SKF India - Waiting for a revival in demand - BRICS

SKF India held a post Q1CY13 conference call. The outlook still remains uncertain, though the company managed to maintain positive cash flow and is also forging ahead with its industrial bearings plans. We remain positive on SKF India's long term prospects and the domestic large industrial bearing market. Maintain Buy on the stock with target price of Rs628. Following were the key highlights of the concall:

- Business environment remained negative across industries and segments. The company usually witnesses a significant uptick in sales in Q1, as it is the last quarter of the financial year (Q4FYs) for most of its customers. However, SKF India's sales declined 8% yoy and 4% qoq in Q1CY13.

- The auto and industrial segments contributed equally to the company's sales for CY12, while exports contributed 7%.

- A majority of the company's exports were to European automotive OEMs and it does not expect any further decline in CY13 (performance to be at least on par with CY12).

- The company is witnessing a shift in demand to higher performance products in the auto segment. Auto OEMs announce bigger warranties, higher mileages, etc. and more and more customers are demanding improved mileage. However, OEMs currently provide a 'commercial' warranty more than a 'technological warranty', which is likely to increase their expenditure.

- SKF India has planned a capex of Rs400-500mn for CY13 (down from its usual planned annual capex of Rs1bn), to be spent on automation, debottlenecking, establishing new product line, energy savings, etc.

- In order to gain market share, the company has been increasing its focus on segments other than auto, out of which, the off-highway sector has been progressing slowly, though conversions in the rail and defence segments are better.

- The company has also been integrating services with production that provides value addition to customers in order to increase its share. Currently, services contribute 1% of the company's revenue, with the real value in services being that it is a medium to attract more clients and build quality relationships with customers.

- Debtor days stood at 52 days, inventory days at 45 days and net working capital at 45 days.

- Raw material as a percentage of sales declined in the quarter due to 1) softening in commodity prices, 2) better sales mix, and primarily 3) decline in traded goods as a percentage of total sales.

- SKF's imports are primarily Euro denominated and hence, the strengthening of the UD$ vs. INR has not significantly impacted the company's imports.

- Employee expenses in Q1CY13 appear to have increased significantly, as the company made a provision for VRS for 180 employees at its Pune and Bangalore plants in the quarter. Moreover, the growth was on an artificially lower base, as the company made a write-back of Rs75mn in Q1CY12, due to excess allocation for provident fund in the prior quarters.

- A fuel-saving product developed for two-wheelers by SKF - StopGo - is in its final stages of testing with key models of three leading two-wheeler OEMs, and commercial production will follow. The company is in negotiations with OEMs to implement the product at the OEM levels.

- SKF Technologies is a subsidiary of the parent company set up in India to manufacture large bearings in the country. All sales of SKF Technologies are done through SKF India, which earns a margin on the goods traded.

SKF Technologies:

* has given SKF India a head start of 3-4 years from the competition
* faces no competition from other global parent peers
* parent company increased its stake in SKF Technologies in CY12 to 89% (from 82.7%)
* customers enjoy advantages as local production lowers burden of import duties, and reduces inventory and lead time (36 months earlier)
* currently, the company has a surplus manufacturing capacity for large bearings, due to a decline in industrial growth
* primarily caters to the highway, defence, rail and wind energy segments

Valuation

We believe the revival in overall auto and industrial production in H2FY14E will benefit SKF. We estimate SKF India to report a CAGR of 15% and 19% in revenue and earnings over CY12-15. We expect the company to record RoCE of 25.1% in CY15 and generate cash & cash equivalents of Rs97/share in CY13E and Rs102/share in CY14E. The stock trades at 12.6x and 10.2x CY13E and CY14E earnings respectively. Based on the DCF method, we arrive at a target price of Rs628. Maintain Buy.

Source : Equity Bulls

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