Varroc Engineering - Improving outlook to raise investor confidence - ICICI Securities

Varroc Engineering (VEL) is poised to witness a strong earnings rebound in H2FY21 (driven by improving demand outlook, strong cost reduction initiatives) after having struggled with numerous challenges in FY20 (e.g. plant fire, Greenfield start-up costs). VEL remains an attractive play due to: a) VLS set to capitalise on higher LED penetration amongst its customers (Ford, VW, Daimler) for various new vehicle programs (e.g. ICE SUV's, EV's); b) production ramp-ups in greenfield facilities along with cost reductions is likely to drive profitability increase from H2FY21; c) strong rebound in China JV profitability; d) domestic 2-W market growth outperformance coupled with content increase due to BS-VI and e) strong FCF generation (~Rs9bn in FY22) as large capex phase is over. Global peers (Koito, Stanley Electric, Valeo, Huayu Automotive) have also witnessed valuations improve (~5-6x EV/EBITDA FY22). We maintain BUY.

- China leads VLS revival: Chinese markets have witnessed strong growth rebound with positive growth for past four months. Increased sales from C-JLR, VW and Changan-Ford programmes have contributed to 31% YoY increase in China JV revenue in Q1 while profitability also has risen to highest in last 8-qtrs at Rs110mn.

- As VLS ramps up focus remains on costs and asset sweating: a) VLS has reached ~90% of pre-Covid revenues in July'20; b) VEL has peak revenue (ex-tooling) potential of EUR1.5bn from current investments (FY20: EUR800mn) while we remain conservative and are modeling ~EUR 900mn in FY22. This leaves us more upside in case revenue growth curve is faster than our expectations; c) capex of EUR165mn has already been completed for new facilities, with balance capex of EUR65mn; FY21E capex has already been slashed to Rs5.5-6bn and d) We expect more fixed cost rationalising (~20% in fixed cost, ~15% of R&D) to support margins;.

- Domestic business beneficiary of 2-W rebound, BS-VI content rise and new order wins: a) BS-VI product ramp-up and aversion of Chinese imports could aid VEL in the long run as this could lead to increased value add for VEL due on localisation. With the onset of festive season, possible GST cut in 2W's and easing on supply-side disruptions the domestic 2-W production could witness acceleration; b) new business wins from Hero (Rs192mn) and HMSI (Rs58mn), MG Motors (Rs220mn), VW (Rs108mn) and M&M (Rs100mn) are expected to support growth.

- Maintain BUY: We expect a modest growth of 4.7% CAGR over FY20-FY22E. The stock remains attractive at ~21% FCF yield on FY22E. We upgrade multiple of VLS (~15% discount to global peers) to 5.0x EV/EBITDA (earlier: 3.5x), 7x P/E (earlier: 6x) FY22E for China JV, and 8x EV/EBITDA (earlier: 6x) FY22E for India business. We arrive at a SOTP-based target price of Rs412 (earlier: Rs283/share).

Shares of Varroc Engineering Ltd was last trading in BSE at Rs.336.55 as compared to the previous close of Rs. 330.65. The total number of shares traded during the day was 61217 in over 3324 trades.

The stock hit an intraday high of Rs. 345.5 and intraday low of 333.4. The net turnover during the day was Rs. 20792952.

Source : Equity Bulls

Keywords