SCHAEFFLER looks future ready to gain from auto sector disruption
SCHAEFFLER's resilient German legacy, a strong domestic foothold with 16% market share, and robust cash flow generation bodes well for the stock. We are LONG.
SCHAEFFLER is one of the largest manufacturers of bearings in India, operating in Automotive Technologies (chassis, engine components, drives), Automotive Aftermarket (replacement parts) and supporting Industrial segments. The company is part of the German Schaeffler Group, having foothold in Europe, America, China & Asia-Pac regions.
India’s auto bearing market is projected to reach INR15,700cr by 2024, growing at a CAGR of 18% thanks to an organic rise in production and aided by favourable regulatory tailwinds. India’s bearing industry is marginally fragmented with 5 companies capturing 74% of the market share. SKF, a company with Swedish origins is the market leader with 27% share, bringing decent competition in the ring for SCHAEFFLER which holds 16%.
Sector supported by strong policy push and broader tailwinds
The broader auto components sector has been well positioned for some time now with policies such as the Automotive Mission Plan 2016-26, Faster Adoption and Manufacturing of EVs (FAME), establishment of special auto parks & SEZs for components manufacturing, duty support to boost local production and introduction of BS-VI norms. Recently introduced Vehicle Scrappage Scheme is further expected to boost demand.
Focus on quality and solid technological backbone key for the future
The company’s product portfolio comprises Automotive Technologies (44% of sales), Automotive Aftermarket (8% of sales), Industrial (37% of sales) and Exports (11% of sales). Increasing thrust on vehicle electrification appears favourable. EVs typically require a lower number of bearings per vehicle, but quality plays a crucial role for withstanding higher torque vs. ICEs – for which international players like SCHAEFFLER are better positioned. Present EV volumes are marginal at best and should be closely watched. SCHAEFFLER is active in both the EV & Hybrid Technology space and expects to blend in as demand picks up. It enjoys a resilient German legacy in terms of its R&D DNA and a global foothold among OEM manufacturers. Current focus is on increasing automotive aftermarket share as the company enters the lubricant oil segment.
Steady growth and sound balance sheet management de-risks the investment profile
Revenue/EBITDA has seen a CAGR of 20%/13% during CY 2016-20 helping the company deliver a lofty 22% ROCE and 15% ROE over the last four years. Operations are unlevered with minimal debt and comfortable interest coverage ratio of 76.8x as at CY 2020. No new debt seems to be on cards. Cash flow generation appears strong with INR472cr of FCFF. Cash on balance sheet as at CY 2020 stood at INR1,246cr, a 30% slice of total assets of the company. The company has increased its capex outlay by 20% and has lined up INR1,200cr investment over 3-years to set up additional capacities for catering increasing demand.
SCHAEFFLER recently released its Q1 2021 results with 3M revenue of INR1,317cr, 42% increase from Q1 2020, owing to 30% Y-o-Y production increase (10% Q-o-Q) as plants returned to normal capacity. Slight improvements in profit margin were also seen with an EBITDA margin of 18% (vs. 16% as at CY 2020) and PAT margin of 11% (vs. 8% as at CY 2020) although fluctuations are expected in near term. FCFF generation stood at INR184cr during the period.
Valuation on absolute and relative terms looks fairly attractive
SCHAEFFLER currently trades at 26.6X P/E and 15.1X EV/EBITDA on FY23F. Close comps SKF India Limited (NSE: SKFINDIA) trade at a premium in comparison at 31.3X P/E and 21.0X EV/EBITDA, Timken India (NSE: TIMKEN) is at 33.1X P/E and 20.9X EV/EBITDA and NRB Bearings (NSE: NRBBEARING) at 15.1X P/E and 8.7X EV/EBITDA on FY23F. The stock trades at INR5,585, -2.8% vs. 52wk high of 5,748. Broader macro factors such as rising commodity prices & auto volumes slowdown after pent-up demand are downside risk factors but not unique to SCHAEFFLER. German parent holds 74% shareholding which is no real cause of concern.
A resilient German legacy, strong domestic foothold with 16% market share, and robust cash flow generation bode well for the stock. We are LONG.
Disclaimer: The views expressed above are the views of Arkvega Partners LLP, and are subject to change at any time based on market and other conditions. This is neither an offer nor solicitation for the purchase or sale of any security, and should not be construed as such. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. We strongly advise you to do your own research and consult an accredited investment advisor before investing based on what you read in a newsletter. Arkvega Partners LLP or its employees may have exposure in the financial instrument discussed above and can close positions in the future without prior intimation.