Shanthi Gears/Shanti Gears

[rkgautam]

This is a special situation - there is an open offer for Shanthi Gears at 81/share. Details in this link:

http://www.bseindia.com/xml-data/corpfiling/AttachLive/Shanthi_Gears_Ltd1_130712.pdf

The investment operation involves buying shares from the market (tomorrow and the days that follow, below 81/share), say at 66.3 (as this would likely be locked on UC of 5%) and getting out at around 80/share or more making around 21% in 4-5 days. Looks like a fairly protected bet with decent returns.

Thoughts?

[RJ2112]

Hi Rohit,

Looks like a good trade if you can buy the shares; it’s likely that the big fish would flood buy orders in the pre-market session.

Interestingly, NSE says the delivery % since 15th July is “-”. Volumes have been spiking since 6 July.

[rkgautam]

More than 10% returns have been achieved since the note in a few weeks (i.e., about 70% annualized). Although adequate, returns have been lower and have taken a lot more time than expected at the time of the note. So, in order to internalize the learning fully, following four questions (as suggested by Buffett to evaluate arbitrage situations) are important to understand:

1). How likely is it that the promised event will indeed occur? The open offer was/is very likely to go through given the status of the acquirer and nature of the deal (an exit price of 81/share offered an adequate upside). As such, there was a high likelihood of daily traded share price going up as we approached the dates for open/end of the open offer.

2). How long will your money be tied up? I was expecting more than adequate returns to come in a matter of days, however, more realistic assumption would have been 8-9 weeks. However, any extension in the dates (unknown and unknowable) would have increased the duration for which money would have been tied up. But even if the process were to take 3-6 months, the expected annualized returns more than justified a buy.

3). What chance is there that something still better will transpire - a competing takeover bid, for example? Almost zero. The acquirer had acquired the promoters’ stake (44.1%) and it didn’t make sense for public (~37%) or DII (~17%) or FII (2%) to come up with a counter offer. If another acquirer came into picture, it would have only made the situation better (but this was almost a zero probability event)

4). What will happen if the event does not take place because of anti-trust action, financing glitches, etc.? The likelihood of the open offer not going through was/is almost zero. The probability of daily share price going up and touching the open offer price with time was high. In case there was price volatility, it was important to stick along till the open offer went through.

The stock was at 66-67 odd levels for quite a few days post the announcement (not to forget the run up from 50-51 levels to 67 in a matter of days, before the announcement was made). Recently, the stock started its upward journey again and has provided high returns on annualized basis even to those who got in at 66/67 levels. In all, a good experience in terms of learning and returns.

The offer will close in a few days and might offer upside to investors who get in now. However, not sure if the stock will continue to be at these levels post the completion of the process.

Best,

Rohit

[rkgautam]

Just to add, the biggest risk in such situations is that the announced event will not take place. Although the probability of the event not taking place was almost zero, the operation involved purchasing the shares from the market and selling them in the market, hence benefiting from price appreciation and not, purchasing the shares from the market and tendering them in the open offer, which would have been a different operation as follows:

)- Purchase at about 67/share

)- Tender the shares in open offer. The offer was to acquire 26% of the share capital at 81/share. The acquirer had acquired 44% of the share capital from the promoter, The acquirer would have about 70% in the company if the open offer went through successfully

)- Assuming ~4-5% of the share capital will not be tendered. If the rest ~52% tender, it would mean that for every two shares that are tendered, one will go through

)- Say, I acquired 100 shares at 67/share, and 50 shares went through at 81/share, I would still be left with 50 shares at 53/share. Would this have been a comfortable situation? There were three factors to consider:

a. As per the open offer document, the volume-weighted average market priceof the shares for a period of sixty tradingdays immediately preceding the date of the PAas traded on the NSE was51/share. All else the same, there was a good chance that stock price would come down to 51/share or below post the process was complete

b. FY12 EPS of 3.44 and a price of 53/share would mean a P/E of 15.4; if one considers Q1FY13 results, LTM P/E would be 17.6. This wasn’t comforting, especially given the not so great return ratios and lower valuation for comparable/better companies

c. The facts mentioned above implied that for the shares not accepted in the open offer, it would be best to sell them in the market. Assuming a complete exit of the remaining shares at 72/share, the total returns in the process would be 14.2%. While higher than the returns in previous case, the returns would have diminished with time, with a possibility of no exit for a few days (say because of lower circuit). As such, the option of purchase and sale in the market was preferred

[Shankar]

Rohit,

This is a case where the deal is announced. Do you also invest in potential deal ideas ( West Coast Paper) etc ? If yes, what metrics do you use to analyse the potential ?

Regards

[Chandragupta]

This thread exists, but there is almost no information about the company in this. I am therefore reviving the thread as if it was a new thread by providing some background information and current developments. Do share your inputs on the company.

Company background

Shanthi Gears was founded in 1969 by a first-generation entrepreneur and was acquired by the Murugappa Group in 2012. Tube Investments now holds more than 70 % stake in the company. The company is now mainly into industrial gears and gearboxes and caters to a reputed clientele from diversified sectors such as general engineering, steel, cement, railways, power and material handling, among others. The company has a manufacturing facility near Coimbatore in Tamil Nadu.

Long Term Story

The business is cyclical and closely linked to the broader capex cycle in the economy. However, there is also replacement business since large gearboxes have a lifespan of five to six years, while the small ones last for two to three years. This leads to steady replacement demand even during lean periods. Sales growth has averaged around 10 to 12 % p.a. since the new promoters took over, while operating profit growth has been higher at above 15 %. Margins have been at more than 16 % p.a. consistently.

SGL is a small company with an efficiently run business model, which has improved consistently over the years. Financials are clean, and an uncomplicated balance sheet leaves gives very little scope for negative surprises. Company has no debt and investment in working capital has also been almost Nil over the years.

Cash flows have been higher than PAT, showing strong conversions of profits. Business is not very capex intensive, leaving decent free cash flows for the benefit of shareholders. Company has been consistent in giving dividends and thanks to a Rs.70 crore buyback in FY20, almost 100 % of the profits earned by the company in the last 9 years have been returned to shareholders. This year, a special dividend of Rs.2 per share has been declared on the occasion of completion of 50 years, taking the total dividend to Rs.5 per share.

The company is strong in the Railway segment, and the current boom in railway capex has been a boon for the business. The management says they get good volumes from the railway capex and Vande Bharat trains etc.

Revenues from the services segment are around 15 to 20 % of company revenues currently.

Forged steel is the main raw material.

Competition

In the listed space, Elecon Engineering is into industrial gearboxes and is much larger than Shanthi. Historically, Elecon has reported higher margins than Shanthi, but the gap is getting bridged in recent times.

I think part of the reason Elecon has higher margins is its higher proportion of exports. SGL’s business is mostly focused on India while Elecon earns around 30 % of its revenues from exports.

Current trends

In recent years, SGL’s operating margins have risen strongly from 15.98 % in Q2 FY21 to 21.60 % in Q4 FY23, bridging the gap with Elecon. Along with this, PAT margins have also increased from around 12 % to more than 15 % in recent quarters. The reason for improvement in margins is better capacity utilization, most likely.

The company’s pending order book stood at Rs 270 Cr as of end-September 2022. In Q3 FY23, the company received orders worth Rs 120 Cr.

The capacity utilization currently is pretty high, according to the management though exact numbers are not available.

Future expansion

According to a brokerage reports, a high proportion of revenues come from customized products (70% of mix in FY 22) which earn higher margins. SGL’s parent company, Tube Investments, is planning to invest Rs 1,000 Cr in its EV endeavour and planning to leverage SGL’s expertise to manufacture gearboxes for electric vehicles.

Company already has surplus land available in Coimbatore for expansion. In addition to that, it has acquired a plant at the Gujarat’s automobile hub, Sanand, to explore growth opportunity from the untapped west and northern markets. The plant will be up and running in the next one or two quarters, according to the company management. Here the company intends to get into renewable energy, though more specific details are unclear.

Concluding Remarks

Clean Balance Sheet, industry tailwinds, strong parentage, improving financials and future expansion plans make Shanthi Gears an interesting stock to consider. The company does not do concalls or release investor presentations, so access to information is sketchy. Hope this post triggers some conversation about the business.

(Disc: Holding)

[Chandragupta]

Notes from the company AGM (E & OE):

1. Company has identified four performance parameters - PBT, Sales, ROIC and FCF which they want to optimize. This year they company has achieved revenue growth of 32 %, PBT growth of 54 %, ROIC of 55 % and FCF of Rs.39 crores (up 15 %).

2. Planning to make Rs.100 crore investment in the next 3 years in building capacity.

3. Plans is to grow 20 % year on year consistently through new product developments, operational efficiencies and quality customer engagements.

4. Sanand plant will be operational in H2 of this year. Company is making an investment of Rs.30 crores over three years at Sanand, which will be funded fully from internal accruals. The target customers for the plant will be from the steel, cement, mining and power sector.

5. Company booked orders of Rs.140 crores in Q1 FY24 and o/s order book as on 30th June 2023 is Rs.270 crores. The order booking is continuously growing, as the image here shows.
   

   

6. Presently, the segment-wise break up revenues is as follows: Steel 30 %, Material Handling 10 %, Mining & Highways 10 %, Tools & Plastic 10 %, Power 10 %, Exports 7 %, Others – about 20 %.

7. Around 20 % of the revenues presently come from the replacement market and this proportion will remain going ahead.

8. Currently 25 % revenue is from standardized gears and 75 % is specialized gears. Plan to enhance this order mix to 40 % over the next four years.

9. Expecting around Rs.8 to 10 crores of sales per annum from Vande Bharat trains

10. Company plans to grow exports at a CAGR of 30 % over the next 5 years, taking the proportion of exports to revenues to 12 % from the current 7 %.

11. Received aerospace certification for the first time. Focusing on ISRO and HAL space. Percentage is not significant presently but doing only capability building. Aerospace is only 1 % of the total size.

12. Plan to participate very selectively into parent company’s EV initiative, as EV is a very price sensitive segment.

13. Renewable energy space also involves very high investment and the ROA is not favourable.

14. Currently there are no concalls as they think they are a small company yet, they will think of it in future.

15. Will explore inorganic opportunities when they come.

[Jitendra_Vyas]

@Chandragupta are you still tracking this company? What’s your recent views on company’s developments and expansions?

[hardik_shah1]

I have been checking this over the last week.

Good Product and Industry Profile. Strong company background with Murugappa group. Good upturn in results and cash flows.

What are the drawbacks here. Anything that is not visible on surface?

[Chandragupta]

Sorry I missed this somehow, hence delay in reply. Yes, I am still invested in this. Fundamentals are strong and industry tailwinds are favorable but valuation is rich. Information is difficult to come by as the company does not hold concalls or release presentations.

[babu44b]

Hi @Chandragupta ,

I hope this message finds you well, Can you please guide me why the debtor days spiked to 80 days in 2024 compared to 78 and 56 in the year 2022 and 2023 respectively. It is a sharp rice if we compare from 2023 to 2024, 42%. Which has resulted in working capital days increase to 134 from 56 in year 2024 compared to 2023.

Has their customer base changed which resulted in delay of payments? please guide me.
Also as company doesn’t do concall or provide investor presentation I am unable to gather information regarding any recent developments or execution on previous plans like participating in EV plans or renewable sector.

I see the sales growth has YOY tapered down , last 1 year growth is around 16% where as last 3 years growth is around 35%. which indicating slowdown in business,

If you can through some light on the above points, that will be also helpful.

Thanks,
Deb

[Chandragupta]

Hi,

I don’t think anything structurally has changed with the company. The Debtor Days are in line with the long-term trend though the number was unusually low last year. If you see the Q2 FY25 results, increase in debtors is not much, so nothing much to read into this. Growth rate also seems to have normalized, 3-year growth may look high due on Covid in 2020 & 2021 and the strong post Covid recovery for the entire economy thereafter.

That said, please note I have exited the company. This is on expectation that there may be a broader slowdown in the engineering / capital goods sector and while other opportunities have become available in the market due to the recent fall. It was a small position anyway and given the information blackout, it becomes difficult to track the company and take a meaningful position.