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In an environment where there is a lull in new vehicle sales, auto component makers with exposure to the replacement markets stand to gain. Setco Auto, a market leader in the supply of clutches for medium and heavy commercial vehicles (MHCVs) is one such player. Counting Tata Motors, Volvo-Eicher, AMW and Ashok Leyland among its clients, the company gets half its revenues from sale of clutches in the replacement market. While this gives visibility to revenue growth, its superior margins and diversification efforts too lend further promise to its prospects. Hence, we recommend an investment in the Setco Auto stock. At Rs 203, it trades at a reasonable price to earnings ratio of about 8.6 times its trailing twelve-month earnings. However, given its small-cap nature, investors are advised to take limited exposures.
Replacement demand
Considering that clutches generally have a life span of about 2 lakh km or two years, the company will benefit from the clutch replacement demand for vehicles sold in 2009-10 and 2010-11. After a slowdown in 2008, MHCV sales grew by a healthy 32- 34 per cent in each of these years. Stronger replacement demand also means better margins for the company as component makers have greater pricing power in this segment than in direct sale to automakers. Besides, replacement demand for technologically superior BSIII-compliant clutches is also expected to come in the second half of FY13. These would improve realisations for Setco.
Diversification
Their exposure to the light commercial vehicle (LCV) segment is another positive. LCVs are not subject to the cyclicality witnessed by heavier vehicles, and thus help volume growth in times of a slowdown, such as the current one. LCV clutches currently bring in 10 per cent of the revenues. This share is expected to increase. Besides, Setco plans to scale up its export revenues from 6-8 per cent of the total now to 15 per cent in the next 2-3 years. While it has entered the eastern European and Latin American markets last year, it plans to increase its footprint in SE Asia, Middle East and Africa as well. This diversification augurs well as exports bring in higher margins than domestic sales.
Financials
For the year ended March 2012, net sales grew by 23 per cent to Rs 371 crore and adjusted profits grew by 35 per cent to Rs 44 crore. EBITDA margins stood at 18 per cent, against 19.8 per cent last year.
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