20151214 Salzer-Electronics-Limited 495 InitiatingCoverage

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Salzer Electronics Ltd.

14 December 2015

Investment

Summary

Association with Indian industrial giant

: Salzer Electronics Ltd. (SEL) has a marketing

arrangement with Larsen and Tubro Ltd. (L&T) the Indian industrial giant in the field of

Engineering, since 1993 for distribution of its switches in domestic market. SEL has

access to L&Ts local network through more than 350 distributors and supplies 40% of

its revenue to L&T. SEL supplies ~60% of its wire & cables, and 40% of its switchgears

to L&T. Though L&T has completely exited its holding from SEL the management

confirms that it will not affect its cordial business relations with SEL.

Strong customer base with marquee clients:

SEL is identified as the preferred supplier

to some of the largest multinational brands like GE, Schneider as well as various local

blue chip companies like BHEL, Nuclear Power Corporation of India, Indian Railways etc.

SEL is a market leader in Indian Rotary Switches commanding a market share of 21%

(largest producer in Asia).

Augmenting product portfolio to drive growth:SEL raised Rs 63 Crs to invest in three

different products (Three phase dry type transformer, Latching relays, Capacitors) and

finalized technical tie-ups with multinationals. According to the management these

products have good growth opportunities.

Advanced engineering capabilities:

SEL has strong engineering capabilities backed by

in-house manufacturing and R&D team. It has technical collaboration with M/S. Plitron

Manufacturing Inc., Toronto, Canada to manufacture Toroidal transformers.

Financials to improve: With change in product mix and the introduction of new products

like three phase dry type Transformer, Latching relays, Capacitors, we believe revenue

will witness a CAGR of 25% over FY16-18E and operating profit margin (OPM) will

improve 358 bps to 16.45% in FY18E. Along with this high growth, we expect return

ratios to improve to teen over next three years.

Valuation

Augmentation of new products and increased contribution from energy saving business

is expected to drive SELs revenue growth and improve its profitability going forward.

Our DCF target is Rs 416 which is based on 11.60 % WACC while our relative valuationtarget is Rs 396 which is based on 12x FY17E EPS of Rs 33. Hence, we arrive at a

weighted average target price of Rs 406 per share indicating 74% upside from current

level. We initiate SEL with aSTRONG BUY

.

Exhibit 1: Key financials

R s m n F Y 2 A F Y 3 A F Y 4 A F Y 5 A F Y 6 E F Y 7 E F Y 8 E

Sales 2,229 2,287 2,445 2,833 3,369 4,243 5,446

EBIT 297 299 312 365 487 628 896

EBIT margin 13.31% 13.05% 12.74% 12.87% 14.45% 14.80% 16.45%

Adjusted PAT * 162 157 160 191 226 339 519

Adjusted PAT margin * 7.25% 6.88% 6.53% 6.75% 6.71% 7.99% 9.54%

Adjusted EPS (Di luted) (Rs) * 15.71 15.30 15.52 18.60 21.98 32.97 50.50* Adjusted net pro fit excludes extraordinary items

Sources : KSL Estimates

Wired for growth,Initiate with Strong Buy

Sector : Electrical Equipment

Target Price : Rs 406

Current Market Price : Rs 233

Market Cap : Rs 320 Crs

52-week High/Low : Rs 364/132

Daily Avg. Volume : 37,534

Shares in issue : 10 mn

Face Value : Rs 10

Beta : 1.08

Pledged Shares : 0%

Year End : 31st March

BSE Scrip Code : 517059

Bloomberg Code : SZE IS

Reuters Code : SALZ.BO

Nifty : 7,610

Sensex : 25,044

Analyst : Hiral Keniya

Price Performance

Shareholding Pattern


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Company background

Salzer Electronics Ltd., one of the leading players in Electrical Solutions in India, wasincorporated on January 8, 1985, by the core promoter, R Doraiswamy, in technicalcollaboration with Salzer Schaltgerate Fabrik, Germany. SEL is a leading player offeringtotal and customized electrical solutions in Electrical switchgears, Wires & Cables, andEnergy management business. The company's thrust is on manufacturing CAM operatedrotary switches with improved versions of utility for both domestic and industrialpurposes. The company caters to a wide range of products with five in-housemanufacturing facilities, located in Coimbatore and Himachal Pradesh.

The company has a wide distribution network locally and globally, exporting to morethan 50 countries. In India, Salzer markets its products through its own distributors aswell as through more than 350 local distributors of L&T. The company has a strong R&Dteam that focuses on developing and commercializing the technologies of the products,

and as a result, can offer total customized electrical solutions to its customers.

Technical tie-ups with multinationals; reap the fruits

SEL is keeping its competitive edge, through collaborations and tie-ups withmultinationals. SEL has signed collaboration agreement with 1) M/s. Plitron GlobalServices, Inc, an affiliate of M/s. Plitron Manufacturing Inc, Canada, for technical know-how for manufacture of improved and higher capacity of Toroidal Transformers. 2) C3Controls, USA for the development of Contactors. This collaboration with full-fledged in-house R&D will help the company to bring technologically advanced products. The R&Dhas been recognized by Ministry of Science and Technology, Department of Science andIndustrial Research, Government of India. SEL also has certificates from followinginstitutes

ISO 9001 2008

EMS Standards 14001

OHSAS Management System 18001

One of the first few companies in compliance of RoHS Directives for European

markets

IEC standard Certifying Body Testing Laboratory

Exhibit 2:

Journey so far- From a single product company to manufacturing of multiple

products across sectors

1985Established to manufacture CAM operated Rotary Switches

1991- 95

Unit I (Coimbaotre)- manufactures contactors, relays, panels, energy savers.

Starting of long term association with L&T

Technical Collaboration with Plitron formanufactires of Toroidal tranformers

Ist Indian Company to bring this technology to India

2001- 06

Unit III - manufacture modular switches

Started Wire & Cable manufacturing for L&T

2010 - 14

Foray into tailor made products and branding for large customers

Specialized panels for OEMs

Source: Company data


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Exhibit 3: About the Management

Exhibit 4: Revenue Breakup as per business segment

Exhibit 5: Geographical breakup

I

Core Promoter with over 2 decades of experienceMr. R. Doraiswamy - MD

Electrical Engineer, India, Post Grduate in BusinessManagement, US.

JMD & CEO of company- responsible for driving the vision ofthe company

Mr. D. Rajeshkumar - JMD

Qualified Company Secrerary & member of FCS IndiaWide experience in Company Law/Corporate Affairs

Mr. S.Baskarasubramaniam-Director, Corporate Affairs &

Company Secretary

Industrial

Switchgear

52%

Copper

Business

40%

Building

Segment

6%

Energy

Saving

2%

India

76%

Latin

America

1%

Africa

2%

Nrth

America

2% Europe

15%

Rest of Asia

4%





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14 December 2015

Investment Rationale

Augmenting product portfolio to drive growth

SEL is a leading player of Total and Customized Electrical Solutions in Switchgears,Wires & cables, and Energy Management business. It is the largest manufacturer ofCAM Operated Rotary switches, with a market share of 21%. 40% of SELs revenuesstem from sales to L&T and the company also has access to its largest clients domesticnetwork of more than 350 distributors. We expect SEL top-line to grow at a CAGR of 25%

over FY16-20E.

Industrial switch gear business

SEL derives 52% of its revenue from Industrial switch gear business which grew by 17%CAGR during FY 11-15.This segment comprise of Toroidal transformers, Rotary switches,Isolators, Contactors and Relays etc., which are R&D driven products. SEL is the largest

supplier of rotary switches and enjoys 25% of market share in domestic market. It alsosupplies load break switches to Indian Railways, and is considered as a preferredsupplier to Nuclear Power Corporation, Schneider Electric and GE Energy. Along with theaddition of new products, we expect this segment to grow at a CAGR of 26% over FY16-18E with the EBITDA margin of ~18% led by reaping the fruits of collaborations withvarious multinationals in this segment.

Exhibit 6: Revenue Projection from Industrial Switch gear Business (Rs mn)

715929

11741468

2062

2793

3808

0

1000

2000

3000

4000

FY12 A FY13 A FY 14 A FY 15 A FY 16 E FY 17 E FY 18 E

Copper business

SEL derives 40% of its revenue from Copper business. Copper business comprises ofwires & cables, flexible bus bars, enamelled wires, bunched conductor and tinnedcopper wires. The segment has grown at 9% CAGR over FY11-15. L&T is the major

contributor to the revenue in this segment and contributing ~40% of revenue. We expectcopper business to grow at a CAGR of 11% over FY15-18E with the EBITDA margin of~13% over FY 16-18E.

Exhibit 7: Revenue Projection from Copper Business (Rs mn)

1050 1000 990

1155

1386

1552

1708

0

500

1000

1500

2000


Source: Company data, Khambatta research



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Building products business

SEL is also present in building products business with 5% contribution to revenue andproducts like modular switches, wire & cables, MCBs and changeover switches. Thissegments product mainly caters to the building segment and retail customers. Thesegment grew by 11% CAGR during FY11-15. We believe, along with the increase inconstruction space, this segment will grow at a CAGR of 27% over FY16-18E whileEBITDA margin will expand to ~16% over FY16-18E.

Exhibit 8: Revenue Projection from Building Segment Business (Rs mn)

47 5463 75

104

135

167

0

50

100

150

200


Energy management business

This segment is a new segment, where SEL is the only manufacturer in India. Energymanagement is primarily used to save energy and it is ideal for Street Lighting,Commercial Lighting, Large, Medium & Small Scale Industries and other Mass Outdoor

Lighting Application. SEL claims it saves 30% energy under normal working conditions.CRISIL has rated SEL, Grade I ESCO operator for street lights. SEL has successfullyinstalled energy saving instruments in Madurai Corporation, Coimbatore Corporationand Navi Mumbai Corporation. This segment currently contributes ~3% of total revenueand we expect it to contribute at least 10% to the total revenue by FY 18E. Goingforward, this segment can contribute robust growth of 40% CAGR over FY16-18E andEBITDA margin may expand to 25% by FY18E.

Exhibit 9: Revenue Projection from Energy Management Business (Rs mn)

3457

103

185

314

0

100

200

300

400

FY 14 A FY 15 A FY 16 E FY 17 E FY 18 E

Advanced engineering capabilities

SEL has strong engineering capabilities backed by in house R&D team. SELs researchand development facility has been recognized by the Department of Scientific andIndustrial Research, Ministry of Science and Technology, Government of India as aRecognized in-house R&D unit since 2002. SEL also has in-house tool-room equipped

with Swiss and German machinery, for manufacturing of dies and tools required for newproducts and undertakes repair & maintenance of its existing moulds. It has technicalcollaboration with M/S. Plitron Manufacturing Inc., Toronto, Canada to manufactureToroidal transformers. SEL has forged a strategic alliance with C3Controls, in theelectrical switch gear space in the US, for the manufacture of contactors. The product




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was developed under validation with UL, which was a leading certification agency. Thecompany had already commenced production and is targeting the US and Asia whichare the key markets for this product.

Association with Indian Industrial Giant

SELs association with L&T (Larsen and Tubro Ltd.); the Indian Industrial Giant in thefield of Engineering since 1993 has helped SEL market its switches throughout India.This association has helped the company in introducing various electrical and electronicproducts in the domestic market. SEL has access to L&Ts local network of more than350 distributors and supplies 40% of its revenue to L&T as on FY15. SEL supplies~60%/40% wire & cables/switchgears respectively to L&T. Although L&T has completelyexited its holding from SEL, the management confirms that it will not affect its cordialbusiness relations with SEL. For the Fiscal 2013, 2014 and 2015, L&T contributed 49%,45% and 40% per cent of SELstotal sales.

Exhibit 10: Industry wise Break - up

Wireless

and Cable

60%

Industrial

Switchgears

40%

Strong customer base

SEL is identified as the preferred supplier by General Electric and Schneider. SEL srelationship with their customer and long presence in this segment helps it in gettingrepeat orders from their customers, adding new customers and foraying into newgeographies.

SEL also supplies to various domestic blue chip companies like BHEL,Nuclear Power Corporation of India, Indian Railways etc. It is a market leader in RotarySwitches having a market share of 21% (largest producer in Asia). Strong clientele willensure SELs revenue growthgoing forward.

Exhibit 11: Marquee Clients




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Financials to improve

SEL has grown at a CAGR of 12% over FY12-15 and we expect the total revenue of thecompany to grow at a CAGR of ~25% over FY15-18E on account of and increasingrecognition from energy saving services and better product mix. We further expectearnings to grow at a CAGR of 31% over FY15-18E.

Exhibit 12: Revenue to grow by ~25 over 3 years (Rs mn)

2229 22872445

2833

3369

4243

5446

0

1000

2000

3000

4000

5000

6000


Exhibit 13: EBIT margins to expand by over 358 bps driven by new products

13.31% 13.05% 12.74% 12.87%

14.45% 14.80%

16.45%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

FY 12 A FY 13 A FY 14 A FY 15 A FY 16 E FY 17 E FY 18 E

Exhibit 14: EPS to grow by ~35 over a period of 3 years

15.71 15.30 15.5218.60

21.98

32.97

50.50

-

10

20

30

40

50

60

FY 12 A FY 13 A FY 14 A FY 15 A FY 16 E FY 17 E FY 18 E





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Exhibit 15: Returns to improve

0

5

10

15

20

25

30

35

FY 14 FY 15 FY 16 E FY 17 E FY 18 E FY 19 E FY 20 E

ROE ROCE

Industry Overview

By 2022, the installed power capacity in India is expected to reach 350 gigawatts (GW)from 243 GW in 2014, on back of increasing industrialization and economicdevelopment. The total market size of electrical machinery in India is anticipated toreach US$ 100 bn by 2022 from US$ 24 bn in 2013.The electrical machinery sectorconsists of generation, transmission and distribution machinery. The transmission anddistribution market expanded at a CAGR of 6.7% over FY07-13. Boilers (16%), cables(10%) and transmission lines and conductors (12%) account for a large chunk of therevenue. The generation equipment market is expected to expand at a CAGR of 12.7%over FY1222. The exports of electrical machinery rose to US$ 3.9 bn in FY14 from US$

3.4 bn in FY12 driven by demand for Boilers & parts, and electrical wires and cables.The Government of India has de-licensed the electrical machinery industry and hasallowed 100% Foreign Direct Investment (FDI) in the sector. It plans to set up theElectrical Equipment Skill Development Council (EESDC) which would focus onidentifying critical manufacturing skills required for the electrical machinery industry.With many bilateral nuclear agreements in place, India is expected to become a majorhub for manufacturing nuclear reactors and associated components. Foreignparticipation in the development and financing of generation and transmission assets,engineering services, equipment supply and technology collaboration in nuclear and

clean coal technologies is also expected to increase demand in this sector.

Indian Electrical Equipment

Indias electrical equipment industry is highly diverse and manufactures a wide range ofhigh and low technology products. The industry directly employs around half millionpeople and provides indirect employment to another one million people. The industrycan be broadly classified into two sectors generation equipment and T&D equipment.For 2011-12, the industry size is estimated at Rs 1.2 lakh cr (US$ 25 bn), of whichgeneration equipment segment consisting of BTG contributed Rs 31,000 cr (US$ 6.5bn) while the major T&D equipment segment of transformers, cables, transmissionlines, switchgears, capacitors, energy meters, etc., provided the larger share of Rs64,235 cr (US$ 13.4 bn). Other electrical equipment, including instrument transformers,surge arrestors, stamping and lamination, insulators, insulating material, industrialelectronics, indicating instruments, winding wires, etc., contributed Rs 25,000 cr (US$5.2 bn).



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Exhibit 16:

Segment-wise Electrical Equipment Industry FY 2013)

Major T & D

Equipment

53%Generation

Equipment

26%

Other

Electrical

Equipment

21%

Valuation

We expect, SELs revenue to grow at a CAGR of 25% over FY16-18E primarily led byaugmentation of its product offering and increasing visibility for energy saving business.We believe that the company will improve its EBITDA margins by 300 bps, consequently,improving its return ratios over FY 16-18E. SEL has also received a preferred suppliertag from its esteem clients like GE, Schneider, Nuclear Power Corporation of India whichinfuses confidence about the revenue growth.

At CMP of Rs 233, SEL is trading at 17.1x its 12-months trailing EPS of Rs 13.6. OurDCF target is Rs 416 based on 11.60 % WACC while our relative valuation target is Rs396 which is based on 12x FY17E EPS of Rs 33. Hence, we arrive at a weighted averagetarget price of Rs 406 per share indicating 74% upside from current level. We initiateSEL with a STRONG BUY.

Valuation Table

Exhibit 17: Weighted Average Target Price Rs)

ethodologies W eights P r ic e Target P r ic e

DCF Valuation Using FCFE 50% 416 208

P/E Valuation (FY 17E EPS Rs. 33) 50% 396 198

Target Price 406

Current Price 233

Upside 74%


Source: KSL Estimates


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Risk Factors

Salzer is dependent on L&T for its business operation and distribution in the domestic

market

SELs relationship with L&T helped the company in introducing various products indomestic market. For the Fiscal 2013, 2014 and 2015, L&T contributed 49.6%, 45.3%and 40.0% respectively of their total sales. In products businesses, they rely on variouschannels including L&T for marketing their products. Unfortunately SEL has limitedability to control and manage the activities of sales channels of L&T which possesssignificant risk to companys top-line and profitability.

Currency headwinds

The company imports raw materials and components, and 20% of SELs sales are fromexport to 40 countries. Consequently, SEL faces risk from currency fluctuation.

Working Capital risk

Though the companys high working capital cycle of ~120 days is in line with theindustry, it may deteriorate SELs cash flow. However,the company is taking measureslike long term contracts and reducing debtors to reduce the high working capital risk.


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Guide to Khambattas research approach

Valuation methodologies

We apply the following absolute/relative valuation methodologies to derive the fair value of the stock as a part of our fundamental research:

DCF: The Discounted Cash Flow (DCF) method values an estimated stream of future free cash flows discounted to the present day, using acompanys WACC or cost of equity. This method is used to estimate the attractiveness of an investment opportunity and as such provides a goodmeasure of the companys value in absolute terms. There are several approaches to discounted cash flow analysis, including Free Cash Flow toFirm (FCFF), Free Cash Flow to Equity (FCFE) and the Dividend Discount Model (DDM). The selection of a particular approach depends on theparticular company being researched and valued.

ERE: The Excess Return to Equity (ERE) method takes into consideration the absolute value of a companys return to equity in excess of its cost ofequity discounted to the present day using the cost of equity. This methodology is more appropriate for valuing banking stocks than FCFF or FCFEmethodologies.

Relative valuation: In relative valuation, various comparative multiples or ratios including Price/Earnings, Price/Sales, EV/Sales, EV/EBITDA,Price/Book Value are used to assess the relative worth of companies which operate in the same industry/industries and are thereby in the samepeer group. Generally our approach involves the use of two multiples to estimate the relative valuation of a stock.

Other methodologies such as DuPont Analysis, CFROI, NAV and Sum-of-the-Parts (SOTP) are applied where appropriate.

Stock ratings

Strong Buy recommendations are expected to improve, based on consideration of the fundamental view and the currency impact (whereapplicable) by at least 15%.

Market-perform recommendations are expected to improve, based on consideration of the fundamental view and the currency impact (whereapplicable) between 5% and 15%.

Underperform recommendations are expected to improve up to 5% or deteriorate, based on consideration of the fundamental view and thecurrency impact (where applicable).

Disclaimer

ANALYST CERTIFICATION

I/We,Research Analysts and authors, hereby certify that all of the views expressed in this research report accurately reflect our views about the subject

securities. We also certify that no part of our compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in

this report.

Terms conditions and other disclosures:

Khambatta Securities Limited (Khambatta Securities) is a full-service, integrated merchant banking and is, inter alia, engaged in the business of stock

brokering and distribution of financial products.

Khambatta Securities is one of the merchant bankers. We and our associates might have investment banking and other business relationship with

companies covered by our Investment Research Department. Khambatta Securities generally prohibits its analysts, persons reporting to analysts and

their relatives from maintaining a financial interest in the securities or derivatives of any companies that the analysts cover.

The information and opinions in this report have been prepared by Khambatta Securities and are subject to change without any notice. The report and

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connection with preparation of the research report.Accordingly, neither Khambatta Securities nor Research Analysts have any material conflict of interest

at the time of publication of this report.

It is confirmed that Research Analysts of this report have not received any compensation from the companies mentioned in the report in the preceding

twelve months. Compensation of our Research Analysts is not based on any specific merchant banking, investment banking or brokerage service

transactions.

The Research Analysts engaged in preparation of this Report (a) may or may not have any financial interests in the subject company or companies

mentioned in this report; (b) do not own 1% or more of the equity securities of the subject company mentioned in the report as of the last day of the

month preceding the publication of the research report; (c) do not have any other material conflict of interest at the time of publication of the research

report.

It is confirmed that Research Analysts do not serve as an officer, director or employee of the companies mentioned in the report.

Neither the Research Analysts nor Khambatta Securities have been engaged in market making activity for the companies mentioned in the report.

We submit that no material disciplinary action has been taken on Khambatta Securities by any Regulatory Authority impacting Equity Research Analysis

activities.

This report has been prepared by Khambatta Securities. Khambatta Securities has reviewed the report and, in so far as it includes current or historical

information, it is believed to be reliable, although its accuracy and completeness cannot be guaranteed.

20151214 Salzer-Electronics-Limited 495 InitiatingCoverage

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