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CD Equisearch Pvt Ltd Nov 2, 2016

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L.G.Balakrishnan&Bros Ltd

No. of shares (m) 15.7

Mkt cap (Rs crs/$m) 1063/159.4

Current price (Rs/$) 677/10.2

Price target (Rs/$) 847/12.7

52 W H/L (Rs.) 728/392

Book Value (Rs/$) 272/4.1

Beta 0.8

Daily volume (avg. monthly) 46240

P/BV (FY17e/18e) 2.3/2.0

EV/EBITDA (FY17e/18e) 7.1/6.2

P/E (FY17e/18e) 14.4/12.0

EPS growth (FY16/17e/18e) -3.9/16.8/19.7

OPM (FY16/17e/18e) 11.4/12.7/12.7

ROE (FY16/17e/18e) 16.9/17.2/17.8

ROCE(FY16/17e/18e) 14.1/14.2/15.5

D/E ratio (FY16/17e/18e) 0.4/0.3/0.2

BSE Code 500250

NSE Code LGBBROSLTD

Bloomberg LGBB IN

Reuters LBG.BO

Shareholding pattern %

Promoters 47.5

MFs / Banks / FIs 13.7

Foreign 1.4

Govt. Holding 0.0

Non-Promoter Corp. 1.6

Total Public 35.7

Total 100.0

As on Sep 30, 2016

Recommendation

BUY

Analyst

KISHAN GUPTA, CFA, FRM

Phone: + 91 (33) 4488 0043

E- mail: [email protected]

Consolidated (Rs crs)

FY14

FY15

FY16

FY17e FY18e

Income from operations 1108.56 1172.98 1205.30 1343.91 1520.39

Other Income 4.60 8.80 3.92 3.83 4.25

EBITDA (other income included) 130.74 151.08 141.60 174.61 197.73

Profit after MI & associate profit

60.07 65.97 63.37 74.03 88.65

EPS(Rs) 38.26 42.03 40.37 47.16 56.48

EPS growth (%) 94.7 9.9 -3.9 16.8 19.7

Company Brief L G Balakrishnan (LGB) manufactures roller chains and undertakes metal

forming, which includes warm & cold forging, fine blanking and precision-

machined parts. Its step subsidiary, GFM LLC, deals in precision stamped

metal parts which are used in automobiles.

Quarterly Highlights

� If recent trend in sales of LG Balakrishnan is anything to go by, then the

domestic two wheeler industry is showing discernible signs of revival.

Income from operations (standalone) jumped 10.1% to Rs 309.95 crs

($46.5m) in Q2 - the best reading in last nine quarters - not least due to hefty

rise in bellwether transmission business sales (10.2%), catapulting its

revenue share to 79.1%. Slackness in two wheeler industry in last few years

could do little to prevent massive rise in transmission business revenue

(standalone) share - 78.8% in FY16 from 67.3% in FY13.

� Its metal forming business - largely dependent on four wheeler industry -

failed to gain ground in last few quarters partly due to restrictions in sales

of diesel powered vehicles. Sales declined 2% last fiscal, which still evokes

doubts on the strength of the recent recovery – sales are up 11.1% in H1.

EBIT margins have been no stabler - declining by some 300 bps to 7.6% in

Q2 from 11.5% in Q1.

� All thanks to higher dispatches, LGB's transmission business margins

ballooned to 12.1% in Q2- the highest in at least three years, resulting in

47.8% growth in its EBIT to Rs 29.64 crs ($4.4m) from Rs 20.05 crs ($3.0m) in

the same quarter a year ago; margins for H1 also expanded by some 130 bps

to 9.4%. With transmission business turning more vivacious, its EBIT share

has started to creep up - 80.8% in H1FY167from 79.9% a year ago. Adjusted

profit after tax rose by 16.3% to Rs 30.65 crs ($4.6m) in H1FY17 from Rs

26.37 crs($4.0m) in the same period a year ago.

� The stock currently trades at 14.4x FY17e EPS of Rs 47.16 and 12xFY18e EPS

of Rs 56.48. Prodigious recovery of the Indian two wheeler industry has

spurred related auto component makers to ramp up production. Perceptible

signs of recovery are all too evident in LGB’s transmission business – higher

volumes in Q2 with margin augmentation. Yet portending the medium

term trend of the consumer centric auto industry is viciously difficult,

invoking need for frequent estimate changes. Weighing odds, we upgrade

the stock to buy with revised target of Rs 847 (previous target: Rs 549) based

on 15x FY18e earnings (peg ratio: 0.8), over a period of 9-12 months.

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CD Equisearch Pvt Ltd


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Outlook & Recommendation

Two wheeler industry

After growing at just 3% last fiscal, the Indian two-wheeler industry has seen resurrection of sorts for the domestic sales has

grown by a blistering 17.5% in the Apr-Sep 16 period. Motorcycle industry obliterated much of the sclerosis of last few years

(four average growth: 1.6%) to post 17.5% growth in domestic dispatches, while the scooter off take remained buoyant at some

27%. Dispatches of Hero Honda, one of the largest two wheeler makers, rejuvenated as it posted 10.8% growth in overall

volumes in Apr-Sep 16, while Bajaj Auto reported marginal decline is dispatches to 1.77m - primarily due to weak export

market. Its exports plummeted some 22%, whereas the domestic sales rose by 18%.

SIAM attributes much of the recent firmness in Indian automobile industry to good monsoons and wage hikes of government

employees, goading it to revise passenger vehicle industry growth to 11-13% for FY17 from its earlier estimate of 6-8%. In view

of better than expected ramp up in demand momentum, ICRA too revised its domestic passenger vehicle demand outlook for

FY17 to 10-12% from 8.5-9.5% earlier. For two wheeler industry, it expects the September domestic sales growth of 21.6% to

sustain for much of the remaining fiscal.

Industry experts believe that volume growth in domestic two-wheeler industry is set to hit double digit mark after a gap of

four years. Y S Guleria, senior vice-president (sales and marketing), at Honda Motorcycle & Scooter India (HMSI) reckons that

demand from both urban and semi-urban areas have driven the growth of Indian two-wheeler industry since April this year.

He posits 13-14% industry growth for the year galvanized by steady rural demand (where monsoon is near normal), increased

salaries of government employees and expansion of services sector. ICRA, a credit rating agency, postulates 10-12% growth for

the Indian two-wheeler industry on the back of 7th Pay Commission payout and the One Rank One Pension rule for the

defense sector.

Financials & Valuation

Underpinned by strong recovery in two-wheeler industry, LGB's transmission business would muster visibility to post 10.2%

growth in sales - the first double digit after a gap of two quarters, attended by higher margins. With two-wheeler industry

growth estimates for current fiscal levitating in 10-14% range, little scope of misjudgment exists in penciling over10%

transmission business annual revenue growth for next two years. Its margins would expand too by at least 150 bps this fiscal

not least for palpable benefits of economies of scale arising from higher capacity utilization at the Jalna plant. Muddled

outlook of the diesel powered four wheeler industry would restrict rapid expansion of metal forming business, which

somewhat teetered last fiscal (EBIT down by 22%) after a phenomenal expansion in FY15.

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LGB's growth strategy is not bereft of piling up capital assets - its gross block has nearly doubled in last five years. Its Jalna

project - targeted to enhance capabilities of both transmission and metal forming businesses- has already seen investments of

close of Rs 150 crs ($22.5m) in last three years. Of the Rs 80 crs ($12.0m) capex earmarked for current fiscal, Rs 30 crs ($4.5m)

would be channelized in the Jalna project and the balance would be maintenance capex. Undoubtedly, the last few years has

seen the greatest overhaul of operations since 2010-11when LGB added five plants (Manesar, Rudrapur, Kadathur, Annur) in

a year's time to boost its footprint.

Bogged down by a fragile recovery in Indian LCV segment, LGB's dealership business has sorely struggled over the years -

revenues down by two-thirds in last three years. It responded to the crisis by shutting down unviable showrooms, which

would help contain losses in case of a prolonged recovery. Effect of improving asset utilization rates would rub off on

margins and asset turnover ratios (see chart). Large operating cash flows would be deployed in either debt retirement or

maintenance capex.

The stock currently trades at 14.4x FY17e EPS of Rs 47.16 and 12xFY18e EPS of Rs 56.48. Stability in earnings underscores

impregnable effects of its large market share of Rolon brand of chains (70% in OEM segment and ~50% in replacement

market) and fine blanking technology. Relentless toil to seek higher turnover from replacement market would indeed

invigorate margins. Yet fragility of business to dramatic shifts in demand of two wheeler industry cannot be undone without

colossal transformation. On balance we upgrade the stock to buy with revised target of Rs 847 (previous target: Rs 549) based

on 15x FY18e earnings (peg ratio: 0.8), over a period of 9-12 months. For more info, refer to our Jan report.

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Risks & Concerns

Firm power cost

LGB reckons that high power cost in India acts a deterrent to low-cost manufacturing. LGB's increasing power cost (from 3% of

sales (standalone) in FY10 to 4.4% in FY16) has somewhat eroded its cost competitiveness over the last few years.

Dreary automobile sector

As the automobile sector forms a bulk of LGB's revenue, slow pick up in two wheeler sales could impact its volumes. Lower than

expected moderation in interest rates would further jeopardize resurrection in auto demand.

Margin pressure

Plethora of factors imperil margins including rising raw material costs, acute power shortages, pricing pressure by clients (read

OEMs) and import of auto components from low cost locations.

Cross Sectional Analysis

Company Equity* CMP Mcap* Sales* PAT* OPM NPM

Int

Cov. ROE

Mcap/

sales P/BV P/E EV/EBITDA

Gabriel India 14 124 1781 1467 77 8.9 5.3 45.5 20.8 1.2 4.5 23.1 13.0

LG Bala 16 677 1063 1136 62 12.3 5.4 6.4 15.4 0.9 2.5 17.2 8.6

Minda Corp 42 113 2373 2613 104 9.2 4.0 4.8 26.0 0.9 5.4 22.9 11.0

Munjal Showa 8 233 931 1516 61 7.3 4.0 360.9 13.1 0.6 1.9 15.3 7.3

*figures in crores; calculations on ttm basis Companies not truly comparable due to product dissimilarity

Note: All dollar value figures expressed in the write up are translated at current exchange rate.

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Financials

Quarterly Results -Standalone Figures in Rs crs

Q2FY17 Q2FY16 % chg. H1FY17 H1FY16 % chg.

Income from operations 309.95 281.54 10.1 574.22 528.39 8.7

Other Income 1.09 1.04 5.4 1.95 1.71 14.0

Total Income 311.04 282.58 10.1 576.17 530.10 8.7

Total Expenditure 264.42 245.63 7.6 500.27 468.17 6.9

PBIDT (other income included) 46.63 36.95 26.2 75.89 61.93 22.6

Interest 3.68 4.54 -19.0 7.61 8.83 -13.8

Depreciation 12.27 10.49 17.0 23.85 19.96 19.5

PBT 30.68 21.92 40.0 44.43 33.14 34.1

Tax 9.53 4.56 109.0 13.78 6.77 103.5

PAT 21.14 17.35 21.8 30.65 26.37 16.3

Extraordinary Item - - - - - -

Adjusted Net Profit 21.14 17.35 21.8 30.65 26.37 16.3

EPS (F.V. 10) 13.47 11.06 21.8 19.53 16.80 16.3

Segment Results Figures in Rs crs

Q2FY17 Q2FY16 % chg. H1FY17 H1FY16 % chg.

Segment Revenue

Transmission 245.09 222.50 10.2 449.15 416.25 7.9

Metal forming 51.71 47.25 9.4 99.09 89.20 11.1

Others 13.15 11.79 11.6 25.97 22.94 13.2

Total 309.95 281.55 10.1 574.22 528.39 8.7

Segment EBIT

Transmission 29.64 20.05 47.8 42.04 33.55 25.3

Metal forming 3.95 4.99 -20.7 9.40 8.10 16.1

Others 1.39 2.25 -38.2 2.24 1.71 30.9

Total 34.98 27.29 28.2 53.68 43.35 23.8

Interest 3.68 4.54 -19.0 7.61 8.83 -13.8

Unallocable exp 0.62 0.83 -24.6 1.64 1.39 18.6

PBT 30.68 21.92 40.0 44.43 33.14 34.1

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Financials

Income Statement - Consolidated Figures in Rs crs

FY14 FY15 FY16 FY17e FY18e

Income from operations 1108.56 1172.98 1205.30 1343.91 1520.39

Growth (%) 15.9 5.8 2.8 11.5 13.1

Other Income 4.60 8.80 3.92 3.83 4.25

Total Income 1113.16 1181.78 1209.22 1347.74 1524.64

Total Expenditure 982.42 1030.70 1067.63 1173.13 1326.91

EBITDA (other income included) 130.74 151.08 141.60 174.61 197.73

Interest 17.90 17.70 17.89 17.25 14.18

EBDT 112.84 133.38 123.71 157.37 183.55

Depreciation 32.79 39.47 45.93 50.68 55.87

Tax 14.90 20.49 12.92 32.00 38.30

Net profit 65.15 73.42 64.86 74.68 89.37

Minority interest 3.24 2.79 2.28 1.56 1.64

Associate profit 0.93 0.58 0.91 0.91 0.91

Net profit after MI&AP 62.84 71.21 63.50 74.03 88.65

Extraordinary item 2.77 5.24 0.13 - -

Adjusted Net Profit 60.07 65.97 63.37 74.03 88.65

EPS (Rs.) 38.26 42.03 40.37 47.16 56.48

Segment Results Figures in Rs crs


Segment Revenue

Transmission 729.50 799.78 859.47 954.01 1087.57

Metal forming 165.95 184.60 180.91 202.62 228.96

Others 213.11 188.61 164.93 187.28 203.86

Net sales 1108.56 1172.98 1205.30 1343.91 1520.39

Segment EBIT

Transmission 73.93 77.85 68.81 90.63 104.41

Metal forming 15.32 23.29 18.14 21.27 24.04

Others 8.70 3.87 8.71 12.02 13.41

Sub Total 97.94 105.00 95.67 123.93 141.86

Unallocable income 0.00 6.61 - - -

Interest 17.90 17.70 17.89 17.25 14.18

PBT 80.04 93.91 77.78 106.68 127.68

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Consolidated Balance Sheet Figures in Rs crs


SOURCES OF FUNDS

Share Capital 7.85 15.70 15.70 15.70 15.70

Reserves 299.89 348.95 400.60 461.41 534.94

Total Shareholders Funds 307.74 364.65 416.30 477.10 550.64

Minority Interest 9.66 12.79 15.32 16.88 18.52

Long term debt 65.99 99.31 94.88 69.77 56.60

Total Liabilities 383.39 476.74 526.49 563.75 625.75

APPLICATION OF FUNDS

Gross Block 486.13 586.02 691.35 761.35 811.35

Less: Accumulated Depreciation 231.41 270.01 310.79 361.48 417.34

Net Block 254.72 316.01 380.56 399.88 394.01

Capital Work in Progress 9.04 36.54 10.22 10.00 5.00

Investments 17.03 17.60 18.52 19.43 20.34

Current Assets, Loans & Advances

Inventory 207.52 230.55 227.88 232.44 248.71

Sundry Debtors 146.10 146.55 152.52 167.78 187.91

Cash and Bank 6.50 7.33 8.04 6.83 9.67

Other Assets 13.80 24.05 35.06 36.83 40.34

Total CA & LA 373.92 408.48 423.51 443.87 486.63

Current liabilities 282.08 305.23 313.19 314.42 284.28

Provisions 6.43 7.18 2.03 3.92 5.81

Total Current Liabilities 288.51 312.41 315.22 318.34 290.09

Net Current Assets 85.41 96.07 108.29 125.53 196.54

Net Deferred Tax (net of liability) -16.99 -16.51 -18.49 -20.08 -20.98

Other Assets (Net of liabilities) 34.17 27.03 27.39 28.99 30.85

Total Assets 383.39 476.74 526.49 563.75 625.75

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Cash Flow Statement Figures in Rs crs

FY15 FY16 FY17e FY18e

Net Income (a) 73.42 64.86 74.68 89.37

Non cash exp. & others (b) 33.19 48.25 51.67 56.08

Depreciation 39.47 45.93 50.68 55.87

Profit / loss on sale of assets -6.70 -0.15 0.00 0.00

Others 0.43 2.47 0.99 0.21

(Increase) / decrease in NWC (c) -23.84 -13.67 -14.45 -29.97

Inventory -23.03 2.67 -4.56 -16.27

Debtors -1.32 -5.73 -15.25 -20.13

Long term loans & advances 3.06 -3.82 0.60 -1.76

Trade payables & others -2.54 -6.79 4.76 8.19

Operating cash flow (a+b+c) 82.78 99.44 111.90 115.49

Proceeds on sale of assets 7.78 0.49 - -

Purchase of fixed assets -104.77 -84.06 -79.31 -45.00

Investments - - - -

Others 0.61 1.25 0.60 0.69

Investing cash flow (d) -96.38 -82.32 -78.71 -44.31

Net borrowings 26.95 0.67 -23.08 -55.11

Dividends paid -12.45 -16.62 -11.34 -13.22

Issue of shares - - - -

Financing cash flow (e) 14.50 -15.95 -34.41 -68.33

Net change (a+b+c+d+e) 0.90 1.17 -1.22 2.84

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Key Financial Ratios


Growth Ratios

Revenue (%) 15.9 5.8 2.8 11.5 13.1

EBIDTA (%) 40.2 13.4 -2.0 23.5 13.2

Net Profit (%) 94.7 9.8 -3.9 16.8 19.7

EPS (%) 94.7 9.9 -3.9 16.8 19.7

Margins

Operating Profit Margin (%) 11.4 12.1 11.4 12.7 12.7

Gross Profit Margin (%) 9.9 10.8 10.3 11.7 12.1

Net Profit Margin (%) 5.6 5.8 5.4 5.6 5.9

Return

ROCE (%) 17.7 16.6 14.1 14.2 15.5

RONW (%) 22.4 20.6 16.9 17.2 17.8

Valuations

Market Cap / Sales 0.3 0.7 0.6 0.8 0.7

EV/EBIDTA 3.6 7.2 6.0 7.1 6.2

P/E 5.3 13.1 10.8 14.4 12.0

P/BV 1.1 2.5 2.7 2.3 2.0

Other Ratios

Interest Coverage 5.3 5.9 5.3 7.2 10.0

Debt-Equity Ratio 0.5 0.5 0.4 0.3 0.2

Current Ratio 1.3 1.3 1.3 1.4 1.7

Turnover Ratios

Fixed Asset Turnover 4.8 4.3 3.6 3.6 4.0

Total Asset Turnover 3.1 2.8 2.5 2.5 2.6

Debtors Turnover 8.2 8.0 8.1 8.4 8.5

Inventory Turnover 4.9 4.7 4.7 5.1 5.5

Creditors Turnover 7.4 6.3 5.7 6.1 6.7

WC Ratios

Debtor Days 44.5 45.5 45.3 43.5 42.7

Inventory Days 75.0 77.6 78.4 71.6 66.2

Creditor Days 49.3 58.4 63.8 59.7 54.6

Cash Conversion Cycle 70.1 64.7 59.9 55.4 54.3

Cash Flows (Rs crs)

Operating Cash Flow 82.8 99.4 111.9 115.5

FCFF 0.2 32.0 45.3 81.1

FCFE 13.3 17.8 10.1 16.1

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Cumulative Financial Data Figures in Rs crs FY13-14 FY15-16 FY17-18e

Income from operations 2065 2378 2864

Transmission revenues 1360 1659 2042

Metal forming revenues 323 366 432

Transmission to total (%) 66 70 71

Transmission EBIT 131 147 195

Transmission EBIT margin (%) 9.6 8.8 9.6

Operating profit 215 280 364

EBIT 156 200 266

PBT 115 165 234

PAT 91 129 163

Dividends 18 25 28 OPM (%) 10.4 11.8 12.7

NPM (%) 4.5 5.6 5.7

Interest coverage 3.8 5.6 8.5

ROE (%) 17.4 18.7 17.4

ROCE (%) 15.4 15.5 14.9

Debt-equity ratio* 0.5 0.4 0.2

Fixed asset turnover 4.7 3.9 3.8

Total asset turnover 3.1 2.7 2.5

Debtors turnover 8.1 8.0 8.4

Inventory turnover 4.6 4.8 5.2

Creditors turnover 7.2 6.2 6.4

Debtors days 45.1 45.8 43.4

Inventory days 79.1 75.7 69.6

Creditor days 51.0 58.5 57.4

Cash conversion cycle 73.1 63.1 55.6

Dividend payout ratio (%) 18.7 18.2 17.4

FY13-14 implies two years ending fiscal 14; *as on terminal year;

Recovery in two-wheeler demand has reinvigorated most auto component makers who have been affected by a dramatic

slowdown in domestic two- wheeler industry. LG Balakrishnan was no exception for it reported an average annual sales

growth of 8.3% in its transmission business (replacement sales included) in last four years when domestic two wheeler industry

grew by a mere 5.3%; yet bettering its four wheeler industry reliant metal forming business whose revenues rose by 3.5%. But

recent buoyancy in domestic motorcycle dispatches (12.7% in Apr-Sep 16 period) has doubtless buttressed estimates -

cumulative sales in FY17-18e period projected to jump by 20.4% to Rs 2864 crs (see table) from the preceding two years.

Thanks to higher volumes, margins would plump too - 12.7% in FY17-18e period from 11.8%, thus perceptibly boosting

earnings. Most pertinently, transmission business cumulative EBIT would increase by a third to Rs 195 crs in FY17-18 period,

galvanizing EBIT margins (which had come off a lot from the peak in last few years) by some 80 bps to 9.6%. Yet lower asset

turnover ratios would hinder rise in return on capital ratios - ROE estimated to decline by nearly 130 bps to 17.4%. Noticeable

debt retirement in the next two years would manifest itself in sharp rise in interest coverage ratio.

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Financial Summary – US dollar denominated

million $ FY14 FY15 FY16 FY17e FY18e

Equity capital 1.3 2.5 2.4 2.4 2.4

Shareholders’ funds 48.6 55.8 60.3 69.1 80.1

Total debt 25.0 28.3 26.8 23.2 15.0

Net fixed assets (incl CWIP) 41.7 54.2 56.8 59.4 57.7

Investments 2.8 2.8 2.8 2.9 3.0

Net current assets 14.2 15.3 16.3 18.8 29.5

Total assets 61.6 74.1 77.3 82.4 91.7

Revenues 183.2 191.8 184.1 201.4 227.9

EBITDA 21.0 23.6 21.6 26.2 29.6

EBDT 18.1 20.7 18.9 23.6 27.5

PBT 12.7 14.3 11.9 16.0 19.1

Profit after MI & asso. profit 9.9 10.8 9.7 11.1 13.3

EPS($) 0.63 0.69 0.62 0.71 0.85

Book value ($) 3.1 3.6 3.8 4.4 5.1

Operating cash flow 13.2 15.0 16.8 17.3

Investing cash flow -15.4 -12.4 -11.8 -6.6

Financing cash flow 2.3 -2.4 -5.2 -10.2

income statement figures translated at average rates; balance sheet and cash flow at year end rates; projections at current rates All dollar denominated figures are adjusted for extraordinary items.

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