

                              Gears                                                          Furnaces

      Ring Gears and                 Differential Gears                 Sealed Quench                       Other Heat Treating
          Pinions                                                       Furnace Lines                          Equipments

      Transmission Gears &                     Gear Boxes                               Pusher Continuous Gas
             Shafts                                                                       Carburising Lines

                                                                                        Pusher Continuous Gas
                                                                                          Carburising Lines
Continuous technological up-gradation support growth                   BGL enjoys a marquee customer profile
                                                                                       Pusher Continuous Gas
The company has adopted „dry cutting‟ technology for transmission      BGL has a strong clientele across all its verticals. Leading OEM‟s
                                                                                          Carburising Lines
gears and „state of the art‟ measuring equipment and blade             like TATA Motors Ltd. (TML), New Holland Tractors, John Deere
grinding machines for Bevel gears. Further, In FY11, it added          Equipment Pvt. Ltd. (JDEPL), VST Tractors (Mitsubishi), Carraro,
machines to upgrade technology.                                        John Deere Coffeyville Works (JDCW), Ashok Leyland, Mahindra,
BGL has foreign technical collaborations and licensing agreements      TAFE, Escorts, JCB and Tier I companies like Dana Corporation in
with world leaders in the respective product groups which ensure       USA, and several others source their complex gears and furnaces
manufacture of premium quality products. It entered into the           requirements from Bharat Gears.
technical knowhow with Holcroft, Michigan, U.S.A. for
manufacturing Furnaces and collaboration with ZF Friedrichshafen,      Various foreign technological collaborations helped the company to
AG, Germany, for manufacturing Gear Boxes.                             maintain a strong reputation regarding quality and technology for
                                                                       their products and services.
The tie-ups enhance the competitive position of the company and it
enjoys a strong reputation regarding quality and technology for
their products and services.

LKP Advisory                                                                                                                        3
                                                                                                                Bharat Gears Ltd.
Augmenting demand for Gears                                         Garnered major market share in Tractor and Off-
                                                                    highway Industry
BGL‟s main customers are original equipment manufacturers
(OEMs) in the tractor and commercial vehicle (CV) industry.         BGL is largely serving to Tractor & Off highway vehicle industry,
Tractors contributes over 48% to its revenue, while CVs             which has managed to grow by more than 30% yoy in sales
contribution stood over 39% and the balance 13% from Utility        turnover. The tractor industry continued to grow at 24% during
vehicles (UV), construction equipments (CE) and others.             FY11. Further, non-agricultural use of tractors (for haulage in
                                                                    construction and infrastructure projects) continued to rise,
We believe that the facility in Mumbai has spare land which can     resulting in higher tractor demand. BGL has also tied up with
be monetized at an appropriate time and could fetch the             major off-highway vehicle manufacturers to supply transmission
company significant inflows which can potentially be higher than    parts in India & overseas which help in augmenting sales
its present market capitalization.                                  growth.

                                                   Tractors Production Trend







                FY06                FY07                FY08             FY09                FY10                 FY11

Capex lined up for Green field investment to enhance                Improving production mix to reduce earnings volatility
future growth
                                                                    BGL‟s earning is highly dependent on the tractor segment,
In view of higher demand from both Domestic and Overseas            contributing nearly 50% of the company‟s revenue and which in
customers, the company is setting up a green field unit at Satara   turn depends on the monsoon season. To reduce its dependency
in the state of Maharashtra. BGL would be spending `650mn in        on a particular segment, the company is streamlining its product
this facility which would be spent in three phases.                 mix. The revenue contribution from CV segment has increased to
                                                                    40% in FY‟11 from 30% in FY07. One of the reasons for the
The funding would be done through a mix of debt and internal        increase in the CV segment is the increase in the share of the
accruals as cash accruals permit the company to undertake this      aftermarket line of business (gear replacement market), which
expansion quite comfortably.                                        has increased from 17% in FY‟07 to 25% in FY‟11.

LKP Advisory                                                                                                                       4
                                                                                                                    Bharat Gears Ltd.

 Replacement Market holds promise
 The pick- up in the replacement market would also boost the sales of BGL, as extensive wear & tear in the CV require more frequent gear
 replacement with an average gear replacement period of 2-3 years. The replacement market for gears is a steady revenue unit for the
 company as it would not be affected by the cyclicality of the automotive Industry movement. The company has forayed into manufacturing
 gears for JCB and other OHV and is planning to gradually increase its revenue share in the UVs and CEs segment.

 Risks & Concern

  Any slowdown in the auto sector can impact the revenue growth going forward. Also, OEM‟s in the non tractor segment have in-house
   gear manufacturing facilities.

  BGL operates in a working capital intensive business and derives close to 30% of revenues from 2 clients – Carraro & John Deere

  Margins are susceptible to volatility in raw material prices as it accounts for more than 55% of its revenues and BGL has limited pricing
   flexibility as the OEMs have bargaining power.

  Business Overview:

  Established in 1971 by the late Dr Raunaq Singh, Bharat Gears Ltd (BGL) is India‟s largest independent gear manufacturer for the
  automotive sector producing a wide range of gears for tractors, commercial vehicles, buses and utility vehicles. BGL has a collaboration
  with ZF of Germany- world leaders in transmission technology.

  BGL has two manufacturing facilities – One in Shilphata in Mumbai and the other in Faridabad in Delhi with a total installed capacity of
  more than 5million gears per annum. Its product profile includes ring and spiral gears and pinions besides transmission and differential
  gears including shafts and gearboxes.

LKP Advisory                                                                                                                           5
                                                                                                                             Bharat Gears Ltd.

                                                    The Indian Auto Component Industry
The `10 billion Gear and gear box market of India is highly dependent on the automotive Industry, engineering Industry and machine tools
Industry for its production. Automotive sector is the largest consumer of gear and gear boxes, followed by the industrial sector. Traditionally it
was the European countries, North America, and some regions of Asia that lead the world gear market. But recently the focus has shifted to
previously unknown regions like China, India, and East Europe. Though gear manufacturing is a low margin in nature, it happens to be a
steady revenue generating business. Moreover, Indian gear manufacturers enjoy the 25-30% cost advantage over developed nations due to
availability of low cost skilled labour in these regions, which opens huge opportunities for the domestic manufacturers to ramp up its export
portfolio. The demand for reliable power, smaller sizes and more energy-efficient power transmission systems create several opportunities
for gear industry. Industrial gears are used in sectors ranging from sugar to steel to textiles, and the major demand driver for these gears is
huge capital expenditure in the industrialization of economy.

                     Turnover of the Auto Component Industry                                 Auto Component Industry- Product Range
                             CAGR 2007-11: 14.6%                                                 7%                                Engine Parts
         100.0               CAGR 2011-21 E*: 11%                                       9%
                                                                                                                           31%     Transmission &
              80.0                                                                10%                                              Steering Parts
 USD Billon

                                                                                                                                   Body & Chassis
                                                                                                                                   Suspension &
              40.0                                                                                                                 Braking Parts
                                                                                                                                   Electrical Parts
                     2007-08    2008-09   2009-10   2010-11 2015-16E* 2020-21E*         12%                                        Others
                     E*: Expected

Importance of Gears in Automotive Sector
Gear Manufacturing is a significant part of the auto component industry and hence is directly proportionate to the movement in the Auto
Industry. The Auto component sector comprises of varied segments like engine and engine parts, transmission and steering parts,
suspension and braking parts, equipments and others. Gears, wheels, steering systems, axles and clutches are important sub-segments of
the Transmission and Steering segment of the industry, which accounts for a 19% of the production in the auto component industry. Bharat
Gears, Gajra Bevel Gears and Eicher are some of the major players in the gears sub-segment. Two international companies, Graziano
Transmission and SlAP Gears India, have set up their base in India, intensifying the competition in the region. Gears play an important role
in gear boxes to control the speed of automobile and taking into consideration the criticality of its role, the automobile industry of India prefers
to import gear box technology in India, thereby opening ample technology sharing and up gradation opportunity for the domestic gear

Over the past 6 years, the auto component industry has registered a healthy revenue growth of 22% (CAGR) and is expected to grow by
over four-fold to US$ 113 billion by 2020. And considering the gear industry‟s dependency on the automotive industry, the former too is
expected to witness similar growth rate in the coming fiscals. Beside, with the Indian economy poised to grow at a rate of 9-10% in the
coming fiscals, the manufacturing base of India is likely to strengthen, which is likely to fuel huge demand for engineering components like
gear, gear box and allied products from diverse sectors various industries like textiles, steel, metal etc.

    LKP Advisory                                                                                                                                   6
                                                                                                                                    Bharat Gears Ltd.
                                                              Financial Summary

Balance Sheet                                                                Profit & Loss Account

 (` million)                      FY10A     FY11A     FY12E      FY13E           (`million)                  FY10A       FY11A        FY12E        FY13E

                                                                                 Net Sales                   2,499.7     3,305.1      4,150.4      5,250.4
 Share Capital                     99.0      88.6      88.6       88.6
                                                                                 Other Income                  4.6        49.6         49.6            49.6
 Reserve and surplus              422.7     502.3     604.6      767.9
                                                                                 Total Income                2,504.3     3,354.7      4,200.0      5,300.0

 Net Worth                        521.7     590.9     693.2      856.5
                                                                                 Expenses                    2,231.7     3,033.5      3,801.0      4,783.2

 Loan Funds                       414.3     581.4     644.3      679.8           EBITDA                      272.6        321.2       399.0        516.7

                                                                                 EBITDA Margin %              10.9            9.6       9.5            9.8
 Net Deferred Tax Liability        14.6      12.1      12.1       12.1

                                                                                 Depreciation                 95.5        90.9        105.0        120.0
 Capital Employed                 950.6     1,184.3   1,349.6    1,548.4
                                                                                 EBIT                        177.1        230.3       294.0        396.7

 Gross fixed assets               1,972.4   2,222.8   2,350.0    2,650.0
                                                                                 Interest                     85.7        84.6        112.2        122.4

 Less: accumulated depreciation   1,347.3   1,426.6   1,531.6    1,651.6         Profit Before Tax            91.4        145.6       181.8        274.3

                                                                                 Tax                          34.5        51.0         61.8            93.3
 Capital Work in Progress          20.3      71.9     100.0      150.0
                                                                                 Profit after Tax             56.9        94.6        120.0        181.1
 Net Fixed assets                 645.4     868.1     431.2      400.0
                                                                                 Adjustments                   4.5            2.6        -              -

 Net Current Assets               305.2     316.2     300.6      329.1
                                                                                 Reported Net Profit          61.4        97.2        120.0        181.1

 Capital Deployed                 950.6     1,184.3   1,349.6    1,548.4         NPM %                         2.5            2.9       2.9            3.4

 Key Ratios

                                                                      FY10A                          FY11A             FY12E                    FY13E

 EBITDA Margin (%)                                                       10.9                         9.6               9.5                      9.8

 NPM (%)                                                                   2.5                        2.9               2.9                      3.4

 ROCE (%)                                                                18.6                        19.4              21.8                     25.6

 ROE (%)                                                                 11.8                        16.4              17.3                     21.1

 EPS (`)                                                                   6.2                       11.0              13.5                     20.4

 P/E (x)                                                                   8.1                        4.6               3.7                      2.4

 BVPS (`)                                                                52.7                        66.7              78.2                     96.7

 P/BVPS (x)                                                                0.9                        0.7               0.6                      0.5

 EV/Operating Income(x)                                                    0.3                        0.3               0.2                      0.2

 EV/EBITDA (x)                                                             3.1                        2.8               2.5                      1.9

 EV/EBIT (x)                                                               4.7                        4.0               3.3                      2.5

LKP Advisory                                                                                                                                                  7
                                                            Bharat Gears Ltd.


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                             Mumbai-400 021.
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LKP Advisory                                                                8

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