Shanthi Gears ICR - Myirisbreport.myiris.com/MR1/SHAGEARS_20140414.pdfShanthi Gears Ltd ‐ Geared...

INITIATING COVERAGE REPORT: SHANTHI GEARS LTDRECOMMENDATION: BUY

CMP: INR 69

TARGET PRICE: INR 86

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Microsec Research 14th April 2014

Investment Highlights

Shanthi Gears Ltd ‐ Geared up to capitalize on the uptick in investment cycle

BUY Sector ‐ Engineering

We recommend Shanthi Gears Ltd (SGL) a “BUY”. Headquartered in Coimbatore, Shanthi Gears is

leading organized player in the industrial gear segment in India. It manufactures wide range of

critical components involved in power transmission like Gears, Gear boxes, Gear motors and

Gear assemblies. The company is strongly positioned in the custom made gears and gear boxes

with ~70‐75% of revenues from customized products catering industries like steel, textiles,

power, chemical, rubber, paper, mining, cement, sugar etc. It operates from five fully integrated

manufacturing units and one foundry division located in Coimbatore.

Fully integrated modern facilities, high presence in customized gears (non‐standard gears),

fewer dependence on imported raw materials, investments in wind mills and power linkages

to aid margins: We believe that with company’s fully integrated facilities which caters to

individual needs of clients and ensures timely delivery of products, high presence in customized

products, fewer dependence on imported raw materials as compared to industry’s 50%

dependence, investments in wind mills and power linkages to save power costs, the company

has the prospects of commanding higher margins in future.

Exposure across various industries, management’s effort to bring back old niche clients and

introduction of new standard products to lead in diversity of clientele: The company’s

exposure across an array of industries helps company to not depend on single client for a

significant portion of revenue, mitigates the risk associated with down turn in any particular

sector and helps retain pricing power. Also, management’s effort to bring back old niche clients

is likely to enhance the clientele base. We believe that with introduction of new products the

company is likely to 1) take benefit of an additional high profile clientele across industries and 2)

earn higher revenue.

Uptick in investment cycle to provide the company ample opportunities to grow: With revival

in economy to uplift investment cycle, the demand for gears is set to surge.

Tube Investments of India’s acquisition to create synergies between both companies: Tube

investments acquiring Shanthi Gears is likely to benefit the company: 1) has headroom for

growth and tap the opportunities in engineering sector 2) foray into sectors like aerospace,

defense and mining equipments and 3) get access to stronger hands i.e. Murugappa group.

Import substitution to take place – positive for Shanthi Gears: With Indian industrial gear

sector’s heavy dependence on imports and the recent sharp rupee depreciation, import

substitution is expected to take place, which is positive for Shanthi Gears.

Scrip ID Shanthi Gears Ltd

Scrip Code (NSE) SHANTIGEAR

Scrip Code (BSE) 522034

Bloomberg Ticker SG IN

Reuters Ticker SHNT.BO

Industry Engineering

Face Value ( INR) 1.00

Equity Share Capital ( INR Cr) 8.17

Avg 5 years P/E 15.14

Avg daily volume (Last 1 Year) 24,875

Beta Vs Sensex 0.35

Dividend Yield 0.87%

Stock Scan

15000

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1‐Jan‐13

1‐Feb‐13

1‐M

ar‐13

1‐Apr‐13

1‐M

ay‐13

1‐Jun‐13

1‐Jul‐13

1‐Aug‐13

1‐Sep‐13

1‐Oct‐13

1‐Nov‐13

1‐Dec‐13

1‐Jan‐14

1‐Feb‐14

1‐M

ar‐14

1‐Apr‐14

Shanthi Gears Ltd Sensex

Analyst: Neha Majithia

[email protected]

+033 66512100

Current Market Price (CMP) 69

Target Price 86

Upside Potential 25%

52 Week High Low 75.90 / 47.55

Market Cap (INR in Crores) 564

Valuation Data

Particulars FY09A FY10A FY11A FY12A FY13A FY14E FY15E FY16E

Net Sales 252.48 121.39 160.36 173.00 145.65 156.25 175.00 210.00

Growth 3.4% ‐51.9% 32.1% 7.9% ‐15.8% 7.3% 12.0% 20%

EBITDA 104.85 50.37 70.94 68.95 43.29 44.81 54.00 67.40

EBITDA Margin 41.43% 40.70% 43.07% 38.83% 29.54% 27.86% 30.00% 31.13%

Net Profit excl Exceptional Items 46.38 16.20 27.85 28.11 15.47 19.72 26.59 35.46

Net Profit Margin (excl Exceptional Items) 18.33% 13.09% 16.91% 15.83% 10.56% 12.26% 14.77% 16.38%

Net Profit Growth 5.03% ‐65.07% 71.91% 0.93% ‐44.97% 27.46% 34.87% 33.34%

Basic EPS 5.39 1.98 3.41 3.44 1.89 2.41 3.25 4.34

Adjusted EPS excl Exceptional Items 5.68 1.98 3.41 3.44 1.89 2.41 3.25 4.34

P/E(x) 4.74 19.16 10.97 11.18 29.87 28.59 21.20 15.90

Adjusted P/E(x) excl Exceptional Items 4.50 19.16 10.97 11.18 29.87 28.59 21.20 15.90

P/BV(x) 1.03 1.47 1.33 1.27 1.79 2.12 2.03 1.90

ROE 22.93% 7.68% 12.15% 11.34% 6.01% 7.42% 9.56% 11.96%

EV/EBITDA(x) 2.37 6.10 3.69 3.74 9.44 10.54 7.99 5.75

Financial Performance of Shanthi Gears Ltd (All figures in INR Crores except % and per share data)

Source: Microsec Research, Company Data

Promoters70.12%

FIIs1.90%

DIIs3.23%

Non‐Institutions24.75%

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Investment rationale

1. Fully integrated modern facilities, high presence in customized gears (non‐standard gears),

fewer dependence on imported raw materials, investments in wind mills and power linkages to

aid margins:

A) Fully integrated and the largest modern facilities: Shanthi Gears has fully integrated and the

largest modern gear making facilities in India with infrastructure for fabrication and engineering,

in‐house foundry and forging facilities and tool room for gear cutting. It also has 7 windmills

which have a total power generating capacity of ~6.66MW. The company has power linkages

with total sanctioned power of 6500 kva and own diesel gensets with a capacity of 8500kva. The

facilities of the Shanthi Gears has are a step up when compared to its peers: CAD work stations,

state‐of‐the‐art manufacturing and quality control machines and equipment, in‐house pattern

making, castings including bronze wheel rings, forgings, fabrication, heat treatment, etc. This

along with a consistent thrust on R&D, technology up gradation and skill up gradation of its

manpower has enabled the company to maintain its designing and manufacturing edge over its

competitors.

Shanthi Gears currently has five Units which carry out following operations:

Unit A&B – Manufacture of components & gears for the textile industry (these units account for

10% of the sales)

Unit C – Engineering Unit (this unit accounts for 90% of the sales)

Unit D – Currently vacant

Unit E – CSR

Unit F – Foundry

B) Investments in Wind mills and power linkages to provide leverage to margins: Shanthi Gears

has seven wind mills in one of its manufacturing unit with an Agreement with Tamil Nadu

Electricity Board (TNEB). The seven wind mills have a total power generating capacity of

~6.66MW. The power generated through the wind mills is used for captive purpose and the

surplus is sold to Tamil Nadu Electricity Board (TNEB). The company also has power linkages with

total sanctioned power of 6500 kva and own diesel gensets with a capacity of 8500kva. We

believe that the possession of captive wind mills and power linkages is likely to help company

save on power cost and fuel costs. Currently, power and fuel cost comprises of ~8% of the total

costs. Please find below the details of Wind mills owned by Shanthi Gears.

Particulars Wind Mill 1 Wind Mill 2 Wind Mill 3 Wind Mill 4 Wind Mill 5 Wind Mill 6 Wind Mill 7

Make Bonus Bonus NEPC Suzlon Suzlon Suzlon Suzlon

Output Power 320KW 2*320MW 2*225MW 1250KW 1250KW 1250KW 1250KW

Installed Mar‐97 Mar‐97 Aug‐95 Mar‐06 Sep‐06 Aug‐06 Sep‐07

Location Unit D Unit D Unit D Tirunelvelli, TN Tirunelvelli, TN Tirunelvelli, TN Tirunelvelli, TN

PPA with TNEB TNEB TNEB TNEB TNEB TNEB TNEB

PPA rate (INR / unit) 2.9 2.9 2.9 2.9 2.9 2.9 2.9

Units Generated * 422,545 868850 493448 2546298 2588796 3017070 3736152

PLF % 15.10% 15.50% 12.50% 23.20% 23.60% 27.60% 28.40%

Note: * During FY 2011; Recent Figures not available / Source: Company Presentation

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We believe that the fully integrated facilities which the company possesses are likely to

benefit Shanthi Gears in many ways. It would enable Shanthi Gears to a) help reduce its

dependence on imports for raw materials which is likely to impact margins positively b) help

control costs and have greater control over production process c) help synergize and focus more

on customized gears which accounts for ~75% of its revenue pie e) ensure meeting the stringent

timelines demanded by customers.

C) High presence in customized gears to uplift margins: The product range of the company is

segmented into standard (non‐customized) and non‐standard (customized) gears and gear boxes.

The standard (non‐customized) gears account for ~35% of the total revenue with an operating

margin between the levels of 10‐15% and the rest is customized gears, which constitutes ~75% of

the revenue with high operating margins between the levels of 30‐35%. Unlike other domestic

gear manufacturers, Shanthi Gears focuses on the customized gears and ensures that its factory

utilization is not more than 85% to take advantage of urgent and emergency orders. Unlike most

of its competitors, Shanthi Gears has been able to maintain operating margins at all times due to

its product mix, and the relatively lower raw material costs incurred for custom built gearboxes.

SGL is a market leader in the customized gears space with operating margins in excess of 25‐30%,

as compared to 15‐17% for Elecon Engineering which is the biggest player in the overall gears

industry. The table given below shows that Elecon engineering despite having a market share of

~30% is commanding lower operating margins due to reasons like 1) lower presence of ~20% in

customized products which usually yield higher margins and 2) higher raw material imports.

D) Fewer dependence on imported raw materials – To act as a saviour: The cost of raw material

composes ~50% of the total cost, out of which merely 2‐3% is imported and rest is indigenous.

Similarly, for its domestic peer company – Elecon engineering, the raw material cost accounts for

~65‐70% of the total cost and 17‐20% of it is imported. Shanthi Gears dependence on imports of

raw materials has significantly reduced from 12% in FY06 to 2% in FY13. On the contrary, the

import of raw materials in case of Elecon engineering has reduced by just 1% from 18% in FY2006

to 17% in FY13.

Hence, we believe that with above mentioned positive factors, the company has the prospects of

commanding higher margins in future. We expect the operating margins to improve from the

current levels of 28% to 31‐32% in future.

Company Name

Market

Share

Standard Gears Customized Gear Domestic Exports Imported Indigenous

Shanthi Gears 35% 75% 93% 7% ~5% 2% 98%

Elecon Engineering 80% 20% 62% 38% ~30% 17% 83%

Segment‐wise revenue contributionGeoghraphic‐wise

contribution

Raw Material

Imports/Indigenous

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2. Exposure across various industries, management’s effort to bring back old niche clients and

introduction of new standard products to lead in diversity of clientele:

A) Exposure across various industries leads to diversity in clientele: Due to company’s high

presence in customized gears, which caters to individual needs of companies ensuring timely

delivery to clients across industries, the company has mixer of clientele. It has exposure across all

sectors like steel, power, mining, Infrastructure, textiles, sugar, etc. It had ~4000 active clients in

2006 which reached the peak level of ~10,000 clients in 2009, with no single customer

accounting for over 5% of the total revenue. Hence, servicing over a large base of customers

across industries helps Shanthi gears in different ways like 1) expand its clientele 2) helps the

company not to depend on single sector/single customer for a significant portion of revenue

3)mitigates the risk associated with down turn in any particular sector and 4) helps retain pricing

power.

B) Management’s efforts to bring back old niche clients to enhance the clientele base: During the

process of management and operational restructuring, the company went through tough times.

This resulted in labour issues and dealer problems just when the industrial cycle was at its low.

During the turbulent phase, the company had to forego its existing clients and opportunities

which lead to plunge in sales. With the company’s nature of business having high presence in

customized products, it couldn’t adhere to the guidelines of timely delivery of products and lost

its clients. Presently, the new management is focusing on bringing back those clients which we

believe is likely to enrich its old client portfolio. According to the management, as mentioned in

Q3FY14 concall, the company has been approaching its lost clients since May ‐ June’13. With

most of the old clients still having lot of confidence in the company’s facilities and products, it is

sure of bringing back most of clients in next couple of month’s time. Pre‐restructuring, the

company had clients like BHEL with requirements for its power plants, giants like GE Electric and

Atlas copco, Jindal group, SAIL, Reliance, etc.

8.4% 6.8% 4.5%

21.4%18.2%

15.3%

30.3%28.3%

24.8%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

FY2010 FY2011 CY2012

Top Customer Top 5 Customers Top 10 Customers

Customer Major Products Valus (INR Cr)

Customer 1 Non standard gear box 7.81

Customer 2 Helical, Bevel helical gear box 6.01

Customer 3 ISO Items 4.4

Customer 4 Worm gear box 4.32

Customer 5 Non standard loose gears 3.89



Customer 8 Helical gear box, Geared motor 3.07



Total 42.76

Note: This represents the figures of FY11, Recent figures not available

Top 10 Customers

The graph shows the progressive broad basing in customer base and decline in concentration amongst the top customers

leading to lower dependence on single customers. Largest customer contribution reduced to only ~4.5% of the revenues.

Note: FY11 Net sales is INR160.36 crore, out of which 25% (i.e. INR42.76 crore) represents the Top 10 customers.

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C) Introduction of new products in standard segment for sectors like compressors, aerospace to

help increase dominance among its peers: The Company which has lower contribution from

standard products segment is planning to introduce new products for sectors like compressors,

aerospace, to help increase its dominance among its peers who have larger market share in this

products segment. We believe that with introduction of new products, the company is likely to 1)

take benefit of an additional high profile clientele across industries and 2) earn higher revenue.

3. Uptick in investment cycle to provide the company ample opportunities to grow:

With the company’s existence in various industries, it is all set to take advantage of the uptick in

the investment cycle. Way back in 1998‐99, with the downturn in economy, the company’s

turnover fell, but in 2000, when the industry revived, the first to benefit was the gear industry

with all sectors outlaying expansion. With the uplift in investment cycle, where companies start

outlaying capex for expansion, which mainly include setting up of plant & machinery, the

demand for gears is set to surge and benefit companies like Shanthi Gears.

Shanthi’s prospects are closely linked to

the fortunes of the heavy engineering

sector. With India’s GDP to improve to 6%

by FY16 and key user industries being in

investment mode, Shanthi is expected to

be a key beneficiary of capital spending

across its user set.

The pie chart below shows the comparison of Shanthi Gears and its domestic peer Elecon

Engineering with respect to their exposure across an array of industries.

Power25%

Chemical &

Fertilizer2%

Mining

4%

Plastic & Rubber6%

Cement7%

Marine8%

Sugar

9%

Steel Conversion 12%

Sponge Iron

3%

Others19%

Elecon Engineering ‐ Industry wise Sales segmentation

General Engineering

40%Machine Tools2%

Mining & Constructions

1%

Steel10%

Textiles7%

Chemicals & Plastics1%

Conveyor & Material Handling

3%

Windmill3%

Earthmoving 3%

Paper & Rubber2%

Lift & Elevators 2%

Cement2% Sugar

1%

Others21%

Shanthi Gears‐ Industry wise Sales segmentation

Capex Outlay for key user industries for XIIth 5 year plan

Particulars Capex (INR Cr)

Heavy Industry 17543

Steel 90975

Mines 18221

Textiles 25931

Fertilisers 15437

Source: Planning Commission of India

Source: Company Presentation

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4. Tube Investments of India’s acquisition to create synergies between both companies:

Tube investments of India is a diversified company deriving 60% of revenue from insurance and

other financial services, ~18% from engineering, ~15% from metal formed products, ~15% from

cycles/components and 2% from Gear business. Tube investments acquired Shanthi Gears mainly

for reasons like 1) to take itself to a higher level of engineering 2) to synergize the transmission

business with its chain business 3) to create an opportunity for both exports and supply for offset

requirements which is expected to become huge in India 4) Shanthi Gear’s strong balance sheet,

cash, surplus land, engineering skills 5) to foray into sectors like defense and aerospace 6) reduce

its reliance on auto sector which is facing various challenges 7) get access to company’s large

customer base. On the contrary, Shanthi Gears is likely to benefit like1) has headroom for growth

and trap the opportunities in engineering sector 2) foray into sectors like aerospace, defense and

mining equipments and 3) access to stronger hands i.e. Murugappa group.

5. Import substitution to take place – positive for Shanthi Gears: The Indian industrial gear

market depends heavily on imports i.e. ~40% imports, especially for high – end gears. The rupee

depreciated to INR68.8/US$ in H2FY14 and is now stable at the levels of INR60‐61/US$. We

believe that rupee which has depreciated almost ~15% from the levels of INR47‐48/US$ more

than two years back, is not expected to reach those levels soon. We expect that with rupee

depreciation making imports costlier, import substitution is likely to take place. Other companies

are likely to prefer buying gears domestically from branded companies like Shanthi Gears. Also,

on raw material front, other companies which import its high amount of raw materials are

expected to pass on the costlier import’s price on their final products to customers, whereas

Shanthi Gears which imports merely 2% of its raw material is likely to pass on no/marginal price

hike on its final products. This makes Shanthi gears again a customer’s preferred choice.

Other Rationales:

Ample land bank leaving huge scope for expansion: During the process of restructuring in 2008‐

09, the company had closed down two factory locations from the six units and had shifted to the

other four operating location. This resulted in surplus land of 70 acres at one unit and 7.5 acres

at other unit. At present, Unit A & B continue their operation of manufacturing textile gears. Unit

C remains the main manufacturing unit, Unit D is currently vacant. Unit E is used for social

services and Unit F is the foundry unit. The company has total of 80‐100 acres of surplus land

which leaves much scope for expansion. The company has no intentions to dispose the land in

near future.

Capacity Unitization to improve gradually: The current capacity utilization is ~35%. This has

reduces from the levels of 60‐65% as the production got hampered during the process of

restricting. As the company gets back its old clients and uptick in investment cycle, the capacity

utilization is expected to improve gradually.

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Industry Overview:

The Gear Industry is segmented into Automotive and non‐automotive (Industrial) gear industry.

The automotive gear segment consumes the largest size of the industry pie. The Industrial Gear

industry usually includes manufacturing of Gears, Gear boxes, Gear Motors and Gear assemblies.

The Gears and gear boxes are categorized as Standard (non‐customized) and Non‐standard

(Customized) which are manufactured by organized, unorganized and international players.

Industrial gear caters mainly to the needs of sectors like steel, cement, Textiles, Power, Sugar,

Paper, Mining, etc. Notably, non‐standard segment includes custom built gears and loose gears

as well. The Indian industrial gear market is mostly dominated by manufacturers of Standard

(non‐customized) Gears and Gear boxes as manufacturing of non‐standard (customized) gears

requires high end expensive technology, skills and facilities to deliver to the specific needs of

different clients in a short span of time. According to FY13 Annual report of Shanthi Gears, the

Standard gearboxes constitute about ~35% of the market and are growing approximately at over

10% CAGR, while the non‐standard (customized) gear boxes constitute over ~75% and is growing

below the Industry average.

The global Gear industry is estimated to be at US$169 billion, out of which industrial gears

constitute 30%, while the rest is consumed by automotive industry. This means the global

industrial gears market size is ~US$50.7 billion and the automotive industry market size

US$118.3 billion. Region‐wise, Asia Pacific is the largest contributor in the gear industry with a

market size of US$68 billion i.e. ~40% of the total gear market. Followed by Asia Pacific, the

second largest region contributing to the overall industry is North America (NA). NA accounts for

~24% of the total industry i.e. US$40 billon. In the US$68 billion Asia Pacific market, China makes

up for ~43% of the pie and rest are Japan and Other Asia Pacific. Similarly, in the US$40 billion NA

market, US adds up to ~75% and rest represents Canada and Mexico. Also, Western Europe

comprises of US$36 billion i.e.

~21% of the global industry

size.

Presently, Indian Gear

industry is estimated to be

INR10,000 crore (US$1.67

billion) out of which ~30% is

Industrial gears and rest

being the Automotive gears.

The Indian Industrial gear

industry is pegged at INR3000

Market Size

(INR2811 cr)

Domestic Sales

(INR2626 cr)

93% of total size

Exports

(INR185 cr)

7% of total size

Market Size

(INR2811 cr)

Domestic Consumption

(INR1744 cr)

62% of total size

Imports

(INR1067 cr)

38% of total size

Particulars 2003 2008 2013 2018e

Gear Industry Size 97.8 134.5 169.5 217

North America: 29.9 32.6 40.4 48.8

United States 23.7 24.8 30.1 36.1

Canada & Mexico 6.2 7.8 10.4 12.7

Western Europe 27.2 32.2 36.2 41.1

Asia/Pacific: 30.9 51.1 68.4 94.6

China 6.7 17.3 29 45.6

Japan 15.2 19.5 19.8 21.9

Other Asia/Pacific 8.9 14.3 19.7 27.1

Central & South 2.9 5.5 7.1 9.3

Eastern Europe 4.6 8.8 11.8 15.7

Africa/Mideast 2.3 4.3 5.6 7.5

World Gear Market Size

Source: The Freedonia Group, Inc.

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crore (US$0.5 billion), which is merely 1% of the global industrial gear market size. The INR3000

crore Indian industrial gear sector is growing at a rate of about 6% p.a. and is expected to touch

about INR4000 crore in the next five years (according to Shanthi Gears Annual Report of FY13).

This means it is expected to grow by approximately INR200 crore p.a.

The Indian industrial Gear Industry depends heavily on imports especially for high‐end gears.

Almost ~35‐40% of it is imported and ~7‐10% is exported.

Company Profile

Shanthi Gears Ltd, now a subsidiary of Tube Investments of India (post acquisition in November,

2012), is one of the largest organized industrial gear manufacturer in India. Headquartered in

Coimbatore, It commenced operations in 1969 and got listed on Indian Stock exchange in 1986.

The company has been promoted by a technocrat entrepreneur named Mr. P Subramanian

having over four decades of experience in the industry. It manufactures wide range of critical

components involved in power transmission products like Gears, Gear boxes, Gear motors and

Gear assemblies. The company is strongly positioned in the custom made gears and gear boxes

with ~70‐75% of revenues from customized products catering across industries like steel, textiles,

power, chemical, rubber, paper, mining, cement, sugar etc. The company has fully integrated

operations with strong in‐house R&D and design. It operates from five manufacturing units and

one foundry division located in Coimbatore.

Key Milestones

C

o

m

• Established as Shanthi Engineering & Trading Co manufacturing small gears

1969

• Converted to a private limited company and started manufacturing gears for textile industry

1972

• Initiated manufacturing of worm gear boxes

1980

• Equity shares listed on stock exchanges

1986

• Started manufacturing industrial and special gear boxes

1987

• Certified ISO 9001

2002

• Certified AS 9100 C: the only gear company in India with such certification

2008

• Internal re‐structuring of management. Professional CEO brought on board

2011

• Started R&D activities in‐house

2011

• Acquired by Tube investments of India Ltd

2012

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pany’s Power Transmission Products – An array of Gears, Gear Boxes and Gear assemblers

Manufacturing Process

Products

•Worm Gear Boxes

•Helical & Bevel Helical Gear Boxes

•Geared Motors

•Cooling Tower Gear Boxes

•Extruder Gear Boxes

•Rolling Mill Gear Boxes

•Textile Gear & Gear Assemblies

Standard Gear &

Gear Boxes Special Gear Boxes for industries like:

•Cement

•Mining

•Power

•Paper•Steel

Special Gear Boxes

•Spur / Helical Gear

•Pinion Shaft

•Internal Gear

•Worm and Wheel

•Straight Bevel Gear

•Spiral Bevel Gear

•Spares for imported machines

Loose Gears

•Capable of designing gears/ gear boxes for standard and customized applications

•CAE and Gear calculation software are used for design

•60 design personnel

1. Design

•Over 20,000 wooden,

aluminum patterns available

•Cast iron foundry with mechanized sand plant

•Centrifugal casting of

phosphor bronze rings

•Steel fabrication upto 10 T

single piece2. Foundry –Ferrous / Non‐Ferrous

•Hot open forging

•Open forging facility upto

500 kg single piece

•Max 500 mm dia

3. Forging

•Capability to go upto a max

diameter of 3,300 mm

4. Turning

•Provides a key way for the

locking of shaft / gear

•Machines available for milling and keyway milling / broaching / slotting

5. Key Way Milling

•Gear hobs and milling cutters upto 30 module

•In‐house gear hobbingmachines

•In‐house cutter manufacturing facility

6. Gear Hobbing / Cutting

•Heat treatment for hardening the surface

•Most modern computer controlled heat treatment plant. 5 nos. pit furnaces including 2,400mm diafurnace

•Surface treatment including nitriding7. Heat Treatment

•Increases accuracy and improves surface finish

•Gear grinders including state of the art ‘Reishauer’ “Gleason Pfauter and Kappgear grinding machines

8. Profile Grinding of Spur Helical

•Gear tooth profile grinding

•In‐house thread/ worm profile grinding machines

•Specialized machines & set‐up for Rotor Grinding

9. Worm Profile Grinding

•Assembling the gear for delivery

•Testing of the gear before packing

10. Assembly

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Shanthi Gears Select Clientele

Shanthi Gears – Sales Segmentation: Domestic and Exports

- 12 -


Key Financials

Peer Comparison

Key Risks

Volatility in raw material input prices: Volatility in prices of raw material’s input like steel

and aluminium alloy, which make up 50% of their input costs is likely to pressurize

margins.

Delay in investments: Delays in investments in the sectors served by Shanthi Gears could

adversely affect its revenues and profits going forward. However, with a diversified

profile with none of the sectors contributing more than 10‐12% of its revenues,

company has a broad‐based scope of growth going forward.

Increase in competition: Increased competition from unorganized as well as foreign

players can prove to be a risk to its market share.

ParticularsCMP Mcap

TTM Net

Sales

TTM

EBITDA

EBITDA

Margin

TTM

PAT

PAT

Margin

TTM

EPSP/E EV/EBITDA P/BV BVPS ROE

Net

Worth

Total

DebtD/E

Shanthi Gears 69 564 151.0 40.7 27.0% 16.6 11.0% 2.0 33.8 12.5 2.1 32.8 6.2% 267.7 0.0 0.0

Elecon Engineering 40 371 514.8 91.4 17.7% 27.7 5.4% 2.5 15.7 6.8 0.7 59.8 5.7% 488.2 253.4 0.5

121.7 162.3 201.4 244.1

252.5

121.4 160.4

173.0

145.7

156.3

175.0 210.0

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

0.0

50.0

100.0

150.0

200.0

250.0

300.0

FY05A

FY06A

FY07A

FY08A

FY09A

FY10A

FY11A

FY12A

FY13A

FY14E

FY15E

FY16E

INR Cr

Net Sales EBITDA Margin PAT Margin

115.5

153.2 183.5 220.4

218.9

112.0

149.8

152.9

134.8

143.8

160.1 190.1

6.2 9.1 17.9

23.7

33.5

9.4 10.5

20.1

10.9

12.5

14.9

20.0

0.0

50.0

100.0

150.0

200.0

250.0

FY05A

FY06A

FY07A

FY08A

FY09A

FY10A

FY11A

FY12A

FY13A

FY14E

FY15E

FY16E

INR Cr

Domestic sales Exports

Source: Microsec Research, Company data Source: Microsec Research, Company data

Source: Microsec Research, Company data

- 13 -


Valuation

Going forward, the outlook for Shanthi Gears looks positive with fully integrated modern

facilities, high presence in customized gears (non‐standard gears), fewer dependence on

imported raw materials, investments in wind mills and power linkages to aid margins. Also, with

exposure across various industries, management’s effort to bring back old niche clients and

introduction of new standard products to lead in diversity of clientele, Uptick in investment cycle

to provide the company ample opportunities to grow and Tube Investments of India’s acquisition

to create synergies between both companies, the company financial prospects look bright.

Adding to the above triggers, the company has strong balance sheet, cash, surplus land,

improving ROE.

We followed consolidated approach to value Shanthi Gears Ltd based on Discounted Cash Flow

(DCF) and P/E Valuation. In addition to arrive at final valuation, we provided equal weights to

each of our valuation methods. A description of the valuation is given below:

Discounted Cash Flow (DCF)

We utilized Weighted Average Cost of Capital (WACC) of 10.08% to arrive at the future earnings

of Shanthi Gears Ltd. In addition, we applied a terminal growth rate of 2.50% for the earnings

beyond FY2017E. We arrived at the WACC with a Cost of Equity of 10.08%, post tax Cost of Debt

of 0.00%, and Debt‐to‐Equity as nil. By adopting Capital Asset Pricing Model (CAPM), we arrive at

Cost to Equity based on Market Return of 12.18%, Risk Free Rate of 8.95% and Beta of 0.35x.

With this, our DCF valuation reflects a target price of INR84 for the stock, which reflects an

upside of 22% from the CMP of INR69.

Price‐to‐Earnings (P/E)

Based on target P/E multiple of 20.18x on FY16e EPS of INR4.34 per share, we arrived at a target

price of INR88 per share, an upside of 27% from the CMP of INR69 per share.

Consolidated Valuation

Considering future earnings growth visibility and current industrial gear market scenario, we

have assigned 50% weightage each to DCF and P/E methodologies. With this, we arrived at a

consolidated target price of INR86 per share for Shanthi Gears Ltd, an upside of 25% from the

CMP of INR69 per share.

- 14 -


Profit & Loss Statement

Particulars (INR in Crores) FY09A FY10A FY11A FY12A FY13A FY14E FY15E FY16E

Net Sales 252.48 121.39 160.36 173.00 145.65 156.25 175.00 210.00

Growth (%)‐YoY 3.42% ‐51.92% 32.10% 7.88% ‐15.81% 7.28% 12.00% 20.00%

Other Operating Income 0.58 2.36 4.33 4.59 0.88 4.58 5.00 6.50

Total Income 253.06 123.75 164.69 177.59 146.53 160.83 180.00 216.50

Growth (%)‐YoY ‐51.10% 33.08% 7.83% ‐17.49% 9.76% 11.92% 20.28%

TOTAL EXPENDITURE 148.21 73.38 93.75 108.64 103.24 116.02 126.00 149.10

as % of sales 58.57% 59.30% 56.93% 61.17% 70.46% 72.14% 72.00% 71.00%

EBITDA 104.85 50.37 70.94 68.95 43.29 44.81 54.00 67.40

EBITDA Margin (%) 41.43% 40.70% 43.07% 38.83% 29.54% 27.86% 30.00% 31.13%

Other Income 0.68 2.78 0.54 0.35 7.64 10.25 13.00 15.00

Operating Profit 105.53 53.15 71.48 69.30 50.93 55.06 67.00 82.40

Depreciation 25.77 26.93 26.85 27.1 28.57 26.63 29 31

EBIT 79.76 26.22 44.63 42.2 22.36 28.43 38.00 51.40

EBIT Margin (%) 31.52% 21.19% 27.10% 23.76% 15.26% 17.68% 21.11% 23.74%

Interest 8.63 1.88 0.88 0.62 0.29 0.02 0.01 0.01

PBT 71.13 24.34 43.75 41.58 22.07 28.41 37.99 51.39

Exceptional items ‐2.33 0 0 0 0 0.00 0.00 0.00

PBT after exceptional items 68.80 24.34 43.75 41.58 22.07 28.41 37.99 51.39

PBT Margin (%) 27.19% 19.67% 26.57% 23.41% 15.06% 17.66% 21.11% 23.74%

Tax 24.75 8.14 15.9 13.47 6.6 8.69 11.40 15.93

Tax (%) 34.80% 33.44% 36.34% 32.40% 29.90% 30.59% 30.00% 31.00%

PAT 44.05 16.2 27.85 28.11 15.47 19.72 26.59 35.46

PAT Margin (%) 17.41% 13.09% 16.91% 15.83% 10.56% 12.26% 14.77% 16.38%

Exceptional Items ‐2.33 0 0 0 0 0 0 0

PAT ( excl EI) 46.38 16.2 27.85 28.11 15.47 19.72 26.59 35.46

PAT Margin (%) (excl EI) 18.33% 13.09% 16.91% 15.83% 10.56% 12.26% 14.77% 16.38%

PAT Growth (%) ‐ YoY 5.03% ‐65.07% 71.91% 0.93% ‐44.97% 27.46% 34.87% 33.34%

Basic EPS 5.39 1.98 3.41 3.44 1.89 2.41 3.25 4.34

Adjusted EPS excl exceptional items 5.68 1.98 3.41 3.44 1.89 2.41 3.25 4.34

Equity Capital 8.17 8.17 8.17 8.17 8.17 8.17 8.17 8.17

Face Value 1 1 1 1 1 1 1 1

No. of Outstanding Shares 8.17 8.17 8.17 8.17 8.17 8.17 8.17 8.17

Source: Company data, Microsec Research

- 15 -


Balance Sheet

Cash Flow Statement


SOURCES OF FUNDS

Share Capital 8.17 8.17 8.17 8.17 8.17 8.17 8.17 8.17

Reserves & Surplus 194.12 202.68 221.04 239.67 249.41 257.67 269.93 288.20

Shareholder's Funds 202.29 210.85 229.21 247.84 257.58 265.84 278.10 296.37

Secured Loans 54.83 15.71 3.86 0.00 0.00 0.00 0.00 0.00

Unsecured Loans 34.43 9.92 0.00 0.00 0.00 0.00 0.00 0.00

Total Debt 89.26 25.63 3.86 0.00 0.00 0.00 0.00 0.00

Finance Lease Liability 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

Total 291.55 236.48 233.07 247.84 257.58 265.84 278.10 296.37

APPLICATION OF FUNDS

Gross Block 338.59 344.13 353.45 360.21 361.09 363.59 366.59 370.59

(‐) Accumulated Depreciation 142.45 169.20 195.54 222.01 245.34 271.97 300.97 331.97

Net block 196.14 174.93 157.91 138.20 115.75 91.62 65.62 38.62

Capital Work ion Progress 7.07 5.17 7.54 5.59 3.62 2.50 2.00 2.00

Goodwill 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

Investments 0.00 0.00 0.00 0.00 37.99 37.99 37.99 37.99

Net Deferred Taxation ‐20.09 ‐17.50 ‐14.26 ‐10.73 ‐6.88 ‐6.88 ‐6.88 ‐6.88

Fixed Assets & Investments 183.12 162.60 151.19 133.06 150.48 125.23 98.73 71.73

Inventories 60.33 46.09 43.54 57.00 42.03 43.40 43.75 44.21

Sundry Debtors 35.42 14.87 25.87 25.62 25.16 25.00 25.00 25.45

Other Current assets 0.95 0.50 0.26 0.79 5.24 5.24 5.24 5.24

Cash & Bank balance 49.01 29.00 47.56 55.93 53.31 91.28 132.07 175.88

Loans & Advances 9.98 6.57 6.04 6.05 5.27 4.69 4.81 5.25

Total Current Assets,Loans & Advances 155.69 97.03 123.27 145.39 131.01 169.61 210.87 256.03

Current Liabilities & Provisions 47.26 23.15 41.39 30.61 23.91 29.01 31.50 31.39

Net Current Assets 108.43 73.88 81.88 114.78 107.10 140.61 179.37 224.64

Miscellaneous Expenditure 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

TOTAL 291.55 236.48 233.07 247.84 257.58 265.84 278.10 296.37



A. Cash Flow From Operating Activites

Net Profit Before Tax 68.80 24.34 43.75 41.58 22.07 28.41 37.99 51.39

Depreciation 25.77 26.93 26.85 27.1 28.57 26.63 29.00 31.00

Interest expense 8.62 1.83 1.03 0.62 0.29 0.02 0.01 0.01

Operating Profit before WC changes 102.62 52.7 68.96 64.86 43.7 55.06 67.00 82.40

(Increase)/Decrease in Inventories ‐5.53 14.25 2.54 ‐13.46 14.97 ‐1.37 ‐0.35 ‐0.46

(Increase)/Decrease in Sundry Debtors 1.94 24.4 ‐10.26 ‐0.29 ‐1.63 0.16 0.00 ‐0.45

(Increase)/ Decrease in loans and advances 0.00 0.00 0.00 0.00 0.00 0.58 ‐0.13 ‐0.44

(Increase)/ Decrease in Other Current assets 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

Increase/ (Decrease) in Current & Liabilities 10.93 ‐24.11 12.37 ‐8.84 3.31 5.10 2.50 ‐0.11

Cash generated from operations 109.96 67.24 73.61 42.27 60.35 59.52 69.02 80.94

Direct taxes paid 23.72 10.74 19.14 17 11.29 8.69 11.40 15.93

Net Cash from Operating Activities 86.24 56.5 54.47 25.27 49.06 50.83 57.63 65.01

B. Cash Flow From Investing Activities

Net Cash used in Investing Activities ‐31.1 ‐3.39 ‐9.53 ‐0.93 0.03 ‐1.38 ‐2.50 ‐4.00

C. Cash Flow From Financing Activities

Net Cash from/(Used) in financing activities ‐23.62 ‐73.11 ‐26.4 ‐15.92 ‐13.72 ‐11.48 ‐14.34 ‐17.20

Net (Increase)/Decrease in cash & cash equivalents 31.52 ‐20 18.54 8.42 35.37 37.97 40.79 43.80

Cash & Cash Equivalents at beginning 17.49 49.01 29.01 47.51 55.93 53.31 91.28 132.07

Cash & Cash Equivalents at End 49.01 29.01 47.55 55.93 91.3 91.28 132.07 175.88


- 16 -


Ratio Analysis


Profitability Ratios

Return on Assets (ROA) 29.79% 16.70% 22.59% 19.33% 11.81% 11.63% 12.61% 13.85%

Return on Capital Employed (ROCE) 15.91% 6.85% 11.95% 11.34% 6.01% 7.42% 9.56% 11.96%

Return on Equity (ROE) 22.93% 7.68% 12.15% 11.34% 6.01% 7.42% 9.56% 11.96%

Per Share

Basic EPS 5.39 1.98 3.41 3.44 1.89 2.41 3.25 4.34

Adjusted EPS excl Exceptional Items 5.68 1.98 3.41 3.44 1.89 2.41 3.25 4.34

Dividend Per share 1.20 0.80 1.00 1.00 0.60 1.20 1.50 1.80

Cash Earning Per Share 2.52 ‐1.31 0.12 0.12 ‐1.60 ‐0.85 ‐0.29 0.55

BVPS 24.76 25.81 28.06 30.34 31.53 32.54 34.04 36.28

Valuation Parameters

P/E (x) 4.74 19.16 10.97 11.18 29.87 28.59 21.20 15.90

Adjusted P/E(x) excl Exceptional Items 4.50 19.16 10.97 11.18 29.87 28.59 21.20 15.90

P/CEPS(x) 10.13 ‐28.93 305.56 311.03 ‐35.27 ‐81.56 ‐234.20 126.42

P/BV(x) 1.03 1.47 1.33 1.27 1.79 2.12 2.03 1.90

Market Cap/Sales(x) 0.83 2.56 1.91 1.82 3.17 3.61 3.22 2.68

EV/EBITDA(x) 2.37 6.10 3.69 3.74 9.44 10.54 7.99 5.75

Liquidity Ratios

Current Ratio 3.29 4.19 2.98 4.75 5.48 5.85 6.69 8.16

Acid Test Ratio 2.02 2.20 1.93 2.89 3.72 4.35 5.31 6.75

Debt‐Equity Ratio 0.44 0.12 0.02 0.00 0.00 0.00 0.00 0.00

Efficiency Ratios (%)

Asset turnover Ratio 0.14 0.06 0.10 0.10 0.05 0.07 0.09 0.11

Working Capital Turnover Ratio 0.43 0.22 0.34 0.24 0.14 0.14 0.15 0.16

Inventory Turnover Ratio 0.77 0.35 0.64 0.49 0.37 0.45 0.61 0.80

Margin Ratios (%)

EBITDA Margin 41.43% 40.70% 43.07% 38.83% 29.54% 27.86% 30.00% 31.13%

EBIT Margin 31.52% 21.19% 27.10% 23.76% 15.26% 17.68% 21.11% 23.74%

PBT Margin 27.19% 19.67% 26.57% 23.41% 15.06% 17.66% 21.11% 23.74%

Net Profit Margin 18.33% 13.09% 16.91% 15.83% 10.56% 12.26% 14.77% 16.38%


Microsec Research14th April, 2014

Microsec Research: Phone No.: 91 33 66512100 Email: [email protected]

Ajay Jaiswal: President, Investment Strategies, Head of Research: [email protected]

Fundamental

Name Sectors Designation Email ID

Nitin Prakash Daga IT, Telecom & Entertainment VP‐Research [email protected]

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Soumyadip Raha Oil & Gas Executive Research [email protected]

Saroj Singh Auto, cement Executive Research [email protected]

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Technical & Derivative Research

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Institutional Desk

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Research‐Support

Subhabrata Boral Research Support Asst. Manager Technology [email protected]

Recommendation

Strong Buy >20%

Buy between 10% and 20%

Hold between 0% and 10%

Underperform between 0% and ‐10%

Sell < ‐10%

Expected absolute returns (%) over 12 months

MICROSEC RESEARCH IS ALSO ACCESSIBLE ON BLOOMBERG AT <MCLI>

Microsec Research14th April, 2014

- 17 -


Disclaimer: This document is prepared by the research team of Microsec Capital Ltd. (hereinafter referred as “MCL”) circulated for purely information purpose to the authorized recipient and should not be replicated or quoted or circulated to any person in any form. This document should not be interpreted as an Investment / taxation/ legal advice. While the information contained in the report has been procured in good faith, from sources considered to be reliable, no statement in the report should be considered to be complete or accurate. Therefore, it should only be relied upon at one’s own risk.

MCL is not soliciting any action based on the report. No indication is intended from the report that the transaction undertaken based on the information contained in this report will be profitable or that they will not result in losses. Investors must make their own investment decisions based on their specific investment objectives and financial position and using such independent advisors, as they believe necessary. Neither the Firm, nor its directors, employees, agents nor representatives shall be liable for any damages whether direct or indirect, incidental, special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information.

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