Mahindra CIE – Rare combination of Opportunistic and Long Term bet

Mahindra CIE is an entity formed by the merger of all automotive component companies of Mahindra Systech and CIEas European forging companies. Post-merger it will be one of the worldas largest forger with presence across North/South America, Europe, India and China.

I couldn’t find a thread on Mahindra CIE, hence opening a new thread asI thought it is a good opportunity that all the fellow members may be able to benefit from after proper due diligence.

I stumbled upon this stock in Jana2014 while discussing long term opportunities with a 5 year perspective and hence the credit goes to my friend KD in introducing this idea to me. As soon as I looked into this opportunity I was convinced about its prospects. I think the market had not identified this opportunity earlier and has only recently started discovering it.

Rather than write a note myself I am reproducing an existing research report by ICICI Direct to initiate the discussion on this stock. The research report is available in the public domain. I am a new member who has joined in the recent past and still a bit hesitant to initiate stock ideas on my own and hence using this report (as I believe I am not at that level right now and still learning). But I have my own convictions in terms of stocks and try to use my basic understanding to invest in the markets.

Opportunistic: This is the short term bet (Arbitrage Opportunity)

Mahindra Ugine (MUgine) and Mahindra Composites (MComposites) will be merged with Mahindra CIE (MCIE).

Share swap ratio:

  • 284 shares of MCIE for every 100 shares held of MUgine a 22% arbitrage opportunity as on todayas closing prices. (Liquidity is good and taking position is easy)

  • 90 shares of MCIE for every 100 shares held of MComposites a 20% arbitrage opportunity as on todayas closing prices. (Liquidity is not good and hence taking position is difficult)

Long Term: This is wherein lies the beauty of this merger (Creation of a Global Auto Ancilliary Behemoth)

  • Strong Tier-1.5 supplier to global OEMs.

  • The company will become the third largest forger in the world with a consolidated revenue size of Rs. 5000 Crs. MCIE would have a presence in Asia (India, China) and Europe (Spain, Germany, UK, Italy, Spain, Lithuania) supplying forgings, castings, gears and stampings, thereby making Mahindra CIE Automotive a strong global player.

I believe that the estimates used in this report are conservative FY17 EPS of Rs. 12 (Approx.).

Bharat Forge today trades at 30 times its earnings, therefore one can use this as a base to try and arrive at the valuations of MCIE 3 years down the line. MCIE in my opinion would have significant advantages as compared to Bharat Forge for reasons stated in this report. I wouldnat like to put a target price from a 3 year perspective. But in my opinion I wonat be surprised to see MCIE give returns of CAGR 40%+ (from present levels and including the arbitrage)for next 3 years. (Please Note: The stock has run up significantly in the recent past.)

The Investment Rationale, Positives and Negatives are given in the report.

TheUrl to the report is: http://www.moneycontrol.com/news/recommendations/buy-mahindra-cie-automotive-target-rs-130-icicidirect_1065980.html

Discl: I have disclosed my portfolio in this forum and I am invested in MCIE/MUgine since much lower levels since the month of Jana2014 and my current allocation towards MUgine stands at 20% of my portfolio. Hence my views on MCIE may be biased.

I would request other fellow members to look at this opportunity and share their views.

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Link to the full report - http://www.moneycontrol.com/mccode/news/article/article_pdf.php?autono=1065980&num=0

Mahindra CIE has already reached its targetted price in a month time.

The oppurtunity looks interesting.

Could we compare this company with one of the international rivals to get more clarity?

I was present in this industry between 2009 and 2013. 1 conclusion that I came to is that this is not an industry which is likely to generate long term shareholder value.

Mahindra Ugine is an alloy steel company which makes steel used in transmission and engine components. These special steels are supplied to forging companies who are tier 1 vendors for automotive companies. There are over 20 special steel companies based in India and a majority of them are currently in the red. There is a huge excess in terms of supply demand gap especially since the greatest volumes come from HCV’s and MCV’s and this segment has shrunk by half since 2011! Furthermore, the industry dynamics are not very good. Almost all materials are sold on open credit of 60 days (90 days in the north) and small forging companies rarely pay on time. Raw materials are all sourced on immediate payment basis and due to the system of credit the finished goods inventory is generally at least 20-30 days in any special steels plant! This makes WC management a nightmare! More often than not, companies are struggling for cash! Further, prices are negotiated with auto OEM’s but forgers seldom buy at agreed rates. They create a competition between approved steel sources and take a discount on agreed rates! Besides CAPEX requirements to augment capacities is gigantic!

There are 2 ways of making steel - EAF route (Mahindra Ugine, Vardhaman, Remi Metals) and Blast Furnace (JSW, Bhushan, Usha Martin, etc.)route. From a cost standpoint, a company producing steel through blast furnace has a variable cost advantage of at least 2-3Rs/kg depending on current prices of scrap, iron ore and coke. Furthermore, companies like Usha Martin due to their vertical integration and own coal mines are far lower on the cost curve. Furthermore, due to higher capacities (a typical Blast furnace will be 1 million tons per annum vs 150,000T for EAF), the fixed costs/ton are also far lower. In an industry where contribution margins are barely 7000-10000Rs/T this can make a massive difference! MUSCO has an amazing range of products and automotive approvals in their portfolio but the future lies with companies that have their own mines and run blast furnaces!

Forging industry is in a similar plight. Forgers typically work as job workers between steel and auto OEM’s sometime’s on wafer thin margins. Again high CAPEX low returns. Bharat Forge might be an exception and that is because of the quality of their OEM approvals. Bharat Forge is the single source vendor for critical components such as crankshafts at a large number of auto OEM’s and this is where they generate their cream. Another advantage they have is that their main source of steel is Kalyani Carpenter which is located next door which on average is saving of 2000Rs/Ton on transportation. The growth rates are tied to industry growth rates and as I mentioned earlier, this is not a very good time to be in the HCV/MCV industry which is where a bulk of the volume is!

Regards,

Abhishek

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Hi Abhishek,

Being an industry insider you would know the industry better than anybody else.

But I think, to understand the size of the aboveopportunity itshould be viewed as below:

  • The most important thing may be is the Valuation Mismatch considering the scale of the opportunity and the turnaround possibilities.
  • MCIE should be seen more as an Automotive Components/Ancillary and Forgings player with strong scale advantage and turn around possibilitiesand not as a part of the Steel industry. Although it would be one of the major forgers in the world but it would be moving towards being a multi-product auto ancillary player.
  • Like Bharat Forge, MCIE would also be the provider of critical components to OEMs and would be a Tier 1.5 supplier (typically enjoy better returns on capital). It would also increase its product portfolio substantially. Further it would have advantages over Bharat Forge because of its global promoters and a scale advantage with global footprintwhich would be well spread (as OEMs adopting local sourcing approach and Thyssenkrupp and Sumitomo Metals would be only other players who would be able to cater to OEM demands on a scale spread across all geographies as OEMs have their assemblies also spread globally) and because of other acquisitions which are in pipeline (See below link)

(http://www.livemint.com/Companies/99yFlTQP5Mw3YM5oSFOR9L/Mahindra-CIE-looks-to-form-tripartite-joint-venture.html)

  • There are other related individual benefits which would accrueand which are from a stock perspective and notfrom an opportunity size perspective like:No major planned capital expenditure as the focus onincreasing the utilisation levels and improving efficiency and whichwould help in deleveraging the B/s and result in strong cashflows. CIE’s track record in turnarounds and managing costs and driving efficiency, etc. (Many such benefits detailed out in the above report).

Cheers!!!

Shareholder’s have approved the schemefor amalgamation.

Merger is now only subject to the approval of Bombay High Court following which the completion of the amalgamation process is likely to conclude by mid-July or August.

ICICI Securities have upgraded the target to 175.

However the price target is not important over here and I have quoted the same’coz it is a part of the report. It is important toview Mahindra CIEas a turnaround story and therefore necessary to look at it with a broader view point for the long term.

Below as quoted by ICICI Sec.

Possible multiplier in financials to reflect in price & multiples

“Mahindra CIE Auto is a unique case of valuation considering the massive turnaround possibilities in MCI and we are factoring in the same. We expect the turnaround to be significant, with non-linear profit growth of ~140% CAGR in FY14E-17E. We expect utilisation levels to improve leading to EBIT margins rising to ~8.3% and RoCE expansion to ~14.6% in FY17E. We expect a significant increase in dividend payouts to ~40% in line with CIEâs philosophy of high dividend payouts (~40-50%). We have valued MCI on a combinational basis of PE and EV/EBITDA, considering it is a turnaround company. Also, we wanted to be more prudent on possibly valuation methodology anomalies. Thus, we arrive at an upgraded target price of |175 with upside of ~54%. We maintain BUY.”

Has done well to move up with rest of the auto ancillary pack!

September 19 is the date for Court approval on the scheme of amalgamation!

Cheers,

HR!

Agree - this is not an industry that creates shareholder value and this is a bus where you need to know where to get off.

To me, industries like steel are buses that go around in circles - they are not buy and hold cases. Rather, they can get you from point A to point B well only and only if you are clear if you know when to alight. otherwise, 5 years later, you will find the same thesis re-packaged and sold to you.

These should trade at net-nets or a meaningful discount to book to make sense - what’s the big deal about ROCE’s hitting FY 17 in an optimistic case ? Too little, too far for value creation to happen

September 19

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@Varadharajan- Actually this is not a steel (commodity ) stock… As I had said that it is an opportunistic as well as long term bet. I have been holding this since 50rs, along with Mahindra Ugine and Mahindra Composites.

The beauty of this stock is that the amalgamation would actually create tremendous shareholder value and it already has for all the stocks to be amalgamated and still there is a long way to go.

Suggest that it would be helpful if you read the entire story above to understand the value that Mahindra CIE has and will create!!!

Cheers,

HR!!!

Has done well to move up with rest of the auto ancillary pack!

September 19 is the date for Court approval on the scheme of amalgamation!

Cheers,

HR!

Is this stock not good other than the merger opportunity which we got last year …
I think it would be ahead in auto ancillary space and had a lot of better future prospects going ahead …

CONFERENCE CALL - from Capital Markets

The company is targeting to double revenues and PAT over next 5 years

Mahindra CIE held a conference call on 25 April 2016. Mr Hemnat Luthra, Chairman and Mr K Ramaswamy, MD and other management officials took the queries in the call.

Key Points of the call:

  • On a standalone basis, for Jan-Mar 2016 quarter, new product launches supported volume growth of the company’s key customers (M&M and TataMotors volumes increased ~11.9%). But the same was largely offset by a decline in steel prices (down 9% YoY) resulting in lower realisations and lower scrap prices (down 30% YoY).

  • The management is focusing on diversifying its standaloneoperations. Currently, its top two clients M&M and Tata Motors accountfor ~45% and ~10% of standalone revenue respectively, which is likely to comedown by 5-7% per year, going forward. This is mainly after the company’sthrust to acquire new OEM and penetrate further.

  • According to the management, steel and scrap prices have fallendrastically in the past six to eight quarters.

  • Raw material cost (mostly steel) is 52-55% of sales and scrap sale is 7-9% of sales. Steel prices havestarted recovering from the lows of 1QCY16. With thegovernment increasing the import duty on steel and minimumsupport price for steel, prices are expected to recover/stabilise,going forward.

  • On a consolidated basis, the management believes the revenuegrowth would be subdued in both domestic and overseas operations. However, the turnaround in various operations is goingsmoothly and is likely to result in EBITDA margin expansion, goingforward.

  • The company is targeting to double revenues and PAT over next 5 years.

  • The company’s plan of improving India business margin from current ~9.4% in 9MCY15 to ~16%(levels of the parent) would be driven by volume growth, cost control andrationalization of product portfolio.

  • Jeco plant was closed down w.e.f 30th Nov 2015, and hence1QCY16 saw benefit of headcount reduction lowering ~200 headcounts resulting in saving of €8 million. However, full benefit from closurewill reflect over next 1-2 quarters.

  • Mahindra Forging Europe’s (MFE) turnaround is progressing steadily with the ‘Phase 1’ action (internal efficiency) being completed while ‘Phase 2’ restructuring is ongoing with JECO plant already closed down.

  • MFE is also reviewing its product portfolio and eliminating low margins segments, thereby expanding margins.

  • A turnaround in the Metalcastello business has improved after MCI had taken restructuring actions last year.

  • Apart from Jeco plant closure, it istargeting optimization of product-process-location at its European operations. Ithas started with outsourcing of low value add/non-core operations likemachining and finishing operations.

  • The management has retained its view on reducing its debtgradually over the next two or three years.

  • For thesubsidiary, the turnaround strategy is progressing slower thanplanned in Germany.

  • All remaining European businesseshave maintained or improved their performance on a sequential basis.

  • The company is participating in all new projects of M&M and Tata Motors, with oldand new products.

  • The company has got orders from Ford, Renault and GM, while it is in process ofgetting orders from Volkswagen and Fiat. However, it would take around 2 years fromordering to commencement of commercial supplies.

  • The company expects supplies of new products to start contributing from4QCY16.

  • The company’s maintenance capex stands at Rs 250-300 crore in current FY

60bc659b-3f64-4e78-a13d-8dc62895b95b(1).pdf (246.6 KB)

Another set of good results from Mahindra CIE. The margins are increasing along with sales. However, this is just standalone results, which is a small portion of their consolidated earnings.

Wondering why company like MahindraCIE is not disclosing the Consolidated Result. Any particular reason ?

Am trying to understand the numbers of Mahindra CIE.
Mahindra CIE follows Financial cycle of calendar year. But unfortunately, it only declares standalone numbers. It has recently declared June Half Calender Year results.

H1 CY2018 EPS 2.17 (Standalone Basis)

I tried to derive the consolidated EPS.
In AR(Calender Year) of 2017:
Standalone Annual EPS-- 1.83
Consolidated Annual EPS-- 9.46

Multiplying Factor (Consolidated/Standalone)- 5.17

Assuming that the Multiplying factor remains same.
H1 CY2018 EPS(Consolidated) -5.17*2.17= 11.2

Comments Invited.

Mahindra CIE Mutual funds holding reports.:

Mahindra CIE Mutual Funds holding reports

The report is till July18, but think in Aug18 and this running months MFs would be increasing their holdings in Mahindra CIE

Mahindra CIE sees tremendous growth opportunity in India, its Chairman Hemant Luthra said in an interview to Bloomberg Quint. Some salient points -

  • On trade was he said it is more smoke and mirrors. Not much has changed in terms of demand. Word from buyers from Mexico plant is that they want to double the capacity.

  • Said he would be disappointed if they don’t manage to do 20% CAGR for next 3 years with the kind of balance sheet they got, and the opportunities that are coming to their fold due to bankrupt companies. Target is to grow 50% more than the industry.

  • With 1000-1200 cr operating cash flow per annum, they will find opportunities to grow organically and inorganically. India is the place to be!

  • Focus will be to match CIE Automotive numbers i.e. 15-16% ROCE with 14-15% EBITDA margins. Mahindra CIE will reach there in next few years. Revenue would grow automatically as the sector is doing very well, but the focus would be on profitable growth.

  • He said clients like Maruti want to consolidate their vendors (from 700 to 300) and would like to work with companies that are well capitalized and can up their game on short notice. Vendor consolidation is the need of the hour across whole automotive sector.

  • The war chest is ready for acquisitions to enter into aluminium and plastics segment. No equity dilution would be required for the same as they got good cash flows and low debt/equity.

  • Europe is doing well. Germany operations have turned around. Mexico operations are doing fine and operating at full utilization. Growth in Europe would be lower and growth in India would be much higher. Currently it is 60:40. In next few years, they want to reverse the scale.

I believe this is one good, diversified, aggressive, well managed company from one of the better corporate groups in India. Sector is definitely cyclical, but this company being diversified into 2 wheelers, 3 wheelers, passenger cars, CV, UV, MHCV and into all verticals like stamping, forging, casting and others is very well positioned.

Spanish promoter CIE Automotive increased stake from lower 50s to higher 50s recently. They want Mahindra CIE to be their arm for expansion in South East Asian countries. Good part is that tech is already available with promoters (CIE Automotive), which just needs to be brought to Mahindra CIE fold.

Technically very well placed as well. If manages to close above 300/315 for a week, would be a multiyear breakout.

Disclaimer: Invested. Added more in last 3 months.

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As expected, Mutual Fund Holdings in Mahindra CIE in Aug’18 has increased:

Mahindra CIE is a company which was christened by Mahindra Group and CIE Group. Found an article which looks a the last 10 years journey of the company.

Article - Mahindra’s CIE deal catapults it into the global arena

Going ahead, it looks CIE would be more in control of the company than Mahindra. Maybe looking at next couple of quarters results should give us more indepth.

Disclaimer: Not Invested.

Quarterly updates

 Sales decline across businesses is below the breakeven point due to the COVID-19 impact.
India business
 BF Mexico changed its functional currency to USD with effect from 1st January
2020. The business has generated a restatement of its 1Q figures, with gains of INR418m in exchange rate fluctuations.
 April and May were heavily affected by the lockdown, so negative EBITDA was
generated mainly during this period. However, June was already reporting positive EBIT.
 AEL received INR122m as grant income in 2QCY20, with 90–95% from the prior
period. The total grant would be INR36m for CY20, of which INR18–20m came in
1H. The total accrual to date is ~INR1b.
 Although employee headcount has reduced, the benefit would reflect in the coming quarters.
 BF Mexico has seen fresh business from new customers; exports are doing well in Bill Forge and Gears.
 Capacity utilization increased to 65–70% in 3QCY20 from 50% in June.

Europe business
 The Europe business is nearing normalcy, with June already coming in EBITDA
positive (excluding restructuring costs).

 Restructuring actions have already been undertaken, and EBITDA includes about
~INR344m of restructuring cost (in MFE and Metal castello). This is for lay-offs,although the execution of the layoffs would happen in the next few months. This would result in a EUR4m reduction in staff cost on an annualized basis.

 Capacity utilization increased to 65–70% in 3QCY20 v/s 55–60% in June.
 Incentives in EU – It received an EUR4m benefit under the schemes during 2QCY20. The benefit was largely for April and May as it was ramping up production in June.

 Outlook: For PVs, 75–80% of CY19 volumes in the next two to three quarters; CY21 expected to be 10% below 2019 levels

Others
 Net financial debt increased to ~INR14.5b in Jun’20 from ~INR11.5b in Mar’20 due to forex fluctuation impact of INR840m and IndAS16 impact of ~INR2.5b.

 The company reduced its breakeven level by 10% to INR9b revenue from INR10b revenue/quarter. Fixed cost reduced by INR 100m/month on fixed cost of INR1000m/month earlier.

 The next quarter should see improvement in margins, and expect pre-COVID-19
margins by the end of the year.
 Tactics to improve profitability:
 Short term (3–6 months) – Cost reductions, profitability, improvements, and
restructuring at Metal castello and MFE
 Medium term (6–12 Months) – OEE improvement, labor productivity
improvement, VAVE, and Bought Out Parts (BOP) insourcing
 Long term (12 months and beyond) – OEE improvement, value stream mapping,
TPM/5S
 It is seeing the emergence of import substitution opportunity in India and has
already acquired similar business in the Gears and Magnets division. Also, it expects consolidation in the vendor base in both India and the EU, a benefit for MACA.
 Capex for CY20 at consolidated level would be ~INR2.4b (INR1.4 b invested in 1H).
 CIE open to increase its stake through a creeping acquisition if market price is
conducive

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Strong Q4 from the Company