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February 25, 2014

Index
 Sector Update >> Automobiles

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investors eye

sector update

Automobiles
Sector Update

Improving growth outlook of bearing companies; accumulate SKF India and FAG Bearings on decline

Key points
 In spite of a continued slowdown in the automobile
(auto) sector (read original equipment manufacturers
[OEMs]), the leading bearing makers have reported a
strong set of financial performance in the recent couple
of quarters on the back of a robust replacement
demand (accounting for 35% of revenues) and a surge
in exports led by the rupees depreciation against the
dollar. Our channel checks show that the demand in
the replacement market is driven by the growing
preference for branded products and the slowdown in
imports (especially from China) led by the rupees
weakness.

Strong replacement demand enables bearing

companies to mitigate impact of OEM slowdown
Despite a challenging macro-economic environment,
bearing companies have been able to weather the
slowdown (these have reported a double-digit revenue
growth in the past two quarters as compared with a flat
growth in the OEM segment).
The OEM segment (auto and industrial segments)
constituting about 65% of the overall mix of the bearing
companies has been under pressure because of limited
policy action that has led to a lower economic growth
and stagnation of the investment cycle. However, the
replacement segment (which accounts for 35% of the total
revenues of the bearing companies) has been buoyant,
thereby enabling the bearing companies to mitigate the
impact of the slowdown in the OEM space. The
replacement demand has shown a strong growth on the
back of consumer preference for branded products.
Further, the rupees depreciation against the dollar has
affected the Chinese imports leading to an increased
demand from the domestic players.

 With the expected revival in auto volumes (on a low

base of CY2013) also adding to the growth in the
bearing sector going ahead, we expect the bearing
companies to report a double-digit revenue growth
over CY2013-15. Also, the margins are expected to
remain in a higher trajectory, given the benign
commodity prices, benefits of operating leverage,
higher proportion of revenues from the replacement
market and currency gains in exports (5-15% of
revenues).

Bearing companies to report strong margins on the back

of benign raw material prices and a favourable mix

 Notwithstanding the recent run-up in the bearings

stocks, we see scope for a 10-15% appreciation in the
share price of the leading bearing companies like SKF
India and FAG Bearings over the next three to six
months. One should look at accumulating these stocks
on declines.

The commodity prices are likely to remain benign which

should help maintain the margins for the bearing
companies. Further, a recovery in the demand would
provide benfits of operating leverage. Also, a favourable
product mix (a higher proportion of products for the
replacement segment) and the rupees depreciation would
boost the export revenues for the bearing players leading
to further margin improvement.

 Though SKF India and FAG Bearings trade at similar

valuations on our CY2015 earnings estimates, but we
prefer FAG India to SKF India, given the formers
capacity expansion (which will enable it to outpace
the industry growth); strong parental focus (the parent
aims to double the contribution from the Indian arm);
superior margin profile; and increased proportion of
exports (14% as compared with 6% in case of SKF India).

Sharekhan

Bearing industry to grow in double digits over CY201315; SKF India and FAG Bearings to be prime beneficiaries of revival in the bearing industry; prefer FAG Bearings to SKF India

February 25, 2014

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investors eye

sector update

it witnessed lower capacity utilisation in the past four to

five quarters (utilisation rate of 60-65% vs that of 75-80%
in the past five years). We believe an uptick in the
investment cycle along with a higher volume growth in
the auto sector would help the company to improve the
utilisation and volume growth going forward (particularly
after the general election).

We expect the bearing industry to post a double-digit

revenue growth over the period CY2013-15 with a revival
in the OEM segment and continued strong momentum in
the replacement segment. The OEM segment is expected
to revive in H2CY2014 due to policy action after the
general election, leading to a revival of the investment
cycle. Also, the low base created in CY2013 would boost
the revenues. Further, the replacement demand is
expected to remain strong on consumers preference for
branded products and the rupees depreciation that is
currently deterring imports.

Rupees depreciation to accentuate import substitution:

The rupees depreciation against the dollar has made
imports costlier for the local players which we believe
will deter cheap Chinese imports and favour the domestic
bearing manufacturers. Given that SKF India is present in
the ball bearing segment and has a higher proportion of
replacement sales (where the import content is high),
we believe the depreciation in the rupee will benefit SKF
India more compared with the other bearing players.

We prefer FAG Bearings to SKF India, given the formers

capacity expansion (which will enable it to outpace the
industry growth); strong parental focus (the parent aims
to double the contribution from the Indian arm); superior
margin profile; and increased proportion of exports (14%
as compared with 6% in case of SKF India) all of which
would boost the earnings, given the rupees depreciation.

Valuation
At the current market price of Rs705, the stock is trading at
17.3x and 14.3x CY2014 and CY2015 estimates respectively
(as compared with the historical average price/earnings [P/
E] of 15x). Despite the recent run-up in the stock price, we
see scope for another 10-15% appreciation from the current
levels and one should accumulate SKF India on declines.

SKF India
Investment arguments
Strong replacement mix to mitigate risk of slowdown in
volumes: SKF India derives 48% of its revenues from the
replacement segment (auto, 15%; industrial, 33%). In recent
years, the replacement market has witnessed a steady
growth versus the declining volumes in the OEM space.
Having a strong foothold in the replacement market helps
it to mitigate the risk of the cyclical nature of revenues in
a tough environment. Currently, the two-wheeler segment
in India is relatively better placed (it reported a mid singledigit growth as against a decline in commercial vehicles
and passenger vehicles) due to a healthy demand in the
rural market and new launches in scooters. Hence, we
believe the gradual improvement in the OEM volumes along
with a steady demand from the replacement market will
drive the companys earnings in the next couple of years.

Valuations
Particulars

CY2012

2417

2228

15.5
311
12.9

Change Y-o-Y %
EBITDA (Rs cr)
OPM (%)
Adj. PAT (Rs cr)
Change Y-o-Y %
FD Adj. EPS (Rs)
Change Y-o-Y %

Addressable market share and diversified customer base

with strong distribution network: SKF India, which is
the market leader in the ball bearing segment (with a
45% market share), will be the largest beneficiary of a
revival in the OEM space due to a strong demand for twowheelers in the Indian rural market (the company mainly
caters to the two-wheeler industry). One interesting fact
is that it has a well-diversified client base (no client
contributes more than 5% of its total revenues) and this
mitigates the risk of overdependence on any particular
client for growth.

CY2013 CY2014E CY2015E

2275

2538

2952

-7.8

2.1

11.6

16.3

259

261

301

363

11.7

11.6

12.0

12.5

223

190

189

215

261

23.7

-14.8

-0.7

13.8

21.3

42.3

36.0

35.8

40.8

49.4

23.7

-14.8

-0.7

13.8

21.3

P/E (x)

16.7

19.6

19.7

17.3

14.3

P/B (x)

3.7

3.2

2.9

2.6

2.3

RoE (%)

22.4

17.5

15.4

15.6

16.8

RoCE (%)

27.8

19.7

17.2

18.0

19.6

One-year forward P/E band

25
20
15
10
5

No major capex ahead; higher capacity utilisation to

improve financials: SKF India already expanded its
capacity during CY2010-12 with a capital outlay of Rs230
crore. However, due to the slowdown in the auto sector,
Sharekhan

CY2011

Net sales (Rs cr)

February 25, 2014

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investors eye

sector update

One-year forward P/E band standard deviation

21

traded bearings, leading to a higher margin. Further,

higher capacity utilisation would help improve the margin.

18

Valuation

15

At the current market price of Rs1,655, the FAG Bearings stock

is trading at 18.6x and 14.6x CY2014 and CY2015 estimates
respectively (as compared with the historical average P/E of
14x). Despite the recent run-up in the stock price, we see
scope for additional 10-15% appreciation from the current levels
and one should accumulate the stock on declines.

12

One Year forw ard P/E

Mean

`+1

Jan-14

Sep-13

May-13

Jan-13

Sep-12

May-12

Jan-12

Sep-11

May-11

Jan-11

Sep-10

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Jan-10

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Valuations

FAG India

Particulars

Investment in capacity expansion and new product

launches to drive growth: FAG Bearings has invested in
expanding its capacity. The gross block has increased from
Rs419 crore in CY2011 to about Rs700 crore in CY2013 (its
revenues grew at a compounded annual growth rate
[CAGR] of 12% over the same period). The company
recently set up a plant in Savli, Gujarat to manufacture
low-friction ball bearings and bearings for renewable
energy. Further, it aims to expand the capacities at the
existing plants in Pune, Hosur and Vadodara. FAG Bearings
has planned a capital expenditure (capex) of Rs350 crore
over the next two years. We expect the capacity expansion
(historical manufactured sales/gross block ratio of 1.5x)
to drive the companys growth going ahead. FAG Bearings
is also planning to launch new products over the next two
years which is likely to fuel growth (it plans to double the
strength of engineers from 175 engineers currently).

Net sales (Rs cr)

Change Y-o-Y %
EBITDA (Rs cr)
OPM (%)
PAT (Rs cr)
Change Y-o-Y %
FD EPS (Rs)
Change Y-o-Y %

CY11

CY12

CY13

CY14E

CY15E

1299

1436

1420

1680

2004

24.9

10.5

-1.1

18.3

19.3

254

220

184

228

292

19.4

15.2

12.8

13.5

14.5

176

159

122

148

188

44.8

-9.5

-23.5

21.1

27.3

105.9

95.8

73.3

88.8

113.0

44.8

-9.5

-23.5

21.1

27.3

BV (Rs)

439.3

529.2

598.5

683.2

792.2

P/E (x)

15.6

17.3

22.6

18.6

14.6

RoE (%)

24.1

18.1

12.2

13.0

14.3

RoCE (%)

31.5

21.4

14.0

15.0

17.1

One-year forward P/E band

25
20
15

Increased exports and strong parentage to drive growth:

FAG Bearings derives about 14% of its revenues from the
export markets. Though the domestic demand is expected
to remain under pressure, but an increased focus on exports
would enable FAG Bearings to mitigate the risks of a
domestic slowdown. Besides, the depreciation of the rupee
would help increase the export revenues for the company.

10
5

FAG Bearings currently contributes about 4% of the

revenues of its parent, the Schaffer group. The parent is
aiming to increase its focus on the Indian market and aims
to generate 8-10% of its revenues from FAG Bearings over
the next few years. (FAG Bearings recently expanded the
capacity at the Savli plant).

Jan-14

Sep-13

May-13

Jan-13

Sep-12

May-12

Jan-12

Sep-11

May-11

Jan-11

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Jan-10

One-year forward P/E band standard deviation

25
20
15
10

Increasing localisation levels and higher capacity

utilisation to boost growth: FAG Bearings aims to increase
the localisation levels particularly in the industrial
segment. The new plant in Savli set up in October 2012
would manufacture low-friction ball bearings and large
bearings that would gradually reduce the proportion of
Sharekhan

One Year forw ard P/E

February 25, 2014

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investors eye

sector update

Annexure
Asia is the largest bearing industry with 50% of the total
market, followed by the USA and Europe (25% each). China
accounts for less than 25% of the world market. The global
bearing industry is growing at 1-2% with an estimated
market size of $51 billion in 2012 while the Indian bearing
industry has shown a phenomenal growth of 14% CAGR in
the past 15 years (market size: Rs85 billion) but constitutes
only 4% of the world market. In India, the organised
segment (a 46% share) grew at 18% CAGR in CY2009-12 vs

a decline of 17% in the unorganised sector (a 16% share),

mainly due to the shifting of focus towards quality
products in the replacement market. As on date, the
demand for bearing products comes from the auto segment
(48%) and the industrial segment (52%). Most of the
organised players such as SKF India, FAG Bearings and
Timken India have witnessed a strong growth in volumes
and an improvement in market share in the specialised
product segments in recent years.

Product positioning, market share and revenue mix

Type of bearings

Spherical
roller bearings

Cylindrical
roller bearings

Needle
roller bearings

Tapered
roller bearings

Thrust
roller bearings

Market size (Rs bn) 46

14

21

Major player
(market share)

SKF (45%)

FAG (45%)

FAG (45%)

NRB (70%)

FAG, National
Engineers, Timken

SKF, National
Engineers

National Engineers INA Bearings,

SKF, NRB
SKF

SKF, FAG, National

Engineers, ABC
Bearings

SKF, FAG,
Timken

SKF

35%

18%

47%

FAG Bearings

25%

35%

40%

NRB Bearings

16%

58%

26%

Other players

Deep grove
ball bearing

Revenue mix

Sharekhan Limited, its analyst or dependant(s) of the analyst might be holding or having a position in the companies mentioned in the article.

Sharekhan

February 25, 2014

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