Precision Camshaft. Pricing looks imprecise... IPO Review. Price band ICICI Securities Ltd Retail Equity Research. Key Investment rationale

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1 IPO Review Rating matrix Rating : Avoid Issue Details Issue Details Issue Opens 27-Jan-16 Issue Closes 29-Jan-16 Total Issue Size () Fresh Issue () 240 Offer for Sales (OFS) () Price Band ( ) No. of Shares on Offer (crore) QIB (%) 5 Non-Institutional (%) 15.0 Retail (%) 35.0 Objects of the Issue The object of the net proceeds of the fresh issue is to establish a machine shop for ductile iron camshafts and for general corporate expense. Shareholding Pattern Pre-Offer Post-Offer Promoters & Promoter Group Public *Assuming issue price of 186 Financial Summary Total Revenues EBITDA EBITDA Margins PAT EPS Valuation Summary (at 186; upper price band) P/E EV/EBITDA P/BV Research Analyst Nishit Zota nishit.zota@icicisecurities.com Vidrum Mehta vidrum.mehta@icicisecurities.com Pricing looks imprecise... January 25, 2016 Precision Camshaft (PCL) is one of the world s leading manufacturers and suppliers (global market share of ~9%) of camshafts. The company was incorporated in 1992 by first generation entrepreneurs Yatin Shah and Dr Suhasini Shah. PCL has a wide range of over 150 SKUs and mainly caters to the passenger vehicle segment (accounting for ~90% of its topline). The current revenue mix in terms of casting & machined camshaft is at 70:30, respectively, while that of export & domestic markets is at 78:22, respectively. Apart from India, PCL supplies camshafts to the US, Brazil, UK, Germany, Austria, Hungary, Russia, South Korea and China. It also has some of the marquee global OEM names like General Motors (27% of revenue) & Ford Motors (30%), Hyundai, MSIL, Tata Motors and M&M. The company s aggregate capacity is ~15.6 million camshafts with the utilisation level of ~65%. We believe the company s business has high concentration risk (in terms of product, segments and clients) and is also commanding a rich valuation. Thus, we recommend AVOID. Key Investment rationale Leading camshaft player; having long term relationship with global OEMs PCL is one of the leading players supplying passenger vehicle camshafts globally. Its market share has consistently improved from 5-6% in 2010 to 8-9% in The company enjoys preferred supplier status and has developed long term relationships with marquee global OEMs in the automobile sector. Its clientele list includes names like General Motors, Ford Motors, Hyundai, MSIL and Tata Motors. The company claims that as of FY15, it has supplied over 58 million units of camshafts in the last 10 fiscals and serviced various customers across different geographies. Apart from India, PCL supplies camshafts across various countries like the US, Brazil, UK, Germany, Austria, Hungary, Russia, South Korea and China. Key Risk & Concerns Precision Camshaft Price band High concentration risk.single product, segment & clientele We believe PCL faces high concentration risk in terms of 1) single product; 2) segment and 3) clientele. The sales of PCL camshafts are directly related to the production & sales of the automobiles industry, especially the passenger vehicle segment that accounts for ~90% of its revenue. Any slowdown in the PV segment is likely to impact its performance. Further, the company primarily manufactures and sells cast iron camshaft. Hence, its inability to diversify its product offerings may impact its growth, going forward. Also, its dependence on top two clients is a major risk for its performance. General Motors and Ford Motors account for ~27% and ~30% of its revenue, respectively. We believe any significant volatility in terms of new orders would directly impact its performance. We believe the loss of one or more of its significant customers operating in a particular region may result in a loss or non renewal of orders from that customer across other geographies in which it operates impacting its operations. Highly valued; priced at 27-28x on FY15 diluted EPS of 6.6 At the IPO price band of , the stock is available at 27-28x on FY15 post issue diluted EPS of 6.6. We believe that even though the company has a decent business model and has put up a good financial performance, the IPO pricing looks elevated. Considering its higher valuation, we recommend that investors AVOID the issue.

2 Exhibit 1: Consolidated Key Financials H1FY16 Total Revenues EBITDA EBITDA Margins PAT EPS RoE RoCE About the Company Precision Camshaft (PCL) is one of the world s leading manufacturer and supplier of camshafts. The camshafts are required in all automobiles using an internal combustion engine, which includes 2-W, 3-W, passenger vehicles, commercial vehicles, off roaders and tractors. The camshaft is one of the five critical components of an engine application in an automobile along with the cylinder block, crankshaft, cylinder head and connecting rod. Exhibit 2: Product display of camshafts manufactured and supplied by PCL PCL was incorporated in 1992 by first generation entrepreneurs Yatin Shah & Dr Suhasini Shah. The company broadly caters to the passenger vehicle segment (accounting for ~90% of its revenue). Other segments like tractor account for ~6% and locomotive & LCV account for the remaining ~4% of revenue. PCL has a wide range of over 150 SKUs catering across segments and categories. The company has two state-of-the-art manufacturing facilities, an export oriented unit (EOU) and a domestic unit both situated at Solapur, Maharashtra. The EOU unit consists of four foundries and two machine shops. Products manufactured at the EOU unit are primarily exported to their overseas customers. The majority of the revenue ~78% is derived through exports while the remaining ~22% of the revenue comes from the domestic market. Apart from India, the company supplies camshafts to various countries like the US, Brazil, UK, Germany, Austria, Hungary, Russia, South Korea and China. PCL has long term relationships with several marquee global OEMs. General Motors & Ford Motors are its top two clients accounting for ~27% & ~30% of the revenues respectively. The other key clientele includes names like Hyundai, Maruti Suzuki, Tata Motors and M&M. Page 2

3 As of September 30, 2015, the total manufacturing capacity is million per annum of casting camshaft and 2.22 million per annum machined camshafts. For FY15, company sold million camshafts resulting into average realisation of per camshaft. The current revenue mix in terms of casting & machined camshaft is at 70:30, respectively. The machined camshaft has higher margins. Therefore, PCL is focusing more on this segment. According to the management, the average margin on casting camshaft is ~18% ( 300 per camshaft) while that of machined camshaft is >30% (~ 1000 per camshaft). PCL also has entered into two joint ventures, which would strengthen its business operations in Asia, going forward. The first JV with NSPCL, the first, Ningbo Shenglong PCL Camshafts Company Ltd, for machining camshafts and the second, PCL Shenglong (Huzhou) Specialised Casting Company Ltd, for setting up a foundry in China. The machine shop at Ningbo, China commenced production in April 2013 while the foundry at Huzhou City, China is currently under construction as on date. Exhibit 3: Consolidated revenue trend H1FY16 Total Revenues Exhibit 4: Revenue mix (domestic & exports) H1FY16 Domestic International Page 3

4 Exhibit 5: Volumes & average realisation per camshaft H1FY16 No of Camshaft sold (million) Realization per camshaft 0 Exhibit 6: Revenue break-up product wise (casting & machined camshaft) H1FY16 Casting Camshaft Machined camshaft Investment Rationale Leading supplier of camshafts for passenger vehicles globally PCL is one of the world s leading manufacturer and supplier of camshafts. According to the Icra research report, the company is one of the leading global players for supplying passenger vehicle camshafts. Its market share has consistently improved from 5-6% in 2010 to 8-9% in In the domestic camshaft market for PV, PCL is one of the leading manufacturer & suppliers with largest camshaft foundry and machining capacity. The company claims that as of FY15, it has supplied over 58 million units of camshafts in the last 10 fiscals and serviced various customers across different geographies. Apart from India, the company supplies camshafts across various countries like the US, Brazil, UK, Germany, Austria, Hungary, Russia, South Korea and China. PCL has long term relationship with global OEMs The company enjoys preferred supplier status and has developed long term relationships with marquee global OEMs in the automobile sector. Its clientele list includes names like General Motors (~27% of revenue), Ford Motors (~30% of revenue), Hyundai, MSIL and Tata Motors. These marquee global OEMs have stringent & time consuming selection procedure for procurement of camshafts, which involves review of the manufacturing expertise, facilities and processes, raw materials, financial capabilities etc. The strength of its customer relationships can be attributed Page 4

5 to their ability to manufacture and supply the camshafts in accordance with their requirement of exact designs & specifications as well as their track record of consistent delivery of quality and cost competitive products over the years. For various OEM customers, PCL has developed relationships and received orders from multiple business divisions and locations globally, including through its efforts to cross sell different camshafts to its global OEM customers. For instance, PCL used to supply camshafts to General Motors for their plants in Austria and Hungary in 2005 but over time has expanded its relationship with General Motors and now supplies camshafts to General Motors plants in Korea, Uzbekistan, US, Brazil, Austria & India. Technology innovation & engineering expertise The company has two state-of-the-art manufacturing facilities- an export oriented unit (EOU) and a domestic unit both in Solapur, Maharashtra. PCL has cost competitive engineering expertise & technologies to meet the stringent requirements of its customers. It uses different technologies for manufacturing different camshafts such as shell sand moulding process technology, which provides the company a cost competitive advantage. The shell sand moulding process technology is a highly specialised process technology for manufacturing chilled cast iron camshafts, which provide an advantage in securing purchase orders from OEMs across the world. PCL has entered into an exclusive agreement with EMAG, a German machining and tooling process company, for transfer of certain know-how and technology for manufacturing assembled camshafts. The company also claims that it has lower defect rate of its products. Consistent financial performance In the past, the company has registered a consistent financial performance. During FY12-15, consolidated revenues witnessed a CAGR of 21% to 532 crore. According to the company, this is primarily due to regular capacity augmentation in foundries and machine shops, acquisition of new customers, improvement in share of business with some of their key customers. Further optimising direct & related costs of sourcing raw materials and consumables, power and fuel expenses & other expense has boosted its profitability. PAT has witnessed a CAGR of 45% to 62.4 crore over FY Exhibit 7: Revenue trend Exhibit 8: Profitability trend Total Revenues PAT Page 5

6 Exhibit 9: EBITDA & PAT margins (%) Exhibit 10: Return ratios (RoE & RoCE) % % % EBITDA Margins PAT Margins RoE RoCE Reducing debt level & improving cash flows The company s net debt/equity has reduced from ~1.2x in FY13 to ~0.4x in FY15. Also, in the past two years, it has generated free cash flows aggregating ~ 64 crore, which is positive for the company. Exhibit 11: Net debt/ equity Exhibit 12: Free cash flow x Net Debt/Equity FCF Page 6

7 Key Risk & Concerns Customer Concentration risk PCL is highly depended on its top two clients General Motors & Ford Motors, which account for ~27% and ~30% of its revenue, respectively. We believe any significant volatility in terms of new orders is likely to directly impact the company s performance Further, loss of one or more of its significant customers operating in a particular region may result in a loss or non renewal of orders from that customer across other geographies in which the customers operates. There also may be additional factors like customers losing their market share, changing their sourcing strategy, replacing existing products with alternative products, etc, which may result in reduction of purchases made and consequently affect its business. Slowdown in automotive sector especially PV space The sales of PCL camshafts are directly related to the production and sales of automobiles sector, specifically in the passenger vehicle segment. Any economic slowdown resulting in lower discretionary spend in any of the countries may impact the performance of the OEM in the respective region which eventually would negatively impact PCL sales. Inability to diversify its product offerings may impact growth The company primarily manufactures chilled cast iron camshafts. The management s recent experience indicates there is a growing shift from chilled cast iron camshafts to ductile iron camshafts and assembled camshafts in the passenger vehicle segment. As part of its growth strategy, PCL is trying to diversify and expand its business operations in terms of new product offerings (from chilled cast iron camshafts to other types of camshafts). However, absence of sufficient customers for their new products may result in lower capacity utilisation and adversely affect their business & financial condition. Foreign currency fluctuation risk The majority of the revenue ~78% is derived through selling of camshafts in the export markets. The company further has diversified wings across geographies like the US, Brazil, UK, Germany, Austria, Hungary, Russia, South Korea and China. Hence, any volatility in their currency may directly impact its performance. A significant part of their long term borrowings are US dollar denominated. Coupled with this, its cost of borrowing and cost of raw materials & components incurred by its foreign subsidiary and joint ventures may rise during a sustained depreciation of the rupee against the US dollar. Page 7

8 Objects of issue The object of the net proceeds of the fresh issue is to establish a machine shop for ductile iron camshafts at the EOU unit and for general corporate purposes. Further, PCL expects the listing of equity shares to enhance its visibility and brand image among its existing and potential customers. The total estimated project cost for setting up the new machine shop for ductile iron camshafts at the EOU unit is crore. Out of this, PCL intend to utilise 200 crore from the net proceeds of the fresh issue. The remaining cost of establishment of the machine shop is to be financed through existing and future internal accrual of the company. Valuations At the IPO price band of , the stock is available at 27-28x on FY15 post issue diluted EPS of 6.6. We believe that even though the company has a decent business model and has put up a good financial performance, the IPO pricing looks elevated. Considering its higher valuation, we recommend that investors AVOID the issue. Page 8

9 Exhibit 13: Consolidated Profit & Loss statement Income Statement H1FY16 Gross Sales Less - excise duty Net Sales Raw materials consumed (Increase)/decrease in inventories Employee benefits expense Other expenses EBITDA Other income Depreciation Finance costs PBT Total tax expense PAT Exhibit 14: Consolidated Balance Sheet Balance Sheet H1FY16 Equity Share Capital Reserves and surplus Total of shareholders' funds Long term borrowings Deferred tax liabilities (net) Trade payables Long term provisions Long term liabilities Total of Non-current liabilities Current liabilities Short-term borrowings Trade payables Other current liabilities Short-term provisions Total of Current liabilities Source of Funds Assets Total Fixed assets Non-current investments Long-term loans and advances Other non-current assets Deferred tax assets Total Non-current assets Inventories Trade receivables Cash and Bank balances Short-term loans Other current assets Total current assets Application of funds Page 9

10 RATING RATIONALE ICICIdirect.com endeavours to provide objective opinions and recommendations. ICICIdirect.com assigns ratings to its stocks according to their notional target price vs. current market price and then categorises them as Strong Buy, Buy, Hold and Sell. The performance horizon is two years unless specified and the notional target price is defined as the analysts' valuation for a stock. Strong Buy: >15%/20% for large caps/midcaps, respectively, with high conviction; Buy: >10%/15% for large caps/midcaps, respectively; Hold: Up to +/-10%; Sell: -10% or more; Pankaj Pandey Head Research pankaj.pandey@icicisecurities.com ICICIdirect.com Research Desk, ICICI Securities Limited, 1st Floor, Akruti Trade Centre, Road No 7, MIDC, Andheri (East) Mumbai research@icicidirect.com Page 10

11 ANALYST CERTIFICATION We /I, Nishit Zota MBA and Vidrum Mehta MBA, Research Analysts, authors and the names subscribed to this report, hereby certify that all of the views expressed in this research report accurately reflect our views about the subject issuer(s) or securities. We also certify that no part of our compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report. Terms & conditions and other disclosures: ICICI Securities Limited is a Sebi registered Research Analyst having registration no. INH ICICI Securities Limited (ICICI Securities) is a full-service, integrated investment banking and is, inter alia, engaged in the business of stock brokering and distribution of financial products. 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