Buy GREAVES COTTON; TARGET PRICE: RS.110 :Kotak Sec

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GREAVES COTTON LTD
PRICE: RS.74 RECOMMENDATION: BUY
TARGET PRICE: RS.110 FY13E P/E: 9.1X
q Greaves Cotton is one of the largest makers of light diesel engines in the
world. Over the years, the company's focus on R&D has resulted in an
efficient product which is gaining acceptance with OEMs like M&M and
Tata Motors. The company is in negotiations with OEMs for taking price
hikes on products. If these hikes materialize then we expect margins to
respond positively in Q4FY12. The stock is down 14% since the beginning
of the month. We reiterate BUY with a target price of Rs.110, providing
an upside of 47%.
q Risks and Concerns: Firming of interest rates is negative for 3W demand.
3W volumes were weak in October especially of Piaggio. Elevated
interest rates may have begun to soften demand. However,
the long-term drivers remain intact (rising urbanization).
Management remains optimistic about the growth outlook and is
enhancing capacities for various products. We recommend buying
into stock correction.
n The company is the sole supplier of light diesel engines to OEMs like Piaggio,
M&M and Atul Auto. Piaggio is the prime client accounting for the bulk of automotive
engines revenue. We estimate 3W's to account for roughly 70-80% of
auto revenues and around 50% of total revenue for the company and hence is
an important variable to monitor.
n The company is thus a part play on the 3W segment (passenger and cargo)
which in turn is driven by rising urbanization and usage of light cargo vehicles for
intra-city transportation.
n The Indian 3W sales volumes during the Apr-Oct 2011 stood at 525809 units vs
454173 units, a growth of 16% yoy. However, the demand has started to moderate
in recent months.
n Piaggio's 3W sales in Apr-Oct 2011 are down marginally. For Oct 2011, Piaggio
3W volumes were down 5.4% yoy for the third consecutive week. However, the
impact has been cushioned by strong volumes from M&M and Atul Auto during
the same period. As a result, the volumes for GCL's OEMs were up 9% yoy in
the same period.
n While the growth in the 3W segment has seen moderation (primarily due to economic
slowdown and higher interest rates), strong numbers from the non-auto
side (Industrial engines, exports and diesel pumpsets) has enabled the company
to post 18% yoy growth in engine segment in H1FY12. The company indicated
that volumes in the industrial engines segment doubled on a yoy basis. Similarly,
international operations (Rs 200 mn in H1 FY12) also reported substantial jump in
revenues in the current fiscal.
n We understand from our industry interaction that the general inflationary conditions
and firm interest rates have pulled down the growth in 3W in current fiscal.
Apart from this, there is general shift in demand from 3W cargo to 4W mini
trucks. Over the medium-term, the 3W segment is forecast to grow at 8-10% pa.

n The 4W LCV segment has continued to defy the economic slowdown and has
been posting strong volumes. LCV volumes in Apr-Oct period have grown 34%
yoy to 220,321 units. Tata Motors continues to lead this segment with a market
share of 55%.
n Tata Motors has an exclusive sourcing arrangement with GCL for single cylinder
diesel engine to be fitted for its Magic Iris/Ace Zip LCV models in the 0.6 ton
range. Supplies have started meaningfully since the month of September.
n The company indicated that initial feedback for this vehicle has been good and
volumes are going up progressively. The company is currently clocking volumes
of 4000 per month and expects to deliver ~30000 units in the 2H FY12.
DG sets - (15-17% of revenues)
GCL is mainly present in the low and mid KVA range upto 250 KVA. The market for
DG sets has slowed down in the current fiscal due to moderating economic activity
and sharp cutback by the Telecom industry. As a result, there has price undercutting
by various players.
Infrastructure Equipment segment - (15-17% of revenues)
In the infrastructure equipment segment, the company makes concrete mixers and
pavers. This segment was affected by monsoons and change in emission norms
which disrupted engine supplies. Consistent interest hikes have also resulted in softening
of demand.
Power Tillers- - (15-17% of revenues)
With the various measures adopted by the government and a normal monsoon the
agriculture sector continue to drive healthy demand for low-cost mechanisation.
The government's strategy to improve credit availability and interest subvention
to farmers coupled with rising cost of manual labour is spurring the growth in this
sector. The power tiller sector in India is largely dependent on Government subsidies
and is growing around 20% p.a. The industry is witnessing intense competition
from Chinese brand tillers that are increasing their presence in the domestic
market and posing a major challenge in this segment. The major player in this segment
is VST Tillers (Revenues of Rs 2.7 bn in FY11). Currently, compared to China,
farm mechanisation remains at low level in india. Realising its potential, GCL has already
spread its presence across the country and is now present in 440 districts. The
revenues from this segment are seasonal in nature with Q3 accounting for bulk of
sales.


Other Highlights
n GCL is in negotiations with OEMs for taking price hikes on products. These are
expected to materialize in Q3 and Q4 and should aid improvement in EBITDA
margins going forward.
n The company continues to be net debt-free with borrowings of Rs 313 mn and
cash worth Rs 289 mn as on September 2011.
n There has been an increase in working capital mainly due to higher inventories
and loans and advances (mainly due to supplier advances).
n The company undertook capex of around Rs 420 mn in FY11 towards general
modernization and Greenfield capacity at Aurangabad. The company expects to
spend about the same in FY12. The company expects to exit the year with close
to 480000 engines pa capacity (360000 units in FY11) spread between
Aurangabad (old and greenfield) and Ranipet (110000 pa).
n The company's medium term objective is to move up into higher capacity engines
and tap greater share of OEM business. The LCV market is largely sub one
ton currently. As the market moved in the higher tonnage category, GCL would
be ready with its engine meeting the applicable emission norms.
n Although the company is not actively looking at acquisitions, but a reasonably
priced facility for manufacturing high precision engine components could be considered.
GCL makes single and twin cylinder engines currently. For graduating
into three cylinder engines, the company may look at acquiring technology.
Valuation
GCL is currently trading at 10.4x and 9.1x FY12 and FY13 earnings respectively. In
view of the strong set of numbers and adequate upside of 47% from current levels,
we maintain BUY on the stock with an unchanged DCF based price target of
Rs.110.