Diwali Dhamaka Picks
Monday, October 19, 2009
Given the signs of gradual recovery in the commercial vehicles segment investors with a long-term horizon can consider buying the stock of Clutch Auto at Rs 39.30.
Factors such as improving industrial production numbers, thrust on highway and infrastructure projects and orders for new buses under the JNNURM programme, suggest that the recovery in commercial vehicle (CV) sales may sustain over the medium term. Trading at a price-earnings ratio of 11 times, Clutch Auto appears well-placed to ride on the CV revival, given its significant exposure to this segment.
Clutch Auto is India’s largest manufacturer and exporter of clutches. Its product portfolio comprises clutch cover assemblies, clutch plates and discs, clutch repair kits, and other related components. With a well-diversified product portfolio, the company caters to CVs, passenger vehicles, tractors and earth movers. Clutch Auto derives about 35 per cent of its revenues from sales to original equipment manufacturers (OEMs), 45 per cent from aftermarket sales and the balance 20 per cent from exports.
The clutch is the most critical auto component that needs to be replaced frequently in a CV and has a replacement cycle of around 10-12 months, while the clutch cover assembly can be replaced once in four years. Clutch Auto has entered into co-branding agreements with some key customers to strengthen its foothold in the replacement market.
Betting on CV
The company focuses primarily on heavy-duty clutches for CVs and tractors. This forms 95 per cent of its sales with the balance 5 per cent coming from the passenger car segment. Tata Motors, Ashok Leyland, Escorts, Eicher, TAFE and Bajaj Auto are some of the major customers in this segment. Apart from slow revival in medium and heavy commercial vehicle (M&HCV) demand, visible growth in the light commercial vehicles (LCV) segment and tractors may help the company manage growth over the medium term.
While M&HCVs registered a decline of nearly 19 per cent between April and September 2009 compared to the corresponding previous period, LCVs have grown by 19.5 per cent. Tractor sales too have risen despite a poor monsoon. Mahindra and Mahindra, a key customer for Clutch Auto that commands a market share of 41 per cent in tractors, saw its tractor sales rise 42 per cent in this period. In the passenger vehicles segment, Maruti Suzuki is the major customer for the company.
The replacement market’s contribution to the company’s total revenues has increased from 25 per cent in 2005-06 to 45 per cent now since they offer better margins compared to the OEM market.
Clutch Auto has a strong R&D expertise and technology knowhow which has helped it not only retain and expand its client base but also build a large replacement market. In FY-09, higher sales from replacement demand have helped the company offset the decline in offtake from the OEMs.
Reaching out to over 40 destinations, 85 per cent of Clutch Auto’s export revenues come from Latin and North America. The acquisition of the clutch division of Pioneer Inc Automotive Products in the US has enabled Clutch Auto expand its presence in the country. The export market is driven mainly by the replacement demand, with Navistar being the major OEM customer. The company plans to increase revenues from exports by 30 per cent by the next fiscal.
From 2003-04 to 2006-07 (the boom period for CVs), Clutch Auto registered a compounded annual sales growth of 25.6 per cent. Sales began to slide from the December quarter of 2007, and due to unfavourable market conditions that prevailed the whole of last fiscal, the company’s net sales fell by about 10 per cent, operating profits by 20 per cent and net profits plunged by 63 per cent on the back of higher interest cost and depreciation charges.
However, as demand for CVs picked up from the last quarter of 2008-09, Clutch Auto has been posting better numbers. In the first quarter of this fiscal, the company posted a sales growth of 17 per cent, boosting its operating profit by 31 per cent and net profits by 11 per cent.
Clutch Auto has improved its product mix to its operating profit margins by about 2 per cent to 15.5 per cent in June 2009. With prices of steel (primary production input) appearing relatively stable for the medium term, the company may not suffer the high input costs that prevailed in the first two quarters of last fiscal.
However, the biggest risk to the company’s outlook is any delay in the revival of the M&HCV segment. With a market cap of about Rs 62.9 crore, the stock’s micro cap status makes it quite vulnerable to market swings.
Shareholders can consider holding on to the stock of Jindal Steel and Power, now trading at 15 times trailing 12-month earnings, despite the run-up in stock price.
While this is at a stiff premium to peers in the steel sector, it is at a discount to power majors such as NTPC and Tata Power, which are at 20 and 19 times trailing earnings respectively.
The premium valuations can be justified by the company’s major expansion plans for both its steel and power holdings, backed by a solid execution track record.
The company’s raw material linkages and high operating margins for its steel business and high realisations and captive fuel for the power business, make the stock a good exposure to both the sectors.
Jindal Steel and Power (JSPL) has gradually added capacity over the past three years to produce three million tonnes of steel at its Chhattisgarh plant, with the product line comprised mainly of ‘long’ products.
These products cater mainly to the infrastructure segment, including Railways and structural products for real estate, bridges, and so on.
JSPL’s raw materials and power requirements for steel are largely met by captive sources. The company’s operating margins, averaging an impressive 38 per cent since 2005 and at 33.4 per cent for FY-09, are higher than peers such as SAIL and JSW, mainly due to this backward integration.
Sales have grown at a compounded average of 44 per cent annually during the same period. The company has plans to add 2.2 million tonnes of capacity at Jharkhand and Chhattisgarh by 2010 and another 7.8 million tonnes at Orissa and existing locations by 2012-13, quadrupling its output over three-four years.
Sober estimates point to a total domestic capacity of 80-85 million tonnes by 2014, of which JSPL’s share is small. Keeping in mind the long overdue push in infrastructure development, these volumes should be easily absorbed by the market. .
With lower debt on its balance sheet than peers giving it a debt:equity ratio of 0.95:1; JSPL enjoys a comfortable interest cover of eight times, with a healthy net profit margin of 28 per cent in 2008-09.
Excluding the value of JSPL’s power subsidiary (valued at about Rs 28,000 crore), the residual market capitalisation for JSPL’s steel business is about Rs 23,700 crore.
That suggests that the steel business is valued at 15 times the 2008-09 earnings. Assuming the company produces 5.2-5.5 million tonnes of steel by 2010-11, the PE multiple would amount to 10 times on forward earnings. However, it is the power business with its high margins and increased capacity that is the company’s trump card.
The power business contributed to a third of the company’s sales and slightly more than half the operating profits in 2008-09.
Despite being an early mover in the private sector power generation, JSPL has conservative capacity-addition targets compared to many new entrants. The company now has a total capacity of 340 MW on its books and 1,000 MW in its subsidiary, Jindal Power (JPL). JPL plans to add 2,400 MW (brownfield expansion) in Tamnar, Chhattisgarh and JSPL targets 2690 MW captive addition for its steel requirement over the next four years.
In addition, JSPL has entered into an MoU with the Arunachal Pradesh Government to set up 4500 MW of hydro projects. Captive coal mines allotted to the company for the 1000 MW power project minimise fuel risks and reduce input and transportation costs. The fact that JSPL’s sales are pegged entirely to merchant power tariffs offers scope for higher realisations than other power generation companies that are subject to regulated tariffs.
The company’s costs are also low, thanks to its fuel linkages. Captive transmission lines (400 KV, 254 km line) connected to the national grid put the company at an advantage to wheel its power for merchant use.
The company will continue to enjoy high realisations, helped by merchant power, given that the demand-supply mismatch is likely to persist over the next three-four years. Surplus capacity from the captive power plant with JSPL is currently being sold on a merchant basis.
With the company adding to captive capacity, surplus generation from these projects may also contribute to revenues over the next couple of years.
Last year, 1125 million units (MU) were sold on a merchant basis from the captive power plant, besides the 6369 MU sold by the power subsidiary. Revenue contributions from the Tamnar project are likely to increase in the current year as the project operates at its full capacity.
JSPL has plans to unlock value in its power subsidiary by listing it early next year. Investors can expect higher earnings growth from the company’s power segment even if average realisations moderate with the demand-supply gap narrowing.
With a good portion of the upcoming power capacity to reflect in JSPL’s own books, the listing of the power subsidiary may only unlock partial value from the power business. Of the total 5090 MW thermal capacity to be added in the next four years, only 2400 MW is being developed by Jindal Power.
Assuming a conservative PE multiple of 15 times the 2010-11 earnings for the power subsidiary, the market capitalisation for this business works out to about Rs 28,000 crore (Rs 363 per share).
We have assumed revenues from the present power capacity of 1000 MW project alone. A proven track record in executing and operating power projects and assured fuel and distribution linkages may make Jindal Power a preferred exposure to the power generation sector.
Demand for pressure cookers in growing consumer markets never runs out of steam. This augurs well for TTK Prestige, the company which owns the single largest pressure cooker brand in the country. Against the 8 per cent growth reported by the industry last year, TTK Prestige reported a 17 per cent growth in its sales volumes. With the company roping in new customers through its retail chain — ‘Prestige Smart Kitchen’ — its auxiliary products (kitchen electrical appliances, cookware) are also doing well in the market with a growth of over 25 per cent in the last five years. The stock trades at 14 times its trailing one-year earnings. Investors can add this small-cap stock to their portfolio.
Pressure cookers are a fast growing segment in the Indian consumer durables market. The demographic shift in favour of the young, an expanding working population and a higher floating population in urban areas are trends that translate into higher demand for pressure cookers in India. Makers of branded cookers are also benefiting from a shift from unbranded to branded products, as safety issues prompt consumers to opt for tried and tested products.
After starting out as a manufacturer of pressure cookers, TTK Prestige now offers complete kitchen solutions with a product range comprising non-stick cookware, rice cookers, gas stoves, kitchen hoods, kettles, sandwich toasters and many other small electrical appliances. The company is also into the modular kitchen segment.
The single largest brand
The average annual production of pressure cookers over the last five years was 40 lakh units. In 2008-09, TTK Prestige, which sold 23.7 lakh units of pressure cookers, accounted for over half this number. The company has been seeing a sharp increase in sales year after year, suggesting that it has managed to gain market share.
TTK Prestige’s sales have grown at an average 21 per cent in the last five years, while industry growth rates were in single-digits.
Hawkins Cookers, the only other listed player, is the company’s major rival with a presence mainly in North India. However, Hawkins is much smaller, with just about half TTK Prestige’s revenues. Apart from TTK Prestige, several smaller regional players such as Premier, Pigeon, Butterfly also compete in the Southern market.
However, the safety aspect does lead to strong brand preferences in the pressure cooker market, giving an edge to established players such as TTK Prestige. TTK Prestige pressure cookers are certified for safety under the Indian (ISI), German and US standards.
TTK Prestige’s cookware and kitchen electrical appliances are also making headway. Their contributions to revenue rose to 15 per cent and 18 per cent in the last year from a little over 12 per cent five years ago.
The company sees considerable opportunity for expansion in these segments, with revenues set to increase sharply once these products are marketed more aggressively.
Unlike the pressure cooker market, competition in the kitchen electrical appliances segment is tough with a number of branded and large regional players in the fray as well. TTK Prestige’s export sales have also been on the rise. Though the last year was challenging due to recession, exports grew over 10 per cent in 2008-09.
The company’s current installed capacity in pressure cookers is 40 lakh units. But as it is running only at 50 per cent of its capacity, there is room for scaling up production with demand expected to rise in the coming years. The company will enjoy higher revenues as the market grows in size with no additional capex/interest.
The company’s new gas stove and kitchen electrical appliances manufacturing unit in Uttarakhand, which is to begin production by March 2010, may lift margins due to excise duty and tax savings. The company has been importing a few kitchen electrical appliances for selling in the domestic market, the initiative of producing those appliances domestically now will be an advantage for the company.
Further, the company will see almost nil interest outgo from the current year (last year’s interest outgo Rs 5.65 crore) as it has repaid all outstanding loans. In 2008-09, the company repaid Rs 26 crore of outstanding loans and another Rs 20.7 crore since April this year.
Supplementing its core business, TTK Prestige has 6.5 acres of surplus land in Bangalore, having shifted its pressure cooker unit from this location. This area is now being developed into a residential and office space, rentals from which will start flowing from 2012. Cash flows could be furthered strengthened from these rental incomes in the coming years.
In the last five years TTK Prestige has reported a solid 56 per cent growth in profits after tax (as revenues rose 21 per cent). Operating margins too have improved from 6 per cent to 9 per cent in this period. Net profit margins grew from 2 per cent in 2005 to 5 per cent in the last year. There was an increase in tax outgo in the last year as the company moved to normal tax regime from MAT (minimum alternative tax).
The company enjoys pricing power to pass on raw material (aluminium and stainless steel) price increases to consumers, given its strong market position. So any steep price rise in inputs from here on may not dent profit margins. As the demand for pressure cookers is price in-elastic, price hikes will not impact off-take.
TTK Prestige has also been quite generous in declaring dividends. A minimum of 30 per cent dividend has been declared every year in the last three years.