India Auto Ancillaries -...

Please refer to Disclosures and Disclaimers at the end of the Research Report.

India Auto Ancillaries Steering leaders - Poised for strong growth uptick

AUTO ANCILLARIES: Management Meet 30 September 2014

PhillipCapital (India) Pvt. Ltd.

We interacted with company management and executives of few four-wheeler steering

manufacturers in India which provided positive outlook for steering gears and other

auto ancillary players supplying to OEMs. We highlight two Steering gear

manufacturers 1) ZF Steering Gears (leading CV steering player) and, 2) Sona Koyo

Steering (leader in PV steering gears); which will benefit immensely from domestic

demand recovery in both PV and CV space.

Steering Industry overview:

Indian steering system industry is worth ~Rs30bn (PV share ~2/3rd) with electric power

system and Hydraulic power system accounting for ~75% of the total market. Manual

steering application used in tractors, 3W and construction equipments etc accounts for

rest of the market. While electric power steering is predominantly used in the passenger

car, Hydrualic power steering system is used in high powered engine UV and CV

segments. Key players in the segment are Sona Koyo, ZF Steering, Rane (Madras), Rane

TRW, NSK Steering and Mondo - most of them are in JV with leading MNC players.

ZF Steering Gear (India):

Play on domestic M&HCV recovery. ZF being the leading M&HCV steering supplier (~75%

of the top-line) will be a key beneficiary of CV cycle turnaround. We believe there could

be a multiple positive triggers in coming quarters/years:

Product mix to turn favourable. Visible signs of turnaround in higher realization and

margin HCV volume from leading CV OEMs to improve top-line and margins

significantly. We expect top-line CAGR of ~24% over next three years on better mix.

Margin expansion to be sharp on structural cost control. We note that post FY09,

when the industry showed a sharp revival, ZF’s EBITDA CAGR was 38% between

FY09-FY12 against sales CAGR of 28% on better utilization and cost rationalization

achieved in down-turn. Current demand revival will have superior impact on margins

as company has reduced fixed and power (own windmill) costs materially in last two

years which will pay-off in up cycle.

Comfort from strong B/S and JV partner. ZF is net cash positive (Rs 426mn at FY14

end) with capex/investment funded through internal accrual. 26% ownership of ZF

Lenksysteme GmbH (now Bosch) provides technology comfort to the company.

Valuation: ZF is currently trading @ ~10.5x expected FY16E earnings with higher

probability of top-line growth and earnings surprise.

Sona Koyo Steering Systems:

We see it as a key beneficiary of significant volume uptick in leading domestic OEMs as

company has ~50% market share in PV steering space. We also think favourable model

cycle of Maruti Suzuki, M&M and Honda will help Sona Koyo as these three OEMs

account for ~60% of the company’s consolidated sales. Company has added new

customers’ like Honda, Renault/Nissan and Toyota through its JV/technology partner

JTEKT last year. Company expects 12-14% sales CAGR over the next 3-5 years.

Expects 100bp margin expansion over 1-2yrs. Management has indicated that higher

volume and superior mix (higher share of EPS/EPAM) may improve its consolidated

margins to ~13.5% from 12.5% currently. Shifting of operation to newly built Dharuhera

plant from Gurgaon plant will be a margin-kicker and monetization of Gurgaon plant land

may retire its existing debt of ~Rs2.5bn fully.

Valuation: Stock is currently trading at ~14x FY16E consensus earnings.

Companies Covered

Sona Koyo Steering CMP Rs55 Reco NOT RATED Bloomberg Ticker SONA IN ZF Steering Gear CMP Rs710 Reco NOT RATED Bloomberg Ticker ZFSG IN Priya Ranjan (+ 9122 6667 9965) [email protected] Dhawal Doshi (+ 9122 6667 9769)

[email protected]

mailto:[email protected]

mailto:[email protected]

– 2 of 10 –

30 September 2014 / INDIA EQUITY RESEARCH / AUTO ANCILLARIES MANAGEMENT MEET UPDATE

ZF Steering Gear (India) Z F Steering Gear (India) is promoted by Munot family and ZF Lenksysteme (now 100% owned by Bosch). The company manufactures steering gears and has current installed capacity of 200k units of mechanical steering gears and 300k units of hydraulic power Steering Gears and 50k units of Rack & Pinion Steering Gears per annum.

Volume and Revenue share of products

Source: Company, PhillipCapital India Research

The company's steering gears are primarily used in trucks, buses and are supplied to large OEMs with Tata Motors being the largest customer. Company’s key operating segments are heavy vehicles like dumper and haulage trucks, buses and tractors. Play on domestic M&HCV recovery. ZF being the leading M&HCV steering supplier (~75% of the top-line) will be a key beneficiary of CV cycle turnaround. We believe there could be a multiple positive triggers in coming quarters/years:

Product mix to turn favourable. Visible signs of turnaround in higher realization and margin HCV volume from leading CV OEMs to improve top-line and margins significantly. We expect top-line CAGR of ~24% over next three years with upside risk on better than expected mix (high HCV volume).

Margin expansion to be sharp on structural cost control. We note that post FY09, when the industry showed a sharp revival, ZF’s EBITDA CAGR was 38% between FY09-FY12 against sales CAGR of 28% on better utilization and cost rationalization achieved in down-turn. Current demand revival will have superior impact on margins as company has reduced fixed and power (own windmill) costs materially in last two years which will pay-off in up cycle.

Comfort from strong B/S and JV partner. ZF is net cash positive (Rs 426mn at FY14 end) with capex/investment funded through internal accrual. 26% ownership of ZF Lenksysteme GmbH (now Bosch) provides technology related comfort to the company as the industry is technology dynamic.

26% stake in ZF Lenksysteme India – an option value - Company has setup another JV with ZF Lenksysteme to manufacture steering gears for passenger vehicles and M&HCVs. Company owns 26% stake (investment of Rs558mn) and 74% is owned by ZF (now Bosch) in the company. The JV is yet to achieve breakeven given investment phase and low capacity utilization. We may see significant value addition from this segment as company looks for their existing OEMs relationship given ZF/Bosch’s strong relationship with them. Company has already won mandate for Tata Zest

-

10

20

30

40

50

60

FY09 FY10 FY11 FY12 FY13 FY14

Share of hydraulic volume (%, including car)

Share of Mechanical volume(%)

-

10

20

30

40

50

60

70

80

90

100

FY09 FY10 FY11 FY12 FY13 FY14

Revenue share of hydraulic power steering (%, including car)

Revenue share of Mechanical power steering (%, including car)

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(according to industry sources). Given the Bosch’s operating structure globally, company may monetize its stake in ZF Lenksysteme India in the long-term.

Valuation: ZF is currently trading @ ~10.5x/7x likely FY16E/FY17E earnings with higher probability of positive growth and earnings surprise.

Abridged P&L (ZF Steering Gear)

Rs mn FY09 FY10 FY11 FY12 FY13 FY14 FY15E FY16E

Reported net revenue 1,661 2,161 2,982 3,522 3,129 2,911 3,197 4,252

Total volume 184,890 262,718 357,006 407,473 347,763 351,132 358,073 447,070

Blended realisation (Rs/steering) 8,984 8,226 8,354 8,644 8,997 8,290 8,929 9,511

RM Costs 1,127 1,421 1,920 2,312 1,962 1,841 2,014 2,670

% of revenue 68 66 64 66 63 63 63 63

Employee costs 156 175 228 305 322 312 344 395

% of revenue 9.4 8.1 7.7 8.7 10.3 10.7 10.7 9.3

Other operating expenses 116 133 199 222 201 165 181 200

% of revenue 7.0 6.2 6.7 6.3 6.4 5.7 5.7 4.7

Reported EBITDA 262 432 635 682 643 593 658 987

EBITDA Margin (%) 15.8 20.0 21.3 19.4 20.5 20.4 20.6 23.2

Interest costs 1 1 3 12 36 7 5 2

Other Income 37 59 99 75 115 73 81 93

Depreciation 80 76 149 169 231 210 215 226

PBT 218 413 582 577 490 449 519 852

Total tax (including prior year period) 75 131 173 216 234 308 156 256

Tax rate 34 32 30 38 48 69 30 30

Current year tax 75 131 173 216 118 126 156 256

Tax rate 34 32 30 38 24 28 30 30

Reported PAT 143 282 409 360 256 141 363 597

Adjusted PAT 143 282 409 360 372 323 363 597

No. of Shares 9 9 9 9 9 9 9 9

Adjusted EPS 15.8 31.1 45.1 39.7 41.0 35.6 40.0 65.7


Abridged B/S (ZF Steering Gear)

Rs mn FY09 FY10 FY11 FY12 FY13 FY14 FY15E FY16E

Share capital 91 91 91 91 91 91 91 91

Reserves & surplus 1,069 1,265 1,568 1,928 2,099 2,166 2,454 2,945

Share holders’ funds 1,160 1,356 1,659 2,018 2,190 2,256 2,545 3,035

Deferred Tax Liability (32) (2) 16 90 98 79 79 79

Total loan funds 227 284 294 646 187 148 148 148

Total Liabilities 1,355 1,637 1,969 2,755 2,475 2,483 2,772 3,262

Application of funds :

Fixed assets 292 518 571 1,212 1,048 1,005 940 914

Investments 600 904 736 1,084 908 995 1,195 1,445

Current assets:

Inventories 320 210 310 269 259 260 323 408

Sundry debtors 155 213 312 361 379 474 513 619

Cash & Bank Balances 170 38 112 214 293 137 164 330

Loans & advances 45 60 269 156 178 202 223 252

Others - - 5 5 11 9 9 9

Total current assets 690 522 1,008 1,006 1,120 1,082 1,230 1,618

Current liabilities :

Sundry Creditors 107 212 209 251 361 399 409 505

Others - - 34 172 105 83 83 83

Provisions : 120 94 104 124 135 116 101 126

Total current liabilities 227 306 346 547 601 598 593 715

Net current assets 463 216 662 459 519 484 638 904

Total Asset 1,355 1,637 1,969 2,755 2,475 2,483 2,772 3,262


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Sona Koyo Steering Systems Started in 1984, Sona Steering Systems is one of the largest steering systems manufacturers in India. Product portfolio includes two distinct product lines - steering and driveline products. Steering systems include both manual and power steering systems, comprises steering gears and columns. Driveline product portfolio includes case differentials, axle components, rear axle assemblies and propeller shafts. Company’s manufacturing facilities are located at Gurgaon, Dharuhera, Sanand and Chennai. Company has technical collaboration with JTEKT which also owns ~20% stake in the company.

Product-wise sales mix


Key investment arguments Growth levered to PV segment: We see it as a key beneficiary of significant volume uptick in leading domestic OEMs as company has ~50% market share in PV steering space. We also think favourable model cycle of Maruti Suzuki, M&M and Honda will help Sona Koyo as these three OEMs account for ~60% of the company’s consolidated sales. Company has added new customers’ like Honda, Renault/Nissan and Toyota through its JV/technology partner JTEKT last year. Company expects 12-14% sales CAGR over the next 3-5 years.

Consolidated Revenue Share of key customers


Driveline11%

Steering & Column

89%

Q1FY15Driveline

10%

Steering & Column

90%

FY14

Others12%

Maruti42%

M&M11%

Renault/Nissan

10%

JSAI8%

HonCa7%

Toyota7%

Exports3%

Q1FY15

Others9%

Maruti46%

M&M15%

JSAI12%

Exports9%

Tata Motors4%

Toyota4%

Hyundai1%

FY14

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Product diversification in key steering & driveline products


New Product ‘EPAM’ can be a game-changer. Company has developed in-house EPAM (Electric power steering Module), which is currently used by John Deere’s off-road vehicles. Company expects ~Rs700mn turnover from the product in FY15 (Rs400mn in FY14). Company highlighted that product turnover to grow at ~50-70% over the next 3-5 yrs as new customers get added apart from John Deere ramp-up. Supply to JTEKT – other growth option: Company is trying to get orders from JTEKT’s global operation as production in India can be cost efficient and warranty for the products can be provided by JTEKT as Indian manufacturing facilities are already manned by JTEKT’s Japanese professionals. If the company is able to get this project running, it can improve capacity utilization and top-line meaningfully over a period. Expects 100bp margin expansion over 1-2yrs. Management has indicated that higher volume and superior mix (higher share of EPS/EPAM) may improve its consolidated margins to ~13.5% from 12.5% currently. Shifting of operation to newly built Dharuhera plant from Gurgaon plant will be a margin-kicker due to better plant efficiency and manufacturing system/processes. Monetisation of Gurgaon plant land can make company debt-free. After shifting of Gurgaon operation to Dharuhera, company will have surplus land at Gurgaon to monetize which can retire its full ~Rs2.5bn debt (at the end of Q1’FY15) without any change in land usage category. However, if the monetization happens after changing the land usage category to commercial, it can generate significant surplus cash to the company over the long-term. Valuation: Stock is currently trading at ~14x FY16E consensus earnings.

EPS, 17

RPS-H, 15

RPS-M, 28

Column, 6

Axle, 10

Others, 24

Q1FY15

EPS, 18

RPS-H, 14

RPS-M, 29

Column, 7

Axle, 8

Others, 23

FY14

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Abridged Consolidated P&L

Particulars FY’11 FY’12 FY'13 FY'14

Net Income from Operations 14,517.1 14,831.8 14,517.1 14,831.8

Other Operating Income 83.1 91.3 83.1 91.3

Total Income 14,600.2 14,923.1 14,600.2 14,923.1

Total Expenditure 12,954.8 13,137.9 12,954.8 13,137.9

Consumption of Raw Material 10,246.0 10,260.7 10,246.0 10,260.7

Staff Cost 1,259.0 1,341.9 1,259.0 1,341.9

Other Expenditure 1,449.8 1,535.4 1,449.8 1,535.4

EBITDA 1,645.4 1,785.2 1,645.4 1,785.2

Depreciation & Amortisation 585 679.5 585 679.5

EBIT 1,060.5 1,105.7 1,060.5 1,105.7

Finance Charges 410.9 392.3 410.9 392.3

Other Income 93.5 42.7 93.5 42.7

PBT before exceptional items 743.1 756.1 743.1 756.1

(Gain)/Loss on Foreign Currency Loan Translation

PBT 743.1 1,110.40 743.1 1,110.40

Tax (including deferred) 263.4 247.3 263.4 247.3

PAT (before Minority Interest) 479.7 863 479.7 863

Share of Profit/ (Loss) of associate -7.7 -7.7

Minority Interest 98.8 177.7 98.8 177.7

PAT 380.9 677.5 380.9 677.5

EPS (.) 1.92 3.41 1.92 3.41

Key Ratios

EBIDTA 12.3% 12.5% 11.3% 12.0%

PAT 3.7% 3.4% 2.6% 4.5%

Raw material 70.7% 70.2% 70.2% 68.8%

Staff Cost 7.3% 8.0% 8.6% 9.0%

Other Expenditure 9.6% 9.4% 9.9% 10.3%


Abridged Consolidated Balance Sheet

Particulars FY’11 FY’12 FY'13 FY'14

Shareholder's Equity 2,056 2,392 2,622 3,089 Minority Interest 382 509 608 785 Total equity Capital 2,439 2,901 3,229 3,874 Total Debt 3,484 3,620 3,107 2,350 Total Liabilities 6,276 6,918 6,336 6,224 Assets

Goodwill on consolidation 11 15 24 0 Net Fixed Assets 4,924 5,910 6,390 6,772 Investments 295 295 295 10 Other assets 218 231 4 4 Inventory 752 607 814 936 Debtors 1,618 1,752 2,275 2,082 Cash and Bank Balance 119 117 25 28 Other Current Assets 161 244 222 94 Loans and Advances 551 361 429 464 Total Current Assets 3,413 3,082 3,764 3,605 Current Liabilities & provisions 2,373 2,615 3,566 3,577 Net Current Assets 1,040 467 198 28 Total Assets 6,276 6,918 10,477 10,390


– 7 of 10 –


Sona Koyo Steering System - Product profile


Consolidated Company Structure


– 8 of 10 –


Steering Industry

Indian steering system industry is worth ~Rs30bn with electric power system and

Hydraulic power system accounting for ~75% of the total market. Manual steering

application used in tractors, 2W/3W and construction equipments etc accounts for rest

of the market. While electric power steering is predominantly used in the passenger car,

Hydrualic power steering system is used in high powered engine UV and CV segments.

Key players in the segment are Sona Koyo Steering, ZF Steering, Rane (Madras), Rane

TRW, NSK Steering and Mondo.

Although the type of steering system to be deployed in a vehicle depends on a particular

OEM’s strategy, its supplier relationship and past experience, there is an evident trend

indicating PV OEMs’ rising preference for EPS steering system. Utility vehicles and high

powered passenger cars continue to work on HPS technology due to certain unique

proposition of HPS coupled with cost of EPS systems in bigger vehicles; the small cars

and many of the mid-size and executive segment sedans launched over the last few

years in the domestic market bear EPS system designs. However, HPS is expected to

continue being a preferred option for larger vehicles having higher GVW.

Share of passenger vehicle steering systems by types Auto component Industry in India – share by components


Peer Comparison

Sona Koyo ZF Steering

Product portfolio Steering columns, Gears, Driveline products including axle

Assemblies and propeller shafts

Mechanical and Hydraulic Power Steering gears

Strengths Technical tie up with JTEKT, a leading steering system

manufacturer globally

Strong presence in EPS, thus ~50% share in

Passenger Vehicle (PV) segment

Strong relationship with MSIL (~42% revenue share)

Technology tie up with ZF Lenksystems, a

leading steering manufacturer globally

Pioneer in HPS systems and caters to all major CV OEMs in India

Strong presence in domestic steering systems for Heavy

Commercial Vehicles (HCV and tractors)

Key Customers MSIL, M&M, Renault/Nissan, Toyota, Honda Tata Motors, Ashok Leyland, Mahindra, Escorts, Volvo,

Sonalika, SML ISUZU


Manual Columns

12%

Manual Gears12%

C-EPS40%

P-EPS11%

HPS25%

Electrical Parts9%

Equipments10%

Suspension & Braking Parts

12%

Body & Chassis

12%

Drive Transmission

& Steering Parts19%

Engine Parts31%

Others7%

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Contact Information (Regional Member Companies)

SINGAPORE

Phillip Securities Pte Ltd

250 North Bridge Road, #06-00 Raffles City Tower,

Singapore 179101

Tel : (65) 6533 6001 Fax: (65) 6535 3834

www.phillip.com.sg

MALAYSIA

Phillip Capital Management Sdn Bhd

B-3-6 Block B Level 3, Megan Avenue II,

No. 12, Jalan Yap Kwan Seng, 50450 Kuala Lumpur

Tel (60) 3 2162 8841 Fax (60) 3 2166 5099

www.poems.com.my

HONG KONG

Phillip Securities (HK) Ltd

11/F United Centre 95 Queensway Hong Kong

Tel (852) 2277 6600 Fax: (852) 2868 5307

www.phillip.com.hk

JAPAN

Phillip Securities Japan, Ltd

4-2 Nihonbashi Kabutocho, Chuo-ku

Tokyo 103-0026

Tel: (81) 3 3666 2101 Fax: (81) 3 3664 0141

www.phillip.co.jp

INDONESIA

PT Phillip Securities Indonesia

ANZ Tower Level 23B, Jl Jend Sudirman Kav 33A,

Jakarta 10220, Indonesia

Tel (62) 21 5790 0800 Fax: (62) 21 5790 0809

www.phillip.co.id

CHINA

Phillip Financial Advisory (Shanghai) Co. Ltd.

No 550 Yan An East Road, Ocean Tower Unit 2318

Shanghai 200 001

Tel (86) 21 5169 9200 Fax: (86) 21 6351 2940

www.phillip.com.cn

THAILAND

Phillip Securities (Thailand) Public Co. Ltd.

15th Floor, Vorawat Building, 849 Silom Road,

Silom, Bangrak, Bangkok 10500 Thailand

Tel (66) 2 2268 0999 Fax: (66) 2 2268 0921

www.phillip.co.th

FRANCE

King & Shaxson Capital Ltd.

3rd Floor, 35 Rue de la Bienfaisance

75008 Paris France

Tel (33) 1 4563 3100 Fax : (33) 1 4563 6017

www.kingandshaxson.com

UNITED KINGDOM

King & Shaxson Ltd.

6th Floor, Candlewick House, 120 Cannon Street

London, EC4N 6AS

Tel (44) 20 7929 5300 Fax: (44) 20 7283 6835

www.kingandshaxson.com

UNITED STATES

Phillip Futures Inc.

141 W Jackson Blvd Ste 3050

The Chicago Board of Trade Building

Chicago, IL 60604 USA

Tel (1) 312 356 9000 Fax: (1) 312 356 9005

AUSTRALIA

PhillipCapital Australia

Level 37, 530 Collins Street

Melbourne, Victoria 3000, Australia

Tel: (61) 3 9629 8380 Fax: (61) 3 9614 8309

www.phillipcapital.com.au

SRI LANKA

Asha Phillip Securities Limited

Level 4, Millennium House, 46/58 Navam Mawatha,

Colombo 2, Sri Lanka

Tel: (94) 11 2429 100 Fax: (94) 11 2429 199

www.ashaphillip.net/home.htm

INDIA

PhillipCapital (India) Private Limited

No. 1, 18th Floor, Urmi Estate, 95 Ganpatrao Kadam Marg, Lower Parel West, Mumbai 400013

Tel: (9122) 2300 2999 Fax: (9122) 6667 9955 www.phillipcapital.in

http://www.phillip.com.sg/

http://www.poems.com.my/

http://www.phillip.com.hk/

http://www.phillip.co.jp/

http://www.phillip.co.id/

http://www.phillip.com.cn/

http://www.phillip.co.th/

http://www.kingandshaxson.com/

http://www.kingandshaxson.com/

http://www.phillipcapital.com.au/

http://www.ashaphillip.net/home.htm

http://www.phillipcapital.in/

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