Setco Automotive posted stellar performance for quarter as well as FY11 with a
consolidated turnover of Rs. 352.91 Cr. in FY11, a growth of 36% Y-o-Y. While the top-line grew by 61% Y-o-Y and 39% M-o-M to Rs. 107.7 Cr. in Q4FY11. This can be
partly attributed to the change in the emission norms that came into effect from 1st October 2010. Post the implementation there came a need for change in upgradation in transmission technology.
Investment Rationale:
Booming Demand in The Auto Sector: The Auto Industry has grown by ~25% in FY10 and ~27% in FY11. On the whole 17.3 million vehicles where sold in India in FY11 over 13.6 million vehicles in FY10. This shows the strong demand for vehicles in India. Going forward this demand is expected to continue (but the growth rate will
slow down due to a higher base) thus boosting higher demand for auto components.
Major OEMas as Clients: Setco Automotive has major OEMas in its long list of clients
which includes Tata Motors, Ashok Leyland, Asia Motor Works, Eicher, Komatsu, Man,
etc. for the Prima range of M&HCVas of Tata Motors Setco is the only supplier of clutches. The company is also working with Daimler for manufacturing and selling
clutches for Daimleras Indian operations.
Strong Consolidated Performance: The financial performance of the company has improved considerably. The top-line increased by 36% to Rs. 352.91 Cr. while the
profits of the company grew by 134% to Rs. 33.5 Cr. this is mainly due to the demand for advanced products that are compliant with BS-III norms. Also the UK
and US plant have achieved break even and will add to the companyas profitability going forward.
India to Attract Global CV players: India has caught the attention of the global CV players and all major players are either chalking out plans to enter the Indian CV
market or have already commenced Indian operations. To reduce operating costs companies generally tend to increase local content. Secto being the market leader
with almost 75% market share in the OEM segment will automatically get attentionfrom these global OEMas. this is likely to have a positive impact on the companyas
profitability
Valuation and Views: The demand from the automotive segment is likely to remain strong; both from the OEMas as well as from the replacement markets. Also with
development in road infrastructure in the country, CV sales are expected to pick-up.
With increase in number of players in the OEM segment, the demand for new technology in ancillary products is likely to increase. Looking at the business environment, the future looks positive for the company
**Shah Investors Home (SIHL)has recommendedBuyonSetco Automotive (Setco)**with a price target of Rs 249 as against the current market price (CMP) of Rs 206 in its report dated Apr. 13, 2012. The broking house gave the following rationale:
Setco Automotive (Setco) is a leading auto component company in India and among the top M&HCV clutch manufacturer in the world. We initiate Coverage on Setco (CMP Rs 20) with BUY recommendation with a target price of Rs 249; which is 21% upside from current levels and an investment horizon of 12 months. The stock at Rs.206 is currently trading at 8.8x FY13E EPS of Rs 23.2 and 7.9x FY14E EPS of Rs 26. Our target price is based on DCF analysis.
Setco`s unique business model, market leader in M&HCV OEM clutch segment, capacity expansion, robust distribution network in OES segment and divergence in new geographies and segment would lead to 20% CAGR growth in revenue from FY12-14E.
Udit H Sheth, ED & promoter of the Co. add.the call with others from the mgt.team.Highlights of the call by Capital Mkt;
Setco Automotive is the largest manufacturer of Premium Quality Lipe brand clutches for the commercial vehicles in India.It is a Tier I supplier of clutches to all the prominent Indian commercial vehicle manufacturers such as Tata Motors, Bharat Benz, Ashok Leyland, Man India, Volvo â Eicher Commercial Vehicles and Asia Motor Works amongst others.The company has almost 100% market share in most of its OEM customers.The company has strategic global footprint with 4 manufacturing facilities, 2 in India, and 1 each in UK and USA.While Setco's major manufacturing is in Kalol, Gujarat, it has a fast expanding facility in Sitarganj, Uttarakhand.
Setco has set up a state of art R&D centre at Kalol certified by Department of Scientific Industrial and Research, Government of India to design, develop and validate full clutches systems. It also has a research and development centre in UK.The company exports to 65 countries.In the last decade the company has taken large market share of CV clutches in India.The company designs its own clutches and is proprietary in nature.
Last year was a challenge for the company however the first two quarters of the current year the company is seeing tremendous response especially in After market (the company chartered into independent AM business with 42 distributors across India).OEM business stood at 52% of sales and it grew 40%.Export business stood at 9% of sales and it grew 40%.AM business stood at 52% of sales and it grew 70% (including independent AM business).20% of PAT is company's dividend policy.The company's competitors is Diakin, Japan.Clutches is changed in 1-3 years.
Earlier the company used to cater to only OES (original equipment spares) markets where clutches used to be changed in 1-3 years. But the company was losing on clients for replacement of longer term duration of 7 years and missing 3 clutch replacements. Independent AM segment caters to this segment.Also the spurious brands could not compete with the company and thus the company gained good business through Independent AM business.The company has almost 90% OE market share.Clutch auto's part in OE level has completely evaporated.The company just entered in LCV, market with 1 product.The company's focus is on the farm segment as replacement there is done after 3000 hours of usage.Car people do not change clutches very often and also the price is low.
Capex for next 2-3 years is Rs 75 crore only for the up gradation and modernization of existing line of business.In addition there is huge backward integration Rs 160 crore foundry project. It has technical collaboration and 20% equity participation with Japanese leading foundry. Capacity will be 30000 tonne. part will be for captive consumption (Setco as well as subsidiary) as the company is witnessing problems in sourcing casting for its own business. This will be in its 80% subsidiary.Funding will be done through Rs 110 crore debt. Commercial production will be done in Feb March 2015.The company works on 2 shifts and utilizes 65%.The company hopes for CAGR of 27-30% for next three years.The company is expecting good 35-40% growth at the OEM level.It is also looking at exploring new geographies like USA.
In Auto component business the clients expect u to cut prices every year so the company has to recover margins from cost cutting and exports.LCV clutches are priced lower than CV clutches. But this segment will give good volumes.
I quite like the new focus on after market and exports and makign clutch assemblies for LCV’s to claw up margins.
On governance front, I am quite worried that giving vadra type of loans to the promoter’s son for constructuring stadium, promoting sports etc. Does anyone have a view on this ?
It’s hidden away in footnotes and the exposure is at least Rs. 3 Cr. (could be much more) in what is a start-up company in an unrelated business which is likely to be non-accretive to shareholders.
I am worried that this can balloon into something big even though it’s a very good business otherwise- any VP-ers who can throw light ?
We sell both setco clutch plates & other OEM clutch assemblies. Setco on recent year (1 - 1.5 yrs) has been aggressively pushing sales in our area through different ways like better retailer margins, good coupon rates, mechanic & dealer schemes. They are also trying to educate the transporters about the quality of the product. Generally for clutch assemblies & similar other endurance & high maintenance products transporters prefer to have OEM spare parts such as ‘TATA Genuine spare part’ for TATA trucks but they are also priced at premium of 10-15% depending upon the product.
Overall my point of view is that assuming CV sector on revival, and seeing setco’s approach towards sales, the future looks positive to me.
Thanks to input of VP-ers here, scuttle butt indicates that setco is doing the right things - improving presence in aftermarket, increasing margins through exports and expanding product range (diaphragm clutch).
Given the v-shaped recovery which should be augmented once HCV/MHCV picks up, it should help add to the bottomline. I think at about 8 x FY 2016 PAT, it can easily give a 40-50%upside.
Only fly is the siphoning by promoters to promote sports - noble thought but I would rather they sell down shares and use that money rather than get interest free loans from the company vadra style
Thanks Bomi - don’t have a view but setco’s promoters have been inventing best practices in siphoning - so I am not able to figure out what this act of folding their shareholding into a subsidiary company would tantamount to.
have a look at the attached note from setco and the report from centrum. I have a position in setco and I think it is an asymmetric opportunity from here - their margins are expanding
like crazy because of their direct aftermarket sales which targets all
old trucks more than 5 years old that do not get serviced in OEM workshops.
My scuttle butt with 2-3 dealers proves that they are pushing setco clutches and are happy too. Plus they are exporting to US which is in the middle of a big CV boom.
So, it’s a triple play
HCV recovery in india
exports pick up to US
after market sales in India - hugely margin accretive
Just curious. Took a rapid fire look and the first thing that caught my eye is the steep fall in NP in Q4. Is there an one time exp or something that skewed it?
STANDALONE Mar’15 Dec’14 Sep’14
Jun’14
Net Sales 130.22 113.43 119.06 95.42
Other Income 0.59 1.75 4.67 2.06
PBDIT 12.62 16.18 15.80 11.22
Net Profit 2.87 6.09 9.95 4.50
After a couple of lackluster quarters, secto has shown some good performance on account of
uptick in the cv cycle. There was a substantial increase in topline and bottomline (PAT increased 450% QoQ) which according to the company presentation (pdf attached below), was because of better aftermarket sales, better margins and introduction of new products. This is a great sign for the stock.
Some highlights
Company continues to hold leadership position in OEM market with expanding customer/product line.
After market share is showing growth and expected to do better.
Expanding sales team for improving exports particularly in US.
New business - developing clutches of Tractors. There is a huge opportunity for both OEM
and after market share in this segment.
Lava Cast pvt ltd - company’s joint foundry has commenced production. This will improve profitability.
In house manufacturing of Diaphragms is operational.
Highest operating margin quarter in the period of last 3 years.
promoter holding increased from 62.92 to 63.54 in last quarter.
dividend payout ratio has increased from 35% in FY15 to 40% in FY16.
My view on Setco:
A leader in the space by a massive margin, has crushed Clutch Auto, and is now head on with Valeo (LCV) and LUK (FES). Products have been well received in MHCV space across OEMs, and likely to see some traction in LCV space (already started with Tata Motors) and FES (expected by end-FY17).
The play is simple and exactly as Varadharajan has mentioned:
CV recovery cycle - mostly MHCV recovery once we see mining ban taken off, more construction work happening, higher intensity capex on infrastructure (especially roads), etc. LCV demand has slowed down, but is likely to act as a corollary to MHCV cycle. LCV clutch abuse is lower than that of MHCV, so replacement cycle is longer - my estimate is 4-5 years. Caveat: realizations are far lower. Margins are higher single digit.
FES introduction - This is a smaller area but adds incrementally to the portfolio capabilities and can further the exposure into export market. The realizations here are low and replacement cycle is longer.
Absolutely no interest in the PV space - Big positive since it is dominated by OE (low margins) and has a negligible replacement market (much higher margin).
Exports - A lot of investments have gone into NA and UK subsidiaries without great traction on either sales or profitability. Currently 30cr odd (5-6% of sales) and losses. This is a longer term play, and if we see any semblance of a recovery in the American or European CV market, this would be a large boost. Mgmt talking of 100cr by FY18/FY19. No manufacturing there, and simply sales offices and product development teams - saves costs since employment costs are 9% of sales in India while 23% of sales in Europe (as per mgmt). Margins are around 20% in my view.
Replacement - Especially with the Independent After Market - realizations are high in this category, due to higher service levels resulting in better reliability and consistency. Regular replacement also has good margins. More than half the sales come from this segment. Margins should be between 12% and 16% and form a chunk of the total EBITDA profile.
Some some concerns:
Mgmt is much more aggressive despite missing targets. In FY10, reveune was 250cr and aim was to touch 1000cr by FY15. In FY13, aim was to touch 1000cr by FY18. In FY16, aim is to touch 1000cr by FY18/FY19. Prefer Vivek Chand Sehgal’s (Motherson Sumi Systems) way of giving a goal, achieving it, and then giving the next.
LavaCast is their foundry to manufacture castings. Thus far the casting quality has not been as good resulting in loss of export orders and affirmation from overseas clients. Cost of project is 180cr odd. Setco’s stake =80% rest belonging to Lingotes (Spanish technical partner and manufacturer of high quality castings to automotive giants). FY16 castings requirement stood at 90cr (from Annual Report). Let’s say they achieve 900cr-1000cr turonver by FY19. Internal casting requirements should move up to 180cr.
Capacity is 30,000MT. Peak utilization expected at 80% or 24,000MT. Internal consumption = 8000MT (1/3 of total capacity) and remaining 2/3 for sales to Lingotes customers among others. A 5% cost saving for internal consumption is 9cr savings (5% x 180cr). We don’t know margin for remaining export supplies. WC assume at 90days (being generous), implies WC of 45cr. Total Capital Employed = 225cr. If we want ROCE of 25%, EBIT should be 58cr. Depreciation = 12cr (15 year life) EBITDA = 70cr. So EBITDA for exports = 70-9=60cr on revenues of 360cr. 17% or so. This would deteriorate overall ROCE while giving access to clients for exports. Thumbs up or Thumbs down - we need to choose.
Debt will increase substantially - 180cr investment into Lavacast, 20cr into diaphragm springs facility, 25cr into regular capex for enhancing capacities.
Added to all of this is promoter interest in TransStadia companies (now there are a 9 privately held entities). 15cr has been dumped into this venture, which is the boxing equivalent of Pro-Kabaddi League, among others. I am displeased that this absolutely unrelated venture sucks up 17cr of equity and loans. So far. What IRRs if any will be generated from these ventures, is a matter of conjecture. This project has had the blessings of our current PM (then Guj CM) but I see it as a curse. I find VRL Logistics to have a far better case - at least it would have been promoter money. Seeing what happened to that stock - scares me.
Then there is this issue of Setco Engineering Private Limited, which is now considered the holding company. These are non-cumulative pref shares at 9% (which btw in FY12 was 10% and mysteriously became 9% thereafter). Mgmt said this would give parent company 9% interest and hence we should be indifferent (from an opportunity cost view). But it is non-cumulative and if there are low profits or some such, the interest payment may not be in full - which is precisely what happened in FY16, where only 8% dividend was paid (citing inadequate profits).
While the core operations are doing well, and are ready to fire, the capital allocation decisions leave much to be desired. Why doesn’t the promoter’s son sell shares and fund these unrelated ventures? Will LavaCast (foundry to make castings) deteriorate returns on capital of the enterprise?
Disclosure: Invested at lower levels. But reconsidering position due to repeated capital allocation issues.
@hash611: nice analysis. There is a major trigger for the stock which is tractor clutch business beginning towards the end of the financial year. But overall I agree with you their capital allocation does concern me. The company has been investing heavily in investing in improving exports, curious to see how that turns out.
Setco Automotive (Setco) is a leading auto component company in India and among the top M&HCV clutch manufacturer in the world. We initiate Coverage on Setco (CMP Rs 20) with BUY recommendation with a target price of Rs 249; which is 21% upside from current levels and an investment horizon of 12 months. The stock at Rs.206 is currently trading at 8.8x FY13E EPS of Rs 23.2 and 7.9x FY14E EPS of Rs 26. Our target price is based on DCF analysis.