Setco Automotive: Buy

The company's superior margins, strong presence in the replacement market and diversification efforts lend promise.



Investors with a perspective of two-to-three years can buy the Setco Automotive stock. The company is the market leader in the supply of clutches for medium and heavy commercial vehicles (MHCVs) and counts Tata Motors, Ashok Leyland, Volvo-Eicher and AMW, among its clients.

Given that after two successive years of 26 per cent growth, the auto industry may face a slowdown, the investment does carry an element of risk. However, the company's superior margins, its strong presence in the replacement market and diversification efforts lend promise. At the current market price of Rs 159, the stock trades at a reasonable PE of about eight times its trailing 12-month earnings.

Support for CV demand

Although headwinds in the form of slower GDP growth, high inflation and interest rates pose a threat, the auto industry is expected to face only a moderation in growth and not a slowdown of the order of 2008-09. As against a 0.71 per cent growth registered in 2008-09, SIAM expects the auto industry to grow at around 12 per cent in the current year. Besides, robust agricultural produce, good export-import growth and the picking up of the infrastructure and construction industry in the last few months suggests that there is room for growth in the CV industry.

This apart, the new BS-III emission norms for CVs introduced in October 2010 will do their bit to keep demand going as BS-III compliant engines require technologically superior clutches. These clutches, being value-added products, would also improve realisations for Setco Automotive. Another factor that will help OE (original equipment) demand trickle in is the launches planned by CV majors. In 2010, Setco has been approved as the sole clutch provider for Tata Motors' ‘World Truck' range of vehicles. Ashok Leyland too is launching about 25 vehicles types in its new ‘U-Truck' platform.

Outside of this, considering that clutches generally have a life-span of two-three years, the company will shortly begin benefitting from the clutch replacement demand for the vehicles sold since 2009. Stronger replacement demand also means better margins for the company. It currently derives about 55 per cent of revenues from the replacement segment and has partnered with existing OE clients to cater to the replacement market using their (OEMs') distribution network.

Diversification initiatives

Setco has recently entered into supply of clutches for light commercial vehicles (LCVs). This acts as a good diversifier, considering that LCVs are not subject as much to the cyclicality of the industry as the MHCVs. Besides, from about 44 per cent of total goods carrier sales in 2007-08, LCVs now garner about 55 per cent of the total volumes, indicating that supplies to LCVs can partly help sustain component makers in times of a slowdown. In the next few years, Setco also expects its exports revenues to scale up to 15 per cent of total revenues from about 8 per cent currently.

Another positive for the company is its efforts to move up the value chain. Towards this, the company has entered into a JV with FTE automotive GmBH, Germany, a leading global manufacturer of hydraulic brake and clutch actuation systems. Setco expects to commence its hydraulic pressure convertor business in India and manufacture clutch actuation systems over the medium-term.

Financials

For the year-ended March 2011, net sales grew by 43 per cent year-on-year to Rs 303 crore, while net profits came in at Rs 33 crore, growing by about 85 per cent. Given its status as the market leader and Tier-I supplier, the company has been able to maintain EBITDA margins at a healthy 19-21 per cent in all the four quarters of 2010-11.



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