– Auto component industry is passing through a rough patch
– Subros has a leadership position in automotive air conditioners in India
– Strong client base and order pipeline give earnings visibility
– Mandatory fitting of ACs or air blowers in trucks cabin in N2 (3.5-12 tonne) and N3 (12-tonne above) categories is a key growth driver
– Foray into home AC segment to boost sales
– Attractive valuations
We have identified Subros Ltd (CMP: Rs251, Mcap: Rs1,640 crore) as an investment idea in the slowdown-struck auto ancillary industry, Subros is a leader in Indian automotive air conditioner (AC) components and the stock has come under pressure due to the ongoing weakness in auto sales. The correction in its stock price has made valuations very reasonable (17.1 times FY21 projected earnings) for this market leader.
What ails the stock?
The Indian automobile industry is passing through a rough patch due to multiple macroeconomic and industry specific challenges. Factors such as a liquidity crunch, non-availability of retail finance, slowdown in the economy, increase in total cost of ownership due to mandatory long-term insurance and implementation of safety regulations in passenger vehicle (PV) segment, impact of axle load norms in commercial vehicle (CV) segment have affected the demand for automobiles and as a corollary the company’s performance.
What could act as key triggers for the company?
There are multiple factors that work in favour of the company. Subros is the market leader and the largest supplier of automotive AC components to original equipment manufacturers (OEM) in India with a market share of around 42 percent. It expanded its market share by 300 bps in Q1 FY20 compared to FY19 on the back of new orders.
Subros is expected to do well on the back of its order pipeline and new order wins. It has won new businesses from Maruti Suzuki India, Tata Motors and from M&M which should continue to support growth. It has also forayed into international markets with the supply of components to Renault Nissan for its models in Brazil and to a model made by Suzuki in Indonesia. These would help in diversifying its sources of revenue.
Another trigger for growth is the mandatory fitting of ACs or air blowers in trucks cabin in N2 (3.5-12 tonne) and N3 (12-tonne above) categories. Subros has achieved 70 percent market share in the segment. The total annual industry opportunity for the company is around Rs100- 450 crore, which is formidable.
Apart from trucks, Subros has entered the railways’ segment where it has achieved market share of 77 percent. Moreover, in order to further diversify its business, it has partnered with Whirlpool to supply condensers for room ACs which has opened up a new line of business for the company and strengthened its topline.
Further, Denso has moved to a technical assistance model from an entrusted model in the last quarter of FY19. Under this arrangement, Subros can supply engine cooling module (ECM) directly to OEMs versus earlier where it supplied to Denso which in turn sold it to OEMs. This would open up a channel for the company to target other OEMs for this product line.
Lastly, the recent move to reduce corporate tax rate is expected to not only improve profitability but also help prop up overall demand.
Q1 FY20 quarter in a snapshot
Despite decline in auto industry sales, Subros’s net revenue from operations grew by 7.6 percent year-on-year (YoY) driven by a ramp-up in the home AC segment. On the profitability front, earnings before interest, tax, depreciation and amortisation (EBITDA) margin contracted by 100 bps YoY. The contraction was due to higher contribution from lower margin home AC products.
Reasonable valuations make it worth a second look
Subros’ stock price has corrected 20 percent from its 52-week high level making valuations very reasonable. The stock currently trades at 17.1 times FY21 projected earnings.
What could be the risks to the business?
A big risk is crude price and currency movement. Plastic is a key raw material and its price is linked to crude and currency. Another risk is the continuing slowdown in MSIL’s volume which could impact Subros’ financial performance. Lastly, slow adoption of air blowers or ACs in trucks could limit growth.