Sharda Motors - Emission tailwinds or EV threat to exhaust systems?

Hello friends,

It’s been 9 years since I joined this wonderful community of selfless investors. Here’s my first attempt at initiating a thread on a business that I feel is potentially under-priced. The business is an auto-ancillary called Sharda Motor Industries Limited (to be referred as SMIL, henceforth).

But first, some initial caveats and disclosures:

  • There is an existing thread here on this forum. However, that thread is closed and hence, I created a new one. I am happy to move this content to the other thread if the admins unlock it.
  • I am not a SEBI registered analyst.
  • The goal of this thread is to collaborate with other investors who may be tracking this business, uncover blind spots and possibly, do some scuttlebutt with automotive experts in this forum.
  • I am invested in SMIL with an allocation of 3% at an average price of Rs. 769.

Summary of why this business could be interesting:
—————————————————————————

  • SMIL has 30% market share in exhaust systems in passenger vehicles/LCV segment
  • Entered into a JV with Eberspaecher for exhaust systems in MHCV segment. Eberspaecher brings in technological know-how and is a segment leader in US/Europe. This JV brings the capability to scale up in MHCV segment and capture market share.
  • Legislation tailwinds - BS VI emission norms along with RDE has the potential to increase content per vehicle in PV/LCV segment. CEV-V and TREM V regulations in 2024 will bring all Construction Equipment Vehicle and Tractors under emission regulation. This has the potential to double the target addressable market in value.
  • Optionalities in EV, sub-component exports and make-for-the-world in the Eberspaecher JV
  • High ROCE business, negative working capital, healthy cash generation
  • Net cash balance sheet. Available at EV/EBITDA of ~9x TTM

Detailed Analysis
—————————

About the company
——————————
CMP as on July 28, 2022 - Rs. 736
Market Cap - 2183 crore

SMIL is an established auto ancillary company offering products and services in the following market segments:

  • Emission control and Exhaust systems
  • Suspension systems
  • Roof systems

It has also entered into the EV space through a JV with Kinetic Green, India. In the initial phase, the JV will focus on assembly of EV battery packs and BMS, primarily for 2W and 3W. It will also explore sub components that go into BMS.

Brief History of the company:
——————————————
1986 - Inception of SMIL
1998 - Foray into Exhaust systems for passenger vehicles with Chennai unit and agreement with Hyundai
2002 - Ventured into Suspension assembly business. Established R&D for exhaust system.
2010 - Established R&D for emission control
2018 - Entered a technical partnership with Bestop Inc. USA for manufacturing of roof systems
2019 - Eberspaecher and SMIL enter into a JV to manufacture CV exhaust systems in India. Eberspaecher brings in global know- how for the local market
2020 - To resolve a family dispute, demerged NDR Auto component limited into a separate listed entity.
2021 - Kinetic Green and SMIL enter into a JV for assembly of Lithium batteries along with BMS for Electric Vehicles – 2W, 3W and Stationary applications

Product Portfolio and market share
—————————————————

  1. Exhaust systems - This forms 90% of SMIL’s revenue and therefore, the bulk of the revenue. It caters to the following sub-segments:
  • Passenger Vehicles and Light Commercial Vehicles - SMIL treats PV and LCV as a same sub-segment because the engine sizes are similar and hence, exhaust sytems are same. SMIL has 30% market share of exhaust systems in the PV/LCV segment. It is a supplier to all major PV/LCV OEM’s except Maruti. SMIL has an in-house intellectual property for these exhaust systems.
  • Medium/Heavy Commercial Vehicles - SMIL has entered MHCV exhaust systems market through a 50:50 JV with Eberspaecher in 2019. Currently, it has 10% market share in this segment. As per management commentary, SMIL is a supplier to the 2 major MHCV OEMs in the country. Currently, this JV is a loss making entity contributing ~120 crores of revenue. As per management, the JV will breakeven at ~200 crore.
  • Tractors - Currently, SMIL primarily caters to the export market in tractors where TREM 5 regulations are in place. This is a very small contributor to overall revenue.
  • Construction Equipment Vehicle - Currently, SMIL doesn’t cater to CEV as the current emission standards don’t require their exhaust systems. However, I am mentioning it here as a sub-segment as this is going to substantially change in the next couple of years.
  1. Suspension systems - This contributes to ~6% of revenue. SMIL has 10% market share in this segment.
  2. Roofing systems - This is a niche category and SMIL entered this market with a technical collaboration with Bestop Inc. SMIL does convertible canopy and soft top canopy in this segment. This is only a minor contributor to SMIL’s revenues.
  3. EV battery assembly and BMS - SMIL has entered into 74:26 JV with Kinetic Green Energy for developing battery packs and BMS for EVs. The initial focus will be on 2W/3W EVs. Kinetic Green will be an anchor customer and already has a presence in electric 3W vehicles. Currently, there is no revenue out of this vertical and production is expected to start from Q3, FY23.

Competitive Landscape
————————————
As per management commentary:

  • Competitive intensity is relatively low in exhaust systems with market share split between 3 major players.
  • PV has more competitive intensity relative to CV/Tractors. This is because the technology involvement is higher in the CV/Tractor segment.
  • Apart from SMIL, the other players are MNCs. As per management, one is an American company and another is a French company.
  • As per an HDFC report shared publicly here, these MNC competitors appear to be Tenneco and Faurecia.

[The competitive landscape requires more detailed work and the management claims need to be independently verified. I have also ignored “Suspension Systems” business from competitive analysis as it only contributes 6% to revenue.]

Legislation tailwinds
——————————
The below slide from SMIL’s investor presentation captures the legislation tailwinds:

To summarize from the above slide:

  • BS VI RDE norms by Apr 2023 has the potential to increase the content per vehicle by 10%-15%
  • CEV V and TREM V norms will bring in all construction vehicles and tractors under its ambit and this has the potential to double the market size SMIL serves today. SMIL already has existing relationships with tractor OEMs and expects a sizable market share in this segment.

Key Risks
——————

  • The biggest risk to SMIL’s business is the gradual move towards EVs that will make the exhaust systems business redundant. This means assigning a terminal value of 0 to that line of business. As per management, the following is their thought process on this risk:
    • They see the electrification happening rapidly in 2W/3W space and hence, their JV with Kinetic on EV batteries/BMS to take advantage of this opportunity.
    • However, in the PV space, they see the shift to happen gradually in India and for CVs and off-road segment, they don’t see the electrification happening in the next 10 years. This needs to be independently validated. Tube Investments recently invested in IPL Tech Electric Pvt Ltd, an electric heavy commercial vehicle startup, as per the news here. It is possible that this transition may happen sooner.
    • The management is also exploring the sub-component export market and intends to be power train agnostic
  • The other risk is the delay in implementation of the emission norms which will push the new market opportunity further down the road. As per management, delays in order of months could happen but not more.
  • Cyclicality in autos is definitely a risk and needs to be managed via the valuation one pays and the allocation

Financials
—————
Pasting the screenshot of financials from screener below:

Important things to note

  • The auto seating business demerged in 2020 as NDR Auto. Therefore, the long term numbers should be seen in that context i.e numbers before 2021 also include the seating business revenues.

  • In the auto-ancillary space, OEMs tend to have a bargaining power. It is notable that SMIL has a negative working capital cycle as an auto-ancillary. It indicates that they may have some bargaining power with OEMs in terms of receivable days and also with their suppliers in terms of payables.

  • ROCEs are therefore, high for the business as the capital employed is less due to negative working capital and high asset turns. Management has indicated that only incremental capex is needed to grow the business indicating lower capital intensity in the business. This needs to be investigated more.

  • CFO/EBITDA is > 84% for the last 2 years

  • Management has provided a slide on adjusted ROCE excluding the seat business. Here is the screenshot:

  • As can be seen, the adjusted ROCE for last 2 years has been 57% and 116% respectively.

Valuations
—————-
Since SMIL is a net cash business, EV/EBITDA is a suitable valuation metric:

Current market cap - 2183 crore
Net cash as on March 2022 - 454 crore
Enterprise Value - 1729 crore
TTM EBITDA - 228 crores
EV/TTM EBITDA - 7.5
Average EBITDA of last 2 years - 178.5 crores
EV/Avg EBITDA - 9.7

The valuation range is [7.5 - 9.7] based on what one chooses as denominator.

Reverse DCF

  • I did a reverse DCF on Tijori finance. Below is the screenshot:
  • At a terminal multiple of 10, the market is pricing is 3.5% of growth over the next 10 years.
  • It appears that the market is pricing in a faster de-growth in the PV/CV exhaust systems than the growth due to tailwinds in CEV/Tractors and optionalities in EV and sub-component export market.

Missing pieces in the story

  • I have not done a checklist on Management Quality yet. Aashim Relan, the CEO, sounds competent in the conf calls. However, I have not done an objective check on walking the talk, capital allocation history and related party transactions.
  • Most of the information here is from conf calls and research reports. I am yet to go through Annual Reports and look at possible accounting tricks.
  • It is not clear why Maruti is not a customer of SMIL when all other major OEMs are. This needs to be digged into.
  • All claims of the management in terms of regulations need to be independently verified through scuttlebutt.

I have heard @Rokrdude in the conf calls and would be happy to hear his thoughts on this business.
Of course, since valuepickr is a collaborative community, I am looking forward to views from everyone.

Sources

29 Likes

Excellent writeup. You really have done your homework on this stock.

Thanks for the starting this thread on Sharda Motors. I have also been studying the company for the last one month and its good to have fellow VP members to discuss this stock with and gather more information on its businesses.

A few open questions for me, request folks to share answers to these if they have any insights (Especially people who may be related to the auto/emission industry). I will also write to the IR team of the company seeking answers to these questions:

  1. What is the share of traded items in their topline? It appears that they purchase catalysts at the request of certain OEMs and supply it to them at no added cost (Its a complete pass through which only adds to revenues not gets subtracted out in COGS and therefore adds no value at gross margin levels or below). This would help us gauge their true profitability and growth.

  2. What is the true moat in their products? The products aren’t very capital intensive (NFA turnover between 8-10x and doesn’t require substantial incremental capex to either increase volumes or change products for PV/LCV/HCV/CEV/Tractors). They have a large R&D Centre in Chennai with over 100 employees. Is the moat in design IP? It would be great to understand this better from some experienced folks. The industry doesn’t seem to have too many competitors, especially MHCVs and off-road vehicles due to high technology barriers. I understand that tying up with Eberspaecher gives them a technology edge, but that’s only for the JV, how strong and what are their moats for the standalone business where they supply to PVs and LCVs?

  3. Why is the Eberspaecher JV taking so much time to ramp up? FY22 revenues seem to be flat YOY at around 120Cr. They have two plants catering to two major CV manufacturers - my guess is Tata and Ashok Leyland? They have said that one of their CV clients has had a lot of issues in scaling up a new engine for which the SMIL JV has the exhaust system contract due to semiconductor and precious metal shortage issues. While I am disinclined to cast doubts on Management without proof, this reason does not really seem tenable to me especially in Q4 when semiconductor supplies started easing out. Could there be something else wrong with this customer’s supplies? The Q1 JV numbers will be critical to track here.

  4. How long are MHCVs expected to continue on fossil fuels? SMIL expects that post 2025, 80% of their revenues will come from MHCVs and off-highway vehicles where they don’t see any EV related disruption for the next decade (i.e. till 2035). How realistic is this assumption as per experts? This will have a major bearing on terminal value for the company.

  5. How well is Kinetic Green (https://kineticgreenvehicles.com/) placed to capture share in the Indian EV 2W/3W market? The JV with Kinetic Green is going to manufacture BMS and assembly battery packs (not cells) for captive usage by Kinetic Green 2W and 3W. Therefore the JVs success depends, to a large extent, on Kinetic Green’s 2W/3W offtake.

They tied up in Jan with a Chinese 2W manufacturer Aima and are talking about aggressively ramping up their production and no. of models

  1. How well and how fast can the company start exports? They plan to supply exhaust system sub-components to Tier I auto ancillaries and other non-auto engine manufacturers such as generator makers in North America and Europe by leveraging their technology and low costs due to backward integration. They are being questioned on this in every concall, but there aren’t any developments yet. Will watch this closely to check how enterprising the Management is - can it unlock export opportunities on its own?

In addition to 400Cr of cash in the balance sheet, the company also has 2 parcels of land near NCR which its willing to monetise as and when they need cash. The value of land is in 3 figures Crs. Great cash conversion, good ROCEs, high NFA turnover business, debt free with huge cash balances, legislation tailwinds, JV with a top global company - the company seems to have a lot going for it. Will the execution match the narrative?

Have a 2% position. Will add once the story becomes clearer and confidence in Management builds.

5 Likes

Steady results from Sharda. 1.6% QoQ growth in revenues and 9.7% EBITDA margins, marginally less than 10.4% margin in the last quarter.

Interestingly, at consol level EPS has increased QoQ from 14.8 to 15.2 because the Eberspaecher JV has turned a profit for the first time (46 Lakhs PAT) in its existence. As per previous management commentary, this must mean that the JV has started hitting 50Cr+ quarterly revenue run rate. Good news!

3 Likes

Some quick notes from Sharda Motors investor call.
(partial notes since was not able to join for first 30 minutes due to conflict):

  • TREM 4 may not be significant, however from regulatory framework perspective will pave way for TREM5 which is significant for Sharda. So far, TREM 5 proposed date is April’24 however may see some delays depending on TREM 4 implementation.

  • BS6 RDE is net neutral or slight positive on revenue since will require scale down of some parts and addition of new parts.

  • Eberspaecher JV clocked ~40 Crs and broke even for this quarter. In general, guidance of 200 Crs. per year for break even.

  • JV capacity can be augmented quickly since it’s an asset light model.

  • Have been approved under PLI scheme for existing set of products. Are still studying the finer details. However, some parts from TREM 5 will fall under the beneficial category of PLI.

  • Kinetic Green JV - Prototypes has been submitted and expected to have trail run in Q3/Q4. Will supply for both 3W and 2W for Kinetic. Positive is that Kinetic has now tied-up with a China based player for 2W tech. They are not replacing any existing vendor with Sharda. This is day-one business with Sharda.

  • Cash Utilization - Significant 500Crs+ of cash in books. Also, expecting decent cash accrual for coming years since mostly asset light. Looking for M&A opportunities in Powertrain agnostic solutions (quoted suspension as an example).


IMHO there may not be significant incremental growth in PV side hereon since they have garnered good ~60% marketshare ex-Maruti. Immediate next leg of growth driver is CV market penetration and scale-up. Asked couple of questions to clarify CV market positioning for them:

  • Question: CV Market size in value/volume terms. Who all/ how many key vendors catering to CV segment. Sharda’s relationship with each of the two major CV OEMs.
    Answer: CV market size is as big as current PV market size. Predominantly two CV OEM and two vendors play. Sharda is supplying for 1-1 engine specific models for both the OEMs.

  • Question: Sharda’s marketshare in CV segment was in the range of 10% -15% a year back. Is there any change to market position now?
    Answer: In the range of what it was a year back (inference ~15%)

  • Question: One of the CV OEM has own subsidiary into emission control products. Why would they source from Sharda?
    Answer: Currently that subsidiary is manufacturing multiple parts of the emission products. Also, that sub is into other lines of manufacturing (i.e engine parts etc.) Sharda is doing canning work for them on emission control products. Going ahead Sharda can look at supplying the end to end emission control product.

[not fully convincing answer though].

  • Question: Second major CV player may be working with a different vendor for the emission control products for their PV business. Would they not prefer working with the same vendor for CV side of business as well?
    Answer: CV Emission solutions are much more complex then PV. Hence, vendor capability to be evaluated independently.

@nirvana_laha - Noticed that you joined the call and asked couple of questions . Please share your notes (specially for first 30 mins of the call).

Disc: No Investment
Regards,
Tarun

4 Likes

My questions on Sharda concall and the answers:

Q1. Company mentions in presentation that TREM V may be delayed by 1 year
A. That’s company’s assumption, given TREM IV has been delayed from Apr to Oct 2022. May not get delayed as much, have to wait and see.
Q2. When will the company start seeing orders for TREM V given a launch date post Apr 24?
A. The company is already in talks with all major tractor manufacturers regarding design of TREM V products. Company expects to take market share equal to or more than its PV/LCV market share (Around 30%) in the tractors segment and so far traction with OEMs is in line with those ambitions. They expect 2 major suppliers including them to be active in TREM V orders with the 3rd CV incumbent not as active in the tractor segment
Q3. Management had earlier guided that Eberspaecher JV needed 50Cr Qtrly value added revenue run-rate to break even, but it has delivered 50Lakhs profit this Q on a value added turnover of 44Cr, have costs come down?
A. Costs have partially come down due to efficiencies but numbers are ball-park in the region of earlier guidance. Next few Qs should be profitable for JV given uptick in CV demand.
Q4. How many engine systems is Sharda supplying to for each of the 2 CV clients under the JV? What ball-park proportion is this number of the total engine programs run by these 2 clients?
A. Sharda is currently supplying to 1 engine program each under the JV. Not aware of total number of engine programs that are run by these clients (Surprising that he doesn’t know, may be did not want to disclose)
Q5. Given that the standalone business (PV + LCV) is capital light and capital doesn’t become a barrier for entry, what makes Sharda the only Indian company capable of fighting a 3-4 horse race in this segment with other competitors who are predominantly subsidiaries of foreign originated companies?
A. [passionate answer here given by Aashim Relan] There are several reasons for this:

  1. Sharda entered the emissions space for BSIV/BSVI very early in the late 90s. That has given them a big competitive advantage in terms of developing their R&D capabilities.
  2. R&D is the moat for them = 100+ engineers in R&D Centre in Chennai (10% of total employee base). Their technologies are now on par with global counterparts and hence they see exports as a large upcoming opportunity
  3. Full backward integration with tube mills and stamping plants which gives them a cost advantage that can’t be replicated easily
    Any new entrant will take several years to build these capabilities as per Mr. Relan.
    Q6. Will the Kinetic JV supply to Kinetic’s 2W only or 3W also (Kinetic has a good market traction in 3W)? If yes, will Sharda-Kinetic JV replace existing BMS supplier for 3W? When is Kinetic expected to manufacture their first 2W batch?
    A. Yes, JV will supply to 2W/3W both. They may not replace the existing vendor but will share the business/focus on a share of incremental volumes (Hesitant answer here, I think he was being diplomatic. My expectation is they will try to replace the vendor once POC is done; Otherwise why make a JV for captive supply?). Kinetic EV 2W production schedule is still dynamic and he isn’t sure of timelines but tie-up news with China’s Aima in Jan was very positive news as per him. Expect trial supplies to start from Q3 FY23.

Apart from this, some general notes on the call:

  1. They keep getting questioned on why they can’t divulge split of revenues into value added and pass-through. Their answer is that this is confidential information and they are yet to receive approval from 2-3 clients to divulge this. Once they get the approval they will stat disclosing the split.

  2. They also keep getting questioned on why revenue numbers don’t align with volume/revenue growth numbers of CV/PV players YOY. For e.g. Growth rate of revenues for OEMs has been far higher than Sharda revenues YOY for the last few Qs. Their answer is that their sales numbers are linked to engine production numbers and not to vehicle sales numbers. There are a lot of stages between their supply and vehicle sales : Sharda supply to OEM, OEM maintains exhaust inventory → OEM manufactures engine and maintains engine inventory → Based on semi-con availability, OEM assembles cars and maintains car inventory → Car sales happen as per demand. As per Mr. Relan, this long supply chain makes 1:1 correlation of retail/wholesale OEM sales and Sharda sales difficult. I am not entirely convinced by this answer, maybe part of the reason is inventory stocking and de-stocking at OEM end. Management has repeatedly assured that they have not lost any market share and hope to grow faster than OEM growth rates this year as they have done for the last several years.

  3. Exports and acquisitions - Still scanning for acquisitions and export opportunities, will update when there is a material development. For exports, they have received some RFPs/bid for some RPQs and expect developments in the future. For acquisitions they are looking at powertrain agnostic options (I don’t mind them taking a few Qs more but if they can nail the right acquisition in a powertrain agnostic space, that might increase their terminal value substantially)

  4. Plans with 500Cr B/S cash - First priority is to deploy it in business i.e. acquisitions. If acquisitions don’t materialize, then will look at returning it back to shareholders via dividends (No timelines given)

  5. Capex plans - Only incremental capex needed to capture future growth including CEV V and TREM V, capex expected to be in line with last few years’ trend.


My views:
PV/LCV segment : They have a large market share here, so unless they crack Maruti, explosive growth opportunities here will be limited, they will grow as per ex-Maruti industry growth. BS VI RDE will only provide incremental additional value added revenues.

MHCV : Growth opportunity is lucrative here. They are at 180Cr run-rate and can do max 400Cr without additional capex. Enrolled with one engine program each with 2 leading CVs, if they can get themselves enrolled in a few other programs or these engines scale up fast for the OEMs, growth here can be fast. Exports in Asia are another lucrative opportunity due to low cost base for Eberspaecher out of India.

CEV/Tractors : Can add a new market as large as existing PV/LCV market. This is the most exciting growth lever especially as Sharda is already supplying TREM V compliant systems to these players for their exports. So there is not much technical challenge to scale, the market seems to be there for the taking and Sharda’s inputs on trials etc. already having started is quite bullish. Can provide a great revenue and EBITDA spike FY24 onwards.

Exports: With the kind of technical capabilities they claim to have, there is not reason they can’t get a small foothold in exports either in the standalone business or in the JV (JV exports are more exciting to me as standalone exports are likely to be low value add)

Open questions for me:

  1. Why can’t Sharda crack Maruti? Does Maruti have an in-house supply system?
  2. Who are the 2 CV clients for the JV - are they TATA and AL or TATA And Mahindra? Which one of them has a subsidiary manufacturing exhaust systems (@T11 Maybe you can answer this)
  3. How many engine systems do these 2 CV clients have and what will it take for the JV to increase their market share with these 2 players? Will it be a slow ramp up as the clients test out their supplies for a period of years and then allow them to apply for other engines or can they exploit the opening created by OBD II?
  4. What is the expected kit value of BMS + cell assembly for 2W/3W (Can we get this info from other players in India/abroad)? How serious is Kinetic’s bid to become a major player in India EV 2W market? I have shared links above which mention big numbers like 500000 units per year ambition, but does the Kinetic Group have what it takes?

Disclosure : Invested.

7 Likes

Thanks for the great collaboration @nirvana_laha and @T11 . Those were very insightful questions to the management and helps bring some more clarity to the story. Sorry for replying late as I have been occupied with family health issues.

I have done some digging on @nirvana_laha’s open questions. Here is what I found for a couple of them:

  • Why can’t Sharda crack Maruti - It appears that Maruti has a JV with Futaba called FMI Automotive Components. The exhaust systems are supplied through this JV. Some relevant links on Maruti-Fatuba here and here
  • Who are the 2 CV clients for the JV - The management has indicated that the top 2 are their customers in one of the concalls:
  • If we go by CV market share data, the top 2 will be Tata and Mahindra. However, CV market share also includes LCV. If we just take MHCV market share, the top 2 are Tata and Ashok Leyland. I am trying to reach out to friends in the automobile industry to confirm this.
  • Note that, in the concall snippet above, they mention that they supply to the joint venture of one of their customers. I believe this joint venture is Tata Cummins. @T11, is that correct ?

Overall, a turnaround in Eberspaecher JV and the continuing strong cash generation were the positives in the results for me. The immediate key monitorables remain ramp up in Eberspaecher JV, foothold in sub-component exports market, ramp up in EV sales and judicious deployment of cash.

5 Likes

Adding some material here that helps to understand the technology behind emission systems:

  1. Passenger cars - The videos below explain the various parts of the exhaust system for a car, like manifold, catalytic converter, resonator and muffler :
  1. Changes in BS6 vs BS4 and Selective Catalytic Reduction
  1. Canning - The management mentioned that they do calibrated canning for one of their customers. Canning is the process of packaging the catalysts on a ceramic substrate in an engine’s After-Treatment-System. The following videos show the canning process:
  1. Euro6 exhaust after treatment unit - The video below is good visualization of how a Euro6 (from which BS6 was derived) CV exhaust system looks like. The system is pretty compact unlike the image shown above:

From the above videos, one can see that:

  • BS6 definitely increases the content per vehicle due to additional after-treatment-system
  • For diesel engines, the content increase is much more due to addition of Diesel Particulate Filter (DPF), Diesel Exhasut Fluid (DEF) and a more complex SCR.

Some additional observations:

  • Since BS6 increases the costs significantly for diesel engines, it has led to Maruti completely stopping it’s diesel vehicles program. More details on this link. Maruti is instead pivoting to CNG.
  • Does this add an additional risk to Sharda’s revenues if other PV manufacturers gradually move away from diesel ? I think it does add a risk of a potential decrease of content per vehicle in the PV exhaust revenues where it has 30% market share. This should also be closely monitored.
4 Likes

Thanks @manpritaurora for your insights on the open questions and the great videos which helped in understanding the entire exhaust system of a vehicle. Meanwhile, I received a telephonic revert from the Sharda’s IR company with answers to some of my questions (Most of the answers were generic though and did not offer much extra insight)

A few points based on the posts in the thread and the revert from SMIL:

1. Maruti : As mentioned, Maruti has a tie-up with Futaba from Japan which is one of the leading 8-10 global companies in automotive exhaust systems. I got to know from SMIL IR team that recently Tenneco has won a small share of business with Maruti. Regarding SMIL’s prospects with Maruti, they didn’t have much to say. I think scope is limited for SMIL with 2 global players already having entered.

2. SMIL product portfolio : As I could understand from the videos shared by @manpritaurora and also others on YouTube, an exhaust system comprises of multiple components such as exhaust manifest, various sensors (O2, NOx etc.), 3-way catalytic converters including SCR for BSVI norms, sound moderation components such as resonators and mufflers and the exhaust pipes including tailpipe.

The question is, what does SMIL manufacture and supply to Indian OEMs? Does it manufacture the entire exhaust system with all components starting from exhaust manifest to tailpipe or does it only manufacture a sub-section of the components?

From SMIL’s product page these are the exhaust products in its kitty :

When SMIL says BSVI system or BSIV system, does it mean the entire set of components? I am confused because the most commonly asked question on the concall is regarding traded vs value-added revenues where-in the trading revenues come from pass-through sales of catalysts which SMIL is made to procure by OEMs. Now I am confused if this “catalyst” means the ceramic with the metals or does this mean the entire catalytic converter unit?

If its the latter, then SMIL may be missing out on good margins as the Catalytic Converter is the most expensive part of an exhaust system in my view (Due to the presence of rare metals like Pd,Pt,Rh). Even the Eberspaecher JV is doing the same.

If its the former, then it seems like SMIL procures the catalyst and then does its own canning work (assembling the catalyst into a single unit as per the video shared in the above post).

Can somebody clarify what’s the actual picture here? Is it that SMIL is missing some capabilities and hence losing out on catalytic converter margins as compared to the likes of Tenneco and Faurecia?

An example of Tenneco’s technology : CSTU (Cold Start Thermal Unit) which ensures proper exhaust screening even during cold starts or extended idles - CSTU | Tenneco

3. CNG Vehicles - are they part of TAM or not? At present SMIL does not supply to CNG models either in PVs or CVs (confirmed by IR Team), But as CNG grows and diesel shrinks, CNG may become a necessary segment for SMIL. The question is, can SMIL supply its diesel/petrol exhaust systems for CNG vehicles? As far as I could research online, there doesn’t seem to be any separate exhaust system design requirement for CNG vehicles. Also the fact that CNG kits are fitted in the aftermarket in gasoline vehicles without changing the exhaust system suggests that CNG should be part of SMIL’s TAM. @manpritaurora When you say reduction in content, do you mean the reduction that will happen due to moving from a higher content diesel model to a CNG model where content is similar to gasoline?

4. CV Clients : It seems like the 2 clients for the JV are Tata Motors & M&M. M&M has both SMIL and Tenneco in its supplier list, so I am assuming Tenneco supplies to M&M PVs and SMIL to M&M CVs. That leaves Ashok Leyland and Eicher in the CV space, would be interesting to find out who is supplying exhaust systems to them.

4 Likes

Great questions @nirvana_laha . I think we need to dig more on what exactly “catalyst” sales mean in the context of SMIL.
On the CNG front, yes, I mean that if CNG and gasoline exhaust systems are similar (and have lesser content per vehicle), any structural move in the PV/CV industry towards CNG (and away from diesel) could lead to a decrease in content for SMIL.

2 Likes

3 Likes

Adding some running notes here on the Indian competitive landscape. It will be great if any industry experts or anyone else tracking this can add to it.
It appears that few of the top OEMs are, in some form, directly involved in manufacturing their exhaust systems:

  • Maruti has a JV with Futaba called FMI Automotive as highlighted earlier here
  • Ashok Leyland has a subsidiary called Albonair that supplies exhaust systems to it. Some relevant links here and here
  • Tata Motors has an affiliate called Tata AutoComp that has a JV with Katcon called Tata AutoComp Katcon Exhaust Systems. Katcon is a global supplier of exhaust systems based out of Mexico. More info here

Apart from OEMs, the space is occupied by MNCs, SMIL and smaller Indian players.
The major MNC players are:

  • Tenneco: It operates its exhaust business in India through “Tenneco Clean Air India Private Limited” It’s financials on Tofler are available here
  • Faurecia: It operates its exhaust business through a JV with the Anand group (same promoters as Gabriel India). More details on the JV on this link. It’s financials on Tofler are available here.

Among other players, the one I found interesting was S. M. Auto. S M Auto had entered into a technical collaboration with Eberspaecher for passenger vehicles. However, for commercial vehicles, Eberspaecher decided to partner with Sharda Motors. It would be interesting to know why Eberspaecher went ahead with Sharda for CV when they already had a collab with S M Auto.for PV.

The other key question is when the OEMs have their own JVs for exhaust systems, then why do they still buy from Sharda/Faurecia/Tenneco/others ?

6 Likes

Ex Sandhar Tech CFO joins Sharda Motors as President Finance and Strategy. Seems like a good appointment to me.

1 Like

Couple of interesting things going on for Sharda:

  • Have been able to capitalize the Bharat 6 emission requirement very well. Close to 35% market share in PV+LCV segment and numero-uno 65% market share ex-Maruti.
  • Step-functional 2.6x growth between 2020 – 22.
  • Bringing in strong partner by way of Eberspaecher for high complexity M&HCV exhaust system. The Eberspächer Group of Companies is an international automotive supplier with 80 locations in 28 countries. The company is a segment leader in the developed economies with a 75% market share in Europe and 50% market share in the US.
    • This M&HCV market (6 ton+ weightage) is ~0.4M units/year where Sharda + Eberspächer group has ~15% market share only. Pace of market share gain will be slow and grinding since this is predominantly 2 OEM and 2-3 vendor market with existing established locked-in relations.
  • Foraying into futuristic segments like EV battery management system by forming JV with Kinetic Green. 74:26 JV for manufacturing of Lithium batteries along with BMS for Electric Vehicles – 2W, 3W and Stationary applications. IIT Madras, will provide technology for Li-ion battery energy storage for electric 2 wheelers, 3 wheelers and other small electric vehicles to the JV.
    • Kinetic is number one player in e-ricksaw segment and equally strong in 2W. Kinetic Green has got great momentum – projection of ~1000 Crs revenue by FY2023 is significant a number for nascent industry with huge TAM still to capture over period.
    • Riding on growth velocity, Kinetic is looking at 3x capacity addition in next 18 – 24 months.
    • Technical collaboration with China’s largest electric two-wheeler maker Aima Technology Group. As per the agreement, Aima will assist Kinetic Green in localising its products for the Indian market
  • Cash-pile of ~500 Crs. (current market-cap of ~2300 Crs). Management open for inorganic avenues – preferably into EV disruption free adjacencies - so far proceeding with prudence and caution. Cherry on top – looking at monetizing two land parcels in G. Noida (indicative 3 digit in crores value).

Significant near/mid-term opportunity where company is positioned advantageously based on existing strong engagement is about TREM 4 and TREM 5.

  • Annual tractor market is ~1m, export constitute of 1 lakh units.

  • TREM 4 applicable for tractor engines above 37kW (50 HP) up to 560 kW (750 HP),

  • Only ~13% of the tractor production will fall into the scope of TREM 4 under (>50HP).

  • Also, industry is expecting some down trade between TREM 4 to TREM 5 implementation period for 50 HP+ segment since >50HP price will go up by 7% -10% to accommodate for TREM 4 requirements.

  • Current projected date for TREM 5 is for April’24 covering a wider range of engines, including those smaller than 8 kW (11 HP) and those larger than 560 kW (750 HP).

  • M&M has lions share of ~40% of entire domestic tractor market followed by TAFE Sonalika group and Escorts. Except Sonalika, rest three are existing customers for Sharda (2/3rd of Indian domestic tractor market). That’s why management is counting TREM 5 as significant opportunities.
    image
    image

  • From an effective timeline perspective, TREM 5 may see significant delay to materialize since TREM 4 itself has been dragging for quite some time. TREM stage IV has seen significant delays - initially from Oct’20 to Oct’21 to March’22 to Oct’22 to ‘yet to be decided/communicated’.

  • Resistance to TREM 4 and 5 implementation is twofold – farmers will have to shell out 7% -10% higher cost for owning tractor. Likewise, tractor manufacturers fears for demand/margin impact due to higher cost.

  • In fact, tractor body TMA (Tractor and Mechanization Association) is putting up stiff resistance by picking holes in very TREM proposals. This whitepaper (White Paper-Emission.pdf (854.9 KB) ) makes for an interesting read and gauge the extent upto which industry body really want to stretch this. Their trump card is creating an impression of policy level conflict between MoRTH and Ministry of Petroleum and Natural gas

“In a drawbar product such as tractors, fuel efficiency and stringent emission norms tend to be oxymoronic as far as cost of ownership is concerned. Thus, it appears that the Ministry of Road Transport and Highways and the Ministry of Petroleum and Natural gas may end up working at cross purposes, as far as the farmer’s interest is concerned. “


Some negative points:

  • CV JV is loss making (except recent quarter where net positive ~35 lacs). Can break even at a run rate of 200 Crs./ year
  • Sharda is not into catalytic converter manufacturing by its own. They render procurement and supply chain management activity on behalf of customer for CC. For an emission system player, that leaves them with cold end products and canning work. This is reflected in the margin profile.
  • EBIDTA margin in the rage of 9 – 11% including other income to the tune of 25 – 30 Crs per year. While margins are optically depressed due to trading of Catalytic converter getting added to revenue with not much margin addition.
  • TREM stage IV has seen significant delays - initially from Oct’20 to Oct’21 to March’22 to Oct’22 to ‘yet to be decided/communicated’. Therefore, safe to assume that TREM 5 is going to take couple of years.

Overall, M&HCV and TREM 5 are two significant opportunities on the horizon which are as big as current PV+LCV that they have been able to convert aptly well. How much and how soon these will unfold is worth tracking. Balance sheet is very strong with debt free status and ~500 Crs of unincumbered cash. Valuation comfort is there by way of 7 times EV/EBIDTA and 13 times Price to Earning.

Thanks,
Tarun
Disc: Recent Position

7 Likes

@manpritaurora and I did some digging into the financials of Sharda’s main competitors in India - Faurecia India, Tenneco India and Tata Katcon (Tata Autocomp JV with Katcon). Here’s a summary of the comparison of the numbers of the 3 companies for FY21 (Tenneco and Faurecia are yet to file FY22 numbers)

A few key points from the above data:

  1. Sharda is the largest player in the industry followed by Tenneco
  2. Although Faurecia seems to have really strong margins, it has booked huge depreciation in FY21 so EBIT and PAT are -ve. Payable days are also too high - may indicate cash flow stress?
  3. This seems to be a high NFAT industry although Faurecia NFAT is low (May be due to recent capex). So Sharda’s high NFAT figure may not be an outlier/cause-for-concern (Needs more digging - How much are trading revenues as % of total? Sharda AR says 50Cr only, but is that all? Concalls seem to suggest higher traded revenues)
  4. This seems to be a very working capital efficient industry with all players more or less having -ve cash-conversion-cycles
  5. Non Indian/Asian OEMs seem to be clients of Faurecia and Tenneco (They are leveraging their global relationships I guess)

A few other key points from industry scuttlebutt (thanks to @GourabPaul):

  1. Industry players seem to be sourcing Oxygen and NoX sensors and Adblue dispensers from the likes of Bosch. They don’t make these in-house. This means emissions players may be restricted to cold-end, hot-end and pipe related mechanical components. This needs to be confirmed with Management.

  2. Couple of private players seem to have invested in JVs with foreign partners recently to tap into TREM IV, TREM V opportunities such as SM Auto (Has tied up with a Finnish Exhaust systems company called Proventia) and
    Mangla Tubes (Has entered a JV with an Italian company called Cornaglia). Need to evaluate how credible their threat of entry is in the TREM IV, TREM V space.

4 Likes

Interesting data point on how domestic tractor market share is evolving across different players (source):

VST (from a very low base though) and International tractor (part of Sonalika group) are garnering market share, gradually. Remarkable feet by M&M who has been able to keep such a large market share over such long period of time and competiton is still miles behind.

Tarun

5 Likes

Good results from Sharda

11% QoQ and 19% YoY revenue growth. EBITDA has expanded by 100bps QoQ.

JV revenues and profits seem flat QoQ.

Extremely healthy cash flows in H1 FY22 - 163Cr. CFO/EBITDA for H1FY22 is 1.19x.

3 Likes

Some quick takeaways from reported numbers:

  • Growth momentum continues with significant ~20% top line growth. However, looks like sales growth was not easy to drive. Had significant trade-off on working capital side - which historically has been under tight reins.

Inventory went up by 59 Crs, AR by 40 Crs and AP gone up by significant 154 CRs.

  • JV profit share of 52 Lacs. consecutive two quarters of reported profit. Hopefully the losses are behind and JV builds up from here on. As management has indicated in earlier calls, JV revenue is not getting clubbed to consolidated number, only consolidation happens at share of net profit level, therefore little difficult to gauge JV revenue contribution (except indicated during concall).

  • ~26 Crs of PPE addition + 12 Crs increase in right to use assets.

  • Cash built-up ~265 Crs. with very limited debt on the books.

Thanks,
Tarun

3 Likes

@T11, @nirvana_laha and I collaborated on the Q2 FY23 concall so as to get more insights from the management on the following next levers of growth:

  • Eberspaecher JV on MHCV: Sharda’s potential to capture market share, MHCV competitive landscape, how this will move the needle
  • EV battery JV with Kinetic Green - What kind of capabilities does Sharda have and how they are filling the gaps
  • TREM 5 regulation for tractors: Prospects of TREM 5 regulation getting derailed or delayed significantly by the Government as TREM 5 will increase the cost of tractors for farmers.

Here are the Q2 FY23 concall notes (transcript here):

Eberspaechar JV on MHCV

  • Focus is on stabilising the JV and bringing it to profitability. In the last 2 quarters, JV has been able to post profits, though quite small for now. As a side note, the management mentioned “focus on stabilisation of JV” quite a few times in the concall.
  • The new engines that this JV is selling to are not performing as well as the other older engines. The older engines are still being preferred in the Indian market
  • MHCV market is concentrated and 5 - 6 engines drive 90% of the market. The JV supplies to newer generation of 2 engines out of these 6.
  • Market share will be dependent on how the new engines perform based on the market response and if they win new RFPs for other engine programs.

EV battery JV with Kinetic Green

  • First prototype is ready and is under testing. If things go well, some minimal production may start at the end of Q3 or Q4.
  • Focus is on phase 1 i.e. on battery assemblies for the JV, test these extensively, put them out in the field and once there is stabilisation, look at phase 2 i.e. expand beyond Kinetic Green.
  • Want to be asset light in phase 1 I.e. will do just designing and assembly of battery packs
  • Not making the BMS, only doing BMS selection right now. For making the BMS, partnerships will be required
  • Market currently is dynamic with technology shifts. They want to be adaptable and flexible as a strategy.

TREM 5

  • Government is very keen on clean air initiatives and they are sure Govt. will go ahead with these initiatives.
  • Management did not want to comment on possible delays in TREM 5 but all customers are preparing full swing for TREM 5 so that gives them a very positive feeling that TREM 5 will be implemented eventually
  • TREM 5 is a bigger opportunity than CEV 5

Exports

  • Looking at exports in 2 segments
  • Segment 1: Off-road or small engine segment for supply of exhaust systems. They already export to couple of customers in America but want to double down and add customers in this segment. Potential addressable market is large.
  • Segment 2: Subcomponents. Some of the proprietary subcomponents they manufacture have a huge export market and they are building an export front. Have a good number of RFQs in their pipeline.
  • Focus is on exports to US and Europe

RDE norms

  • To be effective from Apr 1, 2023
  • Sharda will have a 25% increase in content for Diesel engines and 10% for petrol engines

Cash utilisation and capital allocation

  • First preference is towards M&A in powertrain agnostic products
  • Also want to return it back to shareholders in a tax friendly manner

The meaningful drivers of growth for them in the short/medium term will be:

  • TREM 4 (Jan 2023, minor)
  • RDE (Apr 2023)
  • CPCB 4+ (July, 2023, minor increase)
  • TREM 5/ CEV 5 (Apr 2024, major increase)
  • Sub component exports
  • M & A in power train agnostic
  • EV in medium term
9 Likes

What is Sharda’s stake in the JV with Kinetic Green?