Rating: Buy; Target Price: Rs790; CMP: Rs569; Upside: 39%
Powering the strong “Swaraj” brand
SEL, probably one of the best proxies on the tractor growth story,
should be a key beneficiary of the recent structural change in the
tractors market. We believe that there is a possibility of SEL merging
with Swaraj tractors, now part of M&M FES division, or becoming a part
of the much bigger engine ecosystem at M&M. The Swaraj brand of
tractors, consumer of SEL’s products, has seen remarkable improvement
in operations and market share post acquisition by M&M; it today
commands 14% market share up from 9% in FY08. Zero debt and superior
return ratios will help it withstand adverse business cycles. We are
above-consensus on earnings and target price for this relatively
thinly-covered stock.
$ SEL can be part of a much bigger entity and get the required scale:
We believe that as a logical long term outcome, SEL will either be
merged with the operations of Swaraj tractors, part of M&M FES
division (in line with the structure followed by other tractor
manufactures, integrated unit with in-house engine facility) or will
have the chance to become part of much bigger engine ecosystem at M&M
(logical to have related engines business under one umbrella). This is
subject to M&M successfully taking 17.39% stake from Kirloskar
Industries, the other large shareholder of SEL.
$ Market checks suggest underlying drivers for tractor demand intact:
Our interaction with tractor dealers, financiers and recent data
points related to agriculture/tractor sector largely validate our view
on tractor industry and make us believe that factors such as
increasing use for non-farm (commercial) purposes, shortening of
replacement cycle, rising rural income and shortage of labour would
continue to support volume growth. Further, the current penetration
level for tractors in India is much lower than in developed and other
emerging economies. Hence, we expect the industry to grow at ~10-12%,
in line with growth in FY10-13 (higher than the growth in the last
decade).
$ A proxy on structural shift seen in tractor industry in India,
Swaraj brand getting better foothold: While industry drivers continue
to remain favourable for the domestic tractor industry, growth of SEL
is directly linked to the underlying growth of Swaraj Brand as it
caters to ~80% of Swaraj tractor’s engine requirements. Since the
takeover by M&M, there has been a complete turnaround in the fate of
‘Swaraj’ brand of tractors, with attendant positive impact on SEL.
While Swaraj tractors had slipped to 5th place with 9% market share
before the acquisition by M&M in 2007, it now commands a market share
of 14% and ranks 3rd behind M&M tractors and TAFE.
$ Valuation and key risks: We have valued the company at 11x FY16E EPS
(mean+sd1) as we believe that strong earnings, return ratios and the
ability to generate free cash flow with strong FCF yield at 6% (
average for past 5 years) can engender a further re-rating of the
stock. The absence of a direct comparable (other engine companies are
diversified) can ensure that the stock trades at a premium to other
auto-ancillaries. We arrive at a price target of Rs790, an upside of
39% from the CMP. Key risks to our thesis are: a) Dependence on single
customer i.e. Swaraj brand, and b) Drought in the forecasted period.
Thanks & Regards
��
Powering the strong “Swaraj” brand
SEL, probably one of the best proxies on the tractor growth story,
should be a key beneficiary of the recent structural change in the
tractors market. We believe that there is a possibility of SEL merging
with Swaraj tractors, now part of M&M FES division, or becoming a part
of the much bigger engine ecosystem at M&M. The Swaraj brand of
tractors, consumer of SEL’s products, has seen remarkable improvement
in operations and market share post acquisition by M&M; it today
commands 14% market share up from 9% in FY08. Zero debt and superior
return ratios will help it withstand adverse business cycles. We are
above-consensus on earnings and target price for this relatively
thinly-covered stock.
$ SEL can be part of a much bigger entity and get the required scale:
We believe that as a logical long term outcome, SEL will either be
merged with the operations of Swaraj tractors, part of M&M FES
division (in line with the structure followed by other tractor
manufactures, integrated unit with in-house engine facility) or will
have the chance to become part of much bigger engine ecosystem at M&M
(logical to have related engines business under one umbrella). This is
subject to M&M successfully taking 17.39% stake from Kirloskar
Industries, the other large shareholder of SEL.
$ Market checks suggest underlying drivers for tractor demand intact:
Our interaction with tractor dealers, financiers and recent data
points related to agriculture/tractor sector largely validate our view
on tractor industry and make us believe that factors such as
increasing use for non-farm (commercial) purposes, shortening of
replacement cycle, rising rural income and shortage of labour would
continue to support volume growth. Further, the current penetration
level for tractors in India is much lower than in developed and other
emerging economies. Hence, we expect the industry to grow at ~10-12%,
in line with growth in FY10-13 (higher than the growth in the last
decade).
$ A proxy on structural shift seen in tractor industry in India,
Swaraj brand getting better foothold: While industry drivers continue
to remain favourable for the domestic tractor industry, growth of SEL
is directly linked to the underlying growth of Swaraj Brand as it
caters to ~80% of Swaraj tractor’s engine requirements. Since the
takeover by M&M, there has been a complete turnaround in the fate of
‘Swaraj’ brand of tractors, with attendant positive impact on SEL.
While Swaraj tractors had slipped to 5th place with 9% market share
before the acquisition by M&M in 2007, it now commands a market share
of 14% and ranks 3rd behind M&M tractors and TAFE.
$ Valuation and key risks: We have valued the company at 11x FY16E EPS
(mean+sd1) as we believe that strong earnings, return ratios and the
ability to generate free cash flow with strong FCF yield at 6% (
average for past 5 years) can engender a further re-rating of the
stock. The absence of a direct comparable (other engine companies are
diversified) can ensure that the stock trades at a premium to other
auto-ancillaries. We arrive at a price target of Rs790, an upside of
39% from the CMP. Key risks to our thesis are: a) Dependence on single
customer i.e. Swaraj brand, and b) Drought in the forecasted period.
Thanks & Regards
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