Despite overall sales volumes moderating, the auto industry is witnessing reasonable growth in tractors and commercial vehicles. This plays out favourably for Nelcast, a manufacturer of spheroidal graphite (SG) iron and grey iron castings for the auto industry. Catering to automakers such as Tata Motors, Volvo-Eicher, Ashok Leyland, Mahindras and TAFE, the company derives about half its revenues from supplies to medium and heavy commercial vehicles (MHCVs) and about 35 per cent from tractors. A continuation of the strong demand for tractors, expectations of a pick-up in MHCV sales and de-risking efforts through the entry into manufacture of castings for off-road vehicles hold promise for its long-term prospects.

Hence investors with at least a two-year horizon can buy the Nelcast shares. At the current market price of Rs 23, it trades at a price-earnings multiple of about 7.4 times its trailing 12-month earnings. This is at a discount to peers such as Hinduja Foundries. Considering the small-cap status of the stock and thin trading volumes, only those with an appetite for risk should invest.

Drivers for growth

A cyclical moderation, coupled with slower factory output and high interest rates, has dampened MHCV volume growth to about 8 per cent in April-October 2011, over the same period last year. However, there are a few pointers to the fact that MHCV volumes will pick up sooner than later. These include healthy cargo availability and firm truck rentals as evidenced by the latest report from the Indian Foundation for Transport Research and Training, good agricultural growth and an expected peaking out of the interest rate cycle. Besides, tractor offtake so far too has surprised positively, thanks to higher liquidity and income in the rural areas and good monsoons. The tractor industry is expected to end 2010-11 on a high note, growing by about 18 per cent, as against the estimated 13 per cent. Shortage of agricultural labour, higher farm mechanisation and an increasing trend of using tractors for non-agricultural purposes (haulage) are also expected to keep the market for tractors buoyant over the medium-to-long term. Nelcast will be a beneficiary of the positive feelers emanating from these two industry segments.

Value additions

Although the company has established relationships with major CV and tractor makers and a well-diversified product portfolio, its product offerings are at a slightly lower end compared to Hinduja Foundries and a bigger peer, Kirloskar Ferrous Industries. However, the company has made efforts to move up the value chain.

Firstly, SG castings, which are increasingly preferred by user industries, constitute over 75 per cent of its production. These castings are more versatile, value-additive and have higher ductility and tensile strength compared to grey iron castings. Secondly, the company has de-risked its revenue base from the cyclicality of the auto industry. Nelcast derives a small portion of its revenues (under 10 per cent) from the Railways and industrial castings space and is also developing products for construction and earth-moving equipment, some of which could be launched by the end of the year. This will also help boost its exports, which currently form about 5 per cent of its revenues. Thirdly, the company's focus on increasing the share of machined components will also boost realisations and help margin expansions.

Healthy margins

For the quarter ended September 2011, net sales grew by 25 per cent to Rs.158.6 crore year-on-year and net profits zoomed from Rs 2.5 crore in July-September 2010 to Rs 12.75 crore currently. A 71 per cent fall in interest costs has also played its part in boosting profits. Thanks to price increases, a stabilisation of raw material costs and greater operating leverage, EBITDA margins expanded to 14 per cent from 5.8 per cent in the same quarter last year.

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