30th Jan 2017 SML LIMITED

BSE: 505192 | Sector: AUTO

View - BUY CMP : Rs. 1202 Target Price: Rs. 1720 (In next 12 to 18 mths)

BUSINESS BACKGROUND KEY DATA FACE VALUE Rs 10.00 SML ISUZU Ltd started in 1983 is an automobile manufacturer whose main product base includes Trucks, Buses and Special application vehicles like that of Ambulance, Military vans, Tipper etc. They can be broadly classified into Light, Medium and Heavy DIVD YIELD % 0.66 commercial vehicles. 52 WK HI/LOW 1433/645 SML Isuzu is mainly concentrated in 5 to 12 tonnes GVW segment. In Buses segment, it focuses on school buses, State transport buses, luxury buses and buses for employees NSE CODE SMLISUZU in BPOs, etc. SML Isuzu also exports vehicles to Sri Lanka, , , and Nigeria including other countries and is exploring market in Africa. BSE CODE SMLISUZU INVESTMENT HIGHLIGHTS MARKET CAP RS 1740 CRS

St rong H1FY17 Performance –

SMIL Ltd reported a strong sale s growth of 13 % yoy in Q2 of FY17 totalling SHAREHOLDING PATTERN Rs 303 crs as compared to Rs 267 crs in Q2 last year with EBIDTA of Rs 17.81 crs in Q2FY17 as compared to Rs 12.55 crs in Q2 last year with PAT PROMOTERS - 44% up by 52% at Rs 9.69 crs in Q2 FY17. For H1FY17 total sales are up by 18% at Rs 768 crs as compared to Rs 652 crs in H1 last year with EBIDTA BANKS, MFs & DIIs - 3% totaling Rs 79 crs in H1FY17 from Rs 55 crs recorded in H1 last year with FIIs - 4% PAT totaling at Rs 50.81 crs from Rs 35.42 crs in H1 last year – up by 43% YoY.

PUBLIC - 49% For FY16 the company has recorded a topline of Rs 1164 crs, a EBIDTA of Rs 84.75 crs while PAT was placed at Rs 51.16 crs from Rs 36.93 crs last KEY FUNDAMENTALS year . SMIL paid a dividend of 80% for FY16. vScore: vScore (Value Score) is our proprietary company rating system f YE FY16 FY17 FY18 SMIL is a well established played in the niche 5-12 GVW segment – SMIL manufactures vehicles in 5-12 Gross Value Weight segment. Bus Rev Gr% 5 25 20 segment contributed around 64% of the total revenue mix of the company in FY16, while the rest is derived from commercial vehicles like EBIDTA Gr% 29 52 33 pickup trucks, cargo trucks, etc. It is a very strong player in bus segment. PAT Gr% 38 46 39 The company has plans to launch 3-4 new products every year to create better product mix. EPS Gr% 38 46 39 SMIL enjoys technical & financial collaboration with Isuzu Motors Japan – SMIL Isuzu signed a technical assistance agreement with Isuzu Roe % 16 20 22 motors in June 2006. Isuzu motors acquired 2% stake in SML in 2008 and further raised it to 15% in 2012 showing its confidence. Isuzu Motors Ro ce % Precise 14 17 18 Advice globally is a leading Japanese commercial vehicles and engine Assured…manufacturer company with presence in Asia and Africa. With Isuzu, SML EPS (Rs) 35 52 72 gains technological expertise and innovation. Going ahead there are possibilities that Isuzu motors may sell its commercial vehicles in P/E (x) 23 16 through SML Isuzu and also increase its stake in SMIL further going ahead.

Export business continue to report robust growth – SMIL enjoys a strong market positioning in the school bus passenger segment, which continues to grow rapidly –

SMIL is quite popular and well established in the School/College/Staff bus segment, and has been gaining increased market share here over the years. The overall domestic market share of SML ISUZU in the commercial passenger vehicle segment has increased from 8% in FY14 to 11% in FY16, registering a growth of 24% in the CV segment.

The sustainable market conditions for this growth can be backed up by the increasing number of schools year on year with a CAGR of 4% from FY06-16 and this trend is expected to continue according to Ministry of Human Resource Development.

Also, emphasis laid in providing transportation on educational institutions has necessitated the need to buy/replace buses in regular periods of time. Therefore, the market has adequate space for future growth also. In fact we would like to highlight that since the last 2-3 years most of its passenger bus sales come in the first quarter of the financial year which coincides with the start of academic year for school students, which is mostly in June, hence the sales are bunched largely here from the school bus segment

SMIL has a wide dynamic variation in its bus portfolio which predominantly caters to the school and college bus segment. Mostly these are placed between 5- 7.5 tonnes GVW having a seating capacity of 20 to 32. The buses are preferred based on the requirement like for example; a primary school would prefer either a 20 to 24 seater, while high schools and colleges require a higher 26 or 32 seater.

Moreover, the same school bus model is also facilitated for staff in educational institutes. It is mostly the corporates that prefer special staff buses for their employees.

Out of this SML school/staff buses having GVW between 5-7.5 tonnes are quite active in the market and their sales have increased by over 10% in FY16 compared to the previous year FY15. and hence we believe that the demand for school buses is expected to be sustained going ahead also largely on the back of increasing number of schools.

SMIL operates as a niche player in the Goods segment with a wide range of products –

Out of the total number of vehicles sold at SMIL, the goods segment constitutes around 33% in FY16 and the rest was largely from the passenger vehicles segment.

SML operates mainly in the 5-12 GVW segments which are mostly run by common fleet operators, vendors and other small scale industries. Since the customer base belongs to different product categories, especially more from the medium and large business segments it is quite fair to assume that SMIL’s market share of about 8% might not be as vulnerable to market changes as their big peer companies.

Therefore, GDP growth rate is considered so as to include all the market segments. The GDP (according to new series) has grown 7.4% in FY15 as compared to the previous year 6.6% in FY14 and is expected to grow at 8.0% in FY16E. Here our assessment is that SMIL’s sales volume in the goods segment is likely to increase at a CAGR of 8-9% % between FY16-18E.

SML truck portfolio ranges between 5 - 12 GVW tonnes where models which fall between 5 to 8 GVW are quite high in number wherein 6 models out of the above 9 fall under this segment. The sales volume surged by 48% in the overall truck segment. The share of MCVs (53%) in total truck volume of SMIL is higher than of the LCVs (47%). However, the LCV goods sales have shown a drop in volumes in FY16 but compensated by higher MVC volumes. Among LCV models, Cosmo, Sartaj and Prestige premium have relatively performed well in FY16 where cosmo sales have increased by 81% in FY15 and Sartaj/Prestige has gone up by 20% thus adding to overall sales growth.

Growth Drivers for the Commercial Vehicles industry look strong over the long term –

India has been among the fastest growing countries in Automobile sector. The entry of many foreign players in India and their collaboration with domestic Automobile companies will lead it to be a major player in Automobile market in the world. New and upgraded technology and innovation has increased exports demand to many countries from India.

All segments of Commercial vehicle industry have shown revival in FY16. According to ICRA, M&HCV are likely to register a growth of 8-9% in FY 17 driven by continuing trend towards replacement of ageing fleet and expectations of pick-up in demand from infrastructure, mining and industrial sectors in view of various reforms being initiated by the Government.

LCV segment has grown at lower rate of 4-6% in FY16 due to overcapacity and financing problems but are expected to grow at 11-13% over long term. Bus segment which contributed 13% to the overall commercial industry has shown pickup in demand in 2015 on back of new orders from State Transportation Undertakings. The bus industry has witnessed export demand from Sri Lanka, Bangladesh, Middle East and African countries.

Being a cyclical industry, the domestic share of MCVs has been decreasing from FY11 to FY14 due to reduction in economic activity; attributed to reduced mining activity and construction during FY12-13 and in the meantime LCVs had been shaping up.

Again the trend now seems to have reversed wherein the MCVs are gaining in their share, as there is an overall improvement in Mining, Construction and Manufacturing industries, where such vehicles would be extensively preferred. However, the LCV segment has taken a step back. Nevertheless measures such as excise duty cuts, high discounts are likely to trigger back the sales. Also, perception of monetary easing in FY17E could further revive the overall commercial vehicle industry performance.

On the other hand relative to the domestic CV industry, SMIL has done better as compared to the overall industry performance for the last five years. However, the trend now seems to have been upturned where, during FY16, the industry has grown by 12% while the SML sales have surged by 16%. A similar trend is evident in that of the LCV segment sales versus the industry where, SMIL registered an increase in sales by 25% while the LCV industry remained flat in FY16.

Steady improvement financial performance expected – Revenue growth and margin expansion to continue –

We estimate SMIL’s earnings to witness a CAGR of 19-20% over FY16-19E. This will be driven by steady revenue growth (16-18% CAGR over FY16-19E) and a steady EBITDA margin expansion over the same period.

Over the last 2 years starting 2015 onwards, SMIL has maintained its operating margins between 6% to 8% in FY16 and it has been able to maintain a return on equity of 20%. We expect a significant improvement in both ROCE and ROE over the next 2 years as we expect both the domestic and export markets to grow at a healthy clip where there is good scope for margin improvement and revenue growth.

More importantly the company has reduced its debt significantly to Rs 26 crs in Sept 2016 from Rs 55 crs in FY16 and which will further strengthen the business going ahead for SMIL.

SMIL is also planning a big capex over the next 2-3 years to augument its capacity –

The company has started its capex plan of investing Rs.220 crs by the year 2017 mainly in product development and in improving its technology apart from this it will increase its capacity from its current levels of 18000 nos annually. This investment plan would fuel the growth of the company and thus increase the top line of the company

The present capacity utilization rate of its existing plant for FY16 stands at around 65% which is likely to increase to 75% by FY17E and to 85% by FY18E on account of new vehicle models that are expected to be ready for the consumers by FY17E. Therefore, the sales volume growth is expected to increase at a CAGR of 14% between FY15 and FY18E.

While most of this capex will be funded by internal accruals and ECB funding, the present debt equity structure is quite comfortable to afford this flexibility to the company going ahead to fund its expansion plans comfortably.

Operational leverage to benefit SMIL –

SML Isuzu has been successful in managing its working capital requirements and thus became debt free in FY14. The company will fund its planned capex of Rs. 220 crores with debt and internal accrued funds, thus debt will increase from here on. Current D/E ratio stands at 0.06:1 with total debt of Rs. 26 crs.

With higher sales volume and operational efficiency, EBITDA and PAT margins of the company are expected to improve slightly from current levels. The company has cash and cash equivalents of Rs. 46 crs as on September, 2016.

Business Outlook & Stock Valuation –

On a rough cut basis, in FY17, Topline will see a steady rise wherein Topline is expected to touch Rs 1450 crs.

On the bottomline level we expect the company to record a PAT of Rs 75 crs in FY17E. Thus on a conservative basis, SMIL should record a EPS of Rs around Rs 52 for FY17E. For FY18E and FY19E our expectation is that earnings traction for SMIL would continue to be strong wherein we expect a EPS of Rs 72 and Rs 92 respectively.

Also another attractive point for SMIL is that EPS growth over the next three years between FY16 to FY19 is expected to average 20% plus YoY and to add to this at the current market cap of SMIL at Rs 1743 crs, the SMIL stock trades a market cap to sales multiple of just 1x on FY18E which looks quite low if looks at the topline potential over the the next 2 years.

SMIL is poised to benefit from the revival in the Commercial vehicles industry. The company has surplus capacity to meet the growing demand with confident and efficient management. On operational front, SML Isuzu has been able to manage its working capital efficiently and generate positive cash flows.

Despite of slow single digit growth in Light commercial vehicles segment, SML Isuzu reported growth of 8% in FY16 volumes and 19% in 9 months of FY16 volumes.

Volumes are likely to improve led by economic recovery and SML Isuzu’s plan to launch 3-4 products every year with new and enhanced technology. With better product mix and efficient operations the company can grow annually at 14-15% in next 2-3 years. SMIL’s current market share is 8% while and together have 80% of the market share.

We expect SML Isuzu to benefit from economic revival, falling finance cost, replacement demand, government’s proposal to replace vehicles older than 15 years of age and high demand from bus segment. Bus volumes will improve on back of orders from State Transportation Undertakings, Tourism operators, school and colleges, executive buses for offices. Special vehicles like Ambulances, Police vans, Tipper, Dumper placer, etc. will improve with support from private and government expenditure.

At current price of Rs 1202, SMIL is trading at FY18E P/E of 17x and FY19E PE of 13x. We expect SMIL to report better profits with increase in sales volume and operational efficiency.

Looking at SMIL’s steady financial track record, strong product domain and dominant market share and strong promoters we expect the stock to get re rated in future.

Hence we believe that the SMIL’s stock should be purchased at the current price for a price target of around Rs 1720 over the next 12 to 18 months.

FINANCIALS

For the Year Ended March RsCrs FY15A FY16A FY17E FY18E FY19E Net Sales 1105.5 1164.3 1450.1 1740.12 2018.539 EBIDTA 65.54 84.75 129.1 171.1 215.1 EBIDTA % 5.93 7.28 8.90 9.83 10.66 Interest 5,82 5.16 4.00 6.00 6.00 Depreciation 19.77 19.55 23.1 31.00 37.00 Non Operational Other Income 8.79 8.28 5.0 5.00 5.00 Profit Before Tax 48.74 68.32 107.0 139.1 177.1 Profit After Tax 36.93 51.16 75.0 104.00 133.00 Diluted EPS (Rs) 25.52 35.36 51.83 71.87 91.91 Equity Capital 14.47 14.47 14.47 14.47 14.47 Reserves 288.42 325.65 386.65 510.75 87.61 Borrowings 22.30 55.00 90.00 100.00 100.00 GrossBlock 224.31 269.92 339.92 409.92 474.92 Investments 87.75 36.14 36.14 36.14 36.14 Source Company our Estimates

KEY CONCERNS

Competition from Automobile players namely Ashok Leyland, Tata motor and (Volvo).

Increase in raw material prices will impact its margins.

Slowdown in new investment and economic activities.

DISCLAIMERS AND DISCLOSURES ,

This Research Note is prepared by Avinash Gorakshakar, Research Analyst Registration no INH00000171 complying with the qualification and certification requirements under SEBI (Research Analyst) Regulations, 2014.I have been working in the Indian Capital markets for over 24 years and earlier worked with several leading domestic financial intermediaries.

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