initiating coverage on Setco Automotive Ltd. :: Shah Investor's Research Team

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initiating coverage on Setco Automotive Ltd.

 

CMP Rs.206

Target Price Rs.249

Recommendation BUY

Initiating Coverage

Setco Automotive (Setco) is a leading auto component company in India and among the top M&HCV clutch manufacturer in the world. We initiate Coverage on Setco (CMP Rs.20) with BUY recommendation with a target price of Rs.249; which is 21% upside from current levels and an investment horizon of 12 months. The stock at Rs.206 is currently trading at 8.8x FY13E EPS of Rs.23.2 and 7.9x FY14E EPS of Rs.26. Our target price is based on DCF analysis.

Setco’s unique business model, market leader in M&HCV OEM clutch segment, capacity expansion, robust distribution network in OES segment and divergence in new geographies and segment would lead to 20% CAGR growth in revenue from FY12-14E.

Investment Argument

F  Unique and robust business model

Setco is the largest supplier of M&HCV clutches to Tata Motors, Eicher and Asia Motor works, meeting up 100% of Clutch requirement. It also meets 65% of clutch requirement of Ashok Leyland. Setco is a domestic market leader with 85% market share in OEM segment and 35% market share in OES segment. Revenue from OEM contributes around 43% of total net sales while the OEs segment contributes around 49% of net sales. With increasing number of new generation CVs on Indian roads, the market for branded clutches is rising. Setco deals in OEM and OES segment, giving it a hedge in any downturn in the automobile industry and providing a steady sales pipeline.

F  Higher sales in OES segment will lead to margin expansion

With increasing number of CVs on Indian roads, the market for branded clutches is rising. Wear and tear requires replacement of a clutch every two years or after 200,000km for M&HCVs. The cover assembly needs to be replaced every 4-5 years. Demand in the replacement market is largely catered to by unorganized manufacturers. Going forward, we expect OES segment to contribute ~51% by FY13 due to robust sales of CV in FY10 and FY11 which would come up in replacement market in FY13 onwards. Margins are highest in case of exports, while in replacement markets it is at ~22%-24% vs. margins of ~12%-14% in the OEM segment. We expect EBITDA margin to expand to 20.7% in FY13 from 19.0% in FY11.

F  Entry into LCV segment; diversifying its existing business

Setco has recently commenced into supply of clutches for Light Commercial Vehicles (LCV). This acts as a good diversifier, considering that LCV are not subject as much to the cyclicality of the industry as the M&HCVs. Besides, from about 44% of total goods carrier sales in 2007-08, LCVs now garner about 55% of the total volumes, indicating that supplies to LCVs can partly help sustain component makers in times of a slowdown. Despite Setco being a new entrant in LCV clutch segment, it is likely gain market share as product approval time would be less (4-6 months), given relationship with OEM v/s any new entrant which would have a gestation period of ~3 years. We estimate LCV clutches contribution to be around 25-30% of the overall Setco volumes in next 3 years.

F  Subsidiary Performance

In Jan 2006, Setco had acquired UK-based automotive clutch manufacturer, Lipe clutch, a wholly owned subsidiary of the $10-billion Dana Corporation of UK and had been a technical collaborator of Setco. This facility is now known as Setco Automotive, UK. In FY07 Setco acquired the manufacturing plants of Haldex in Paris, USA, in an asset-purchase deal. It became the sole owner of the LIPE brand globally. It has already commenced hydraulics pressure converters business through its subsidiary in USA and also started supplying to Caterpillar. Both these subsidiaries have broken-even in FY11, contributing ~2% to consolidated PAT. Going ahead, we believe contribution from subsidiaries to remain more or less in the same range.

Outlook & Valuation

Setco has pro-actively increased its capacity over some years which have helped in maintaining its market dominance. With a CAGR growth of 11-12% of OEMs coupled with largely untapped OES and export segment, we estimate a 20% CAGR growth in revenues from FY12-14E. Due to introduction of BS III norms for CVs, we estimate significant upgradation in CV clutches which would translate into higher realization per clutches. Higher CV sales in FY10 and FY11 will lead to higher demand in OES segment which result into higher operating efficiency as margin in OES is higher as compared to OEM.

We recommend a BUY with a Target price of Rs.249 on DCF basis; with an investment horizon of 12 months and upside potential of 21%. 

 

Thanks & Regards

Shah Investor's Research Team