Centrum Wealth - L.G Balakrishnan & Bros. Ltd - Initiation - Dominant player to rise on motorcycle revival

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L.G. Balakrishnan & Bros. Ltd

BUY

Target Price: Rs662

CMP: Rs522

Upside: 27%

Dominant player to rise on motorcycle revival

L.G. Balakrishnan Ltd. (LGB) is the largest producer of transmission chains (~68% of its revenue) primarily for the motorcycle segment.  They are also present in other transmission components and metal formed parts (fine blanking) mainly for the automotive sector (~26% of revenue). Exports account for 8-10% of revenue. LGB has a dominant 70% market share in the domestic motorcycle OEM (Original Equipment Manufacturer) segment for transmission chains and 50% share in the aftermarket segment through its flagship brand ‘Rolon'. We believe that as a market leader in chains, LGB is best positioned to benefit from the expected recovery in motorcycle sales in India. Further, major OEMs in India are expanding their capacity which should lead to higher demand for LGB chains. Going ahead, we estimate PAT CAGR of 14.5% over FY2015-17E. The stock is currently trading at 9.5x P/E and 5x EV/EBITDA on FY2017E basis and appears attractive. We initiate coverage with a BUY rating and a target price of Rs662, valuing it at 12x its FY2017E EPS.

Dominance in aftermarket offers stability: The addressable market for transmission parts in the aftermarket segment is much larger than the OEM market as these parts are usually replaced every 3 years. The addressable size of aftermarket sales is also set for expansion due to rapid growth in motorcycle sales during prior years. Currently, LGB is the leading player in the aftermarket segment with its ‘Rolon’ brand (~27% of its revenue) for its transmission products like chains, sprockets tensioners and others. Further, the company also supplies these products to OEMs for sale in the aftermarket segment under the OEMs brand name (~8% of revenue). This aftermarket segment offers a steady source of revenue that will help counter the swings in the OEM cycle over the long term.

Recovery in motorcycle sales to boost LGB: Going forward, we expect the domestic motorcycle market to see a revival in demand on the back of higher economic growth, rise in disposable incomes and increased rural spending. LGB also stands to benefit from the rise in status of India as an export hub for motorcycles. While the domestic motorcycle industry has expanded at a CAGR of 7.9% over FY2010-15, the corresponding CAGR in motorcycle exports over the same period has been a robust 15.3%. As motorcycle makers like Bajaj, Hero and Honda continue to penetrate new markets around Africa, Latin America and Asia, exports are increasingly becoming a strong source of sales growth for motorcycle OEMs. Further, key clients like Bajaj Auto and Hero MotoCorp have announced capacity expansion plans that should result in increased orders for LGB.   

Healthy financials: We forecast net profit CAGR of 14.5% over FY2015-17E on the back of 1) Reduced capital expenditure going forward leading to improving operational leverage, 2) Stabilization in interest costs as LGB could use operating cash flows to reduce debt (currently Rs157 crore), 3) Favorable revenue mix with increased share of higher margin transmission segment, 4) Minimization of losses in Light commercial vehicle (LCV) trading business and 5) Improving profit margins from overseas subsidiaries.  

Risk factors:1) Volatile raw material prices 2) Slowdown in motorcycle sales

Valuation: We expect LGB’s revenue CAGR of 11.2% over FY2015-17E on the back of steady aftermarket sales, revival in motorcycle demand and capacity expansion on the part of its key clients like Bajaj and Hero. The stock is currently trading at 9.5x P/E and 5.0x EV/EBITDA on FY2017E basis and appears attractive. We initiate coverage on the stock with a BUY rating and a target price of Rs662, valuing it at 12x its FY2017E EPS.