Initiating Coverage Diversified 09 March Tube Investments of India Ltd. Growth, value and diversification combined. Investment Arguments

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1 Tube Investments of India Ltd. Growth, value and diversification combined Tube Investments of India Ltd. (TI) is a company with multiple businesses ranging from diversified auto-ancillary products, bicycle retailing, and financial services. It belongs to the South India based Murugappa group. Market leadership across its engineering and metal forming related product portfolio; preferred vendor status TI has market leadership (40%-60%) across its engineering and metal forming product portfolio: precision welded tubes, roll formed car doorframes, automobile/industrial chains, and railway wagon sections. These varied product segments that TI is present in require stringent tolerances, surface finishing, mechanical properties and product innovation, that requires engineering capabilities that take years to develop. The limited size of the market of these product segments and the proficient engineering capabilities that are required limit the number of players and thus leads to healthy margins (14%-15%) for the players involved. That TI has been able to maintain market leadership and growth across its product portfolio with the rapid growth in the Indian automobile space is a testimony to its engineering prowess, ability to enter new product segments and meet client requirements. The businesses have grown at a CAGR of over 20% over the past two years Well established consumer (bicycle) business with good hinterland penetration - TI is also one of the major domestic bicycle players, owning the well established BSA and Hercules brands. It enjoys an overall market share of ~30%. TI s strong brand recall, reach, product presence across segments and asset light business model makes this business highly scalable and profitable. The business has high RoCE (more than 50% over the last 2-3 years), contributes ~27% of TI s standalone EBIT (FY11) and provides stability to the overall business portfolio Investment Arguments Holding company of Murugappa groups s financial services business TI is also the promoter of the Muruguppa group s financial services businesses, which are gaining significant traction. It holds ~54.49% stake (assuming infusion of additional equity capital) in the listed NBFC Cholamandalam Investment & Finance Company Ltd (CIFCL) and 74% stake in a general insurance JV with the Mitsui Sumitomo Insurance Group of Japan, the largest general insurance company in Japan and 5th largest insurance group globally. CIFCL s loan book has grown at a CAGR of 55% over the last 7 quarters to `111.3bn in Q3FY12 Strong growth prospects Its market leadership across its product portfolio and capacity expansion plans make TI well-placed to benefit from robust growth prospects in the automobiles, consumer and financial services sectors. Within its diversified autoancillary products business and bicycles business, TI has a capex plan of `7bn over FY12-FY13 to augment capacities across products (both brown-field and greenfield) and enter new product segments like large diameter tubes and stainless steel tubes. We expect TI s revenues and profits to grow at a CAGR of 12.1% and 15.0% respectively over FY11-FY14E Rating CMP Target Upside % BUY Source: NSE, ABML Research Risk Return Matrix Return Low Medium High Low Medium High Risk Source: ABML Research Company Data BSE Code NSE Code TUBEINVEST Equity Capital (` mn) Face Value (`) 2.0 Market Cap (` bn) 25.6 Avg Daily Volume (Qtly) week H/L (`) 170.3/97.6 Source: NSE, BSE Shareholding (%) Holders Dec 11 Sep 11 Jun 11 Promoters FIIs MFs/Banks & FI s Public & Others Source: BSE Chart: Tube Investment vs. Sensex 135 Relative Performance Mar-11 Apr-11 Jun-11 Jul-11 Sep-11 Oct-11 Dec-11 Jan-12 Mar-12 Tube Investments Return Sensex Return Source: Capitaline Attractive valuations We like TI on account of its (1) diversified businesses in high growth sectors of automobiles, consumer and financial services, (2) market leadership in various product segments and (3) capacity expansion plans. We value TI on a SOTP basis. Our 1 year forward fair value for TI comes to `191 per share, which implies a potential upside of 37.1%. We, thus, initiate coverage on Tube Investments of India Ltd. with a BUY rating Analyst Details Akhil Jain akhil.jain@adityabirla.com Standalone Financial Snapshot (` mn) In ` mn Sales YoY(%) EBITDA YoY(%) PAT YoY(%) EPS(`) YoY(%) EBITDA (%) RoE(%) P/E(x) EV/EBITDA(x) P/B(x) FY11 29, , , FY12E 34, , , FY13E 36, , , FY14E 41, , , Source: ABML Research, company data Page No. 1

2 Company Background Tube Investments of India Ltd. (TI) is a company with multiple businesses ranging from diversified autoancillary products, bicycle retailing, and financial services. It belongs to the South India based business group Murugappa. TI s standalone business comprises three divisions Engineering, Metal formed products and Cycles/components/e-scooters. TI s engineering division includes the (1) precision welded steel tubes business and the (2) cold rolled steel strips business. Its metal formed products division has three main businesses (1) automotive/industrial chains and fine blanked components (2) roll formed car doorframes and (3) railway products. The cycles/components/e-scooter division involves retailing of bicycles, bicycle components, e- scooters and fitness equipment. TI s consolidated business includes its standalone business, its financial services subsidiaries and an industrial chains French company called Sedis which was acquired in TI s financial services business comprise its ~54.49% stake (assuming infusion of additional equity capital through issue of mn `160 per share on a private placement basis) in the listed NBFC Cholamandalam Investment & Finance Company Ltd (CIFCL) and 74% stake in a general insurance JV with the Mitsui Sumitomo Insurance Group of Japan, the largest general insurance company in Japan and 5th largest insurance group globally. TI s financial services businesses have shown strong traction. CIFCL s loan book has grown at a CAGR of 55% over the last 7 quarters to `111.3bn in Q3FY12. Sedis was acquired to get a foothold in the European market and strengthen its product profile in India. The share of revenue and EBIT among the three divisions of TI s standalone business is presented in Chart-1 and Chart-2 below. Chart 1: FY11 share of revenue among divisions in TI s standalone business Cycles / components / e-scooters 36.3% Engineering 38.7% Metal formed products 25.1% Chart 2: FY11 share of EBIT among divisions in TI s standalone business Cycles / components / e-scooters 26.7% Engineering 38.5% Metal formed products 34.7% Page No. 2

3 Engineering division Non auto sector share in revenues to increase through product diversification In FY11, TI s engineering division contributed about 38-39% of standalone TI s revenues and an equivalent share of the EBIT. Its engineering division comprises the (1) precision welded steel tubes business and the (2) cold rolled steel strips business. Precision welded steel tubes business: Precision tubes are tubes with close tolerances i.e. clearly defined inner and outer diameter and superior physical/mechanical properties. They are usually used as a part of equipment in automobiles, boilers, heat exchanges, valves, exhaust piping, pumps and other equipment categories. Based on the manufacturing process, precision tubes are categorised into (1) welded tubes and (2) seamless tubes. Of the 385,620 tonnes of welded tubes consumed domestically in FY10, 76.6% (295,109 tonnes) was ERW (Electric Resistant Welded) tubes and 23.4% (90,151 tonnes) was CDW (Cold Drawn Electric Welded) tubes. ERW tubes are of commodity nature and easy to manufacture. Its commodity nature combined with the relative abundance of raw material has led to the ERW tubes market being infested with a large number of manufacturers from the unorganised sector. CDW tubes, on the other hand, requires stringent tolerances, surface finishing, and superior mechanical properties. It, thus, enjoys higher realisations and margins than ERW tubes. The average price per tonne of CDW precision tubes can range from times the price per tonne of similar grade ERW precision tubes. In the precision welded steel tubes business, Tube Investments of India dominates the CDW market segment and has ~50% market share in this segment. Other prominent players include Innoventive Industries, Caparo, Tata Tubes and Bhushan Steel. The limited size of the CDW tubes market and the proficient engineering capabilities that are required limit the number of players and thus leads to healthy margins (12%-15%) for the players involved. Currently, ~80% of the TI s revenues from precision welded tubes come from the auto sector and the rest 20% from non-auto (Refer Chart-3). Of the auto sector sales, two wheelers comprise 50%, passenger vehicles 25% and commercial vehicles 25%. Most of the auto sector sales (~90%) are to automobile component players, i.e. Tier 2 and 3 suppliers. About 10% goes directly to OEM s. Chart 3: Sales mix of precision tubes sector wise Non-auto 20.0% Auto 80.0% The auto industry has grown at a tremendous pace since the recovery from the global recession from mid onwards. As a result, TI s precision tube volumes have grown at a CAGR of ~21% over FY09- FY11 to 126,639 tonnes. In H1FY12, it has grown 17% YoY to tonnes. Given the high base and economic growth moderating on account of high interest rates, inflation and supply side bottlenecks, there is likely to be some moderation in auto sector growth going forward from about 25% in FY11. However, we still expect auto sales to grow at a CAGR of ~12% for the next 5 years on account of robust domestic demand and the country becoming a global hub for auto manufacturers. Moreover, TI caters to the all the segments of the auto industry. So slowdown in one segment is likely to be offset by growth in another. Of the auto sector sales, two wheelers comprise 50%, passenger vehicles 25% and commercial vehicles 25%. TI also has a fairly diversified clientele. Being the market leader, we expect TI s sales to at least match the growth of the auto sector, if not more. To cater to the expected growth in demand, TI is setting up a green-field capacity of precision tubes in North India at a cost of `1.5bn. This is expected to increase its capacity by tonnes p.a. (up 20-25%). Page No. 3

4 To reduce the volatility of its sales on account of the large dependence on the auto sector, TI is setting up a green-field facility of large diameter tubes focused on the infrastructure sector, primarily for construction and engineering equipment, for eg, hydraulic cylinders. The large diameter tubes facility would be at a cost of `2.5bn and would have an ERW capacity of ~85000 tonnes and CDW capacity of tonnes. Moreover, TI is on the verge of setting up a new product line of stainless steel tubes, which is expected to come up in Q4FY12E. This would cater to the non-auto segment like food, chemicals, power, etc. TI plans to increase the share of revenue from the non-auto segment from currently about 25% to 50% over the next 5 years. We expect precision welded tubes volumes to grow at a CAGR of 14.6% over FY11-FY14E to tonnes. The cold rolled strips division rolls HR steel coils into strips based on size, thickness and width. The cold rolled steel strips are both sold in the market and used captively for making of chains, fine blanked components and CDW tubes. We expect TI s engineering division to deliver above 12% CAGR growth in operational profitability over FY11-FY14E through (1) product diversification - large diameter precision tubes and stainless steel tubes and (2) volume growth in the auto sector Metal formed products division - Chains and railways section businesses to drive growth In FY11, TI s metal formed products division contributed about 25% of standalone TI s revenues and 35% of the EBIT. The metal formed products division has three main businesses (1) automotive/industrial chains and fine blanked components (2) roll formed car doorframes and (3) railway products. The limited size of the market of these businesses and the proficient engineering capabilities that are required limit the number of players and thus leads to healthy margins (17%- 19%) for the players involved. Automotive/industrial chains: In the automotive chains business, TI has a market share of ~40%. LG Balakrishnan & Brothers (LGB) is the main competitor. TI also caters to the replacement market in the automotive chains business. In the industrial chains segment, TI has a market share of ~40%. This segment caters to the non-auto sector. TI s automotive/industrial chains plants are located in Chennai, Hyderabad and Uttarakhand. In the industrial chains business, TI has acquired a French company Sedis to get a foothold in the European market and strengthen its product profile in India. Over FY09-FY11, the automotive/industrial chains volumes have grown at a CAGR of ~27% and has continued to grow strongly in H1FY12, growing 24% YoY. We expect strong growth for TI s automotive/industrial chains business on account of reasonably robust growth in the auto sector, improvement in industrial and infrastructure growth and leveraging of the acquisition of Sedis to increase domestic sales and exports of industrial chains. To cater to the expected growth in demand, TI is expanding its chains capacity by 50% over FY12E and FY13E. Roll formed car doorframes: In the roll formed car doorframes business, TI is the market leader with ~60% market share. The main competitors are Mark Exhaust (supplying to Maruti) and Gestapp (supplying to Hyundai). TI s clients include Maruti, Hyundai, M&M & Tata Motors. The car doorframes plants are located near the automobile hubs in Chennai and Sanand in Gujarat. Over FY09-FY11, the car doorframes volumes have grown at a CAGR of ~24% to 1.15mn units. In H1FY12, though, there has been a de-growth of ~9% to 530kt units in the car doorframes volumes on account of lower capacity utilisation due to lower-than-expected demand for Tata s Nano car. Investment in the car doorframes business is model-specific. We expect the TI s car doorframes business to be soft in the short term on account of lower capacity utilisation of its Sanand plant. However, we expect the business to recover over the medium term on account of robust domestic demand and emergence of India as a global hub for manufacturing of small cars. Railway Products: In the railway products business, TI makes sections for railway wagons and passenger coaches. Recently, the PMO has decided to monitor the progress of the construction of the Dedicated Freight Corridor project covering a length of ~3300km along the Western and Page No. 4

5 Eastern Corridor of India, after being dissatisfied with the role of the Railways in monitoring the execution of it. The Western Corridor from Dadri in Uttar Pradesh to Jawaharlal Nehru Port Trust near Mumbai measuring 1499 km will connect Haryana, Rajasthan, Gujarat and Maharashtra. The 1839-kmlong Eastern Corridor from Ludhiana to Dankuni in West Bengal will connect Punjab, Uttar Pradesh, Bihar and West Bengal. The construction of the Dedicated Freight Corridor project is expected to be completed in phases till The Dedicated Freight Corridor is expected to lead to a substantial increase in the share of goods transported by the Indian Railways and thus increase the demand for railway wagons business. The Dedicated Freight Corridor project holds strong long term prospects for TI s railways section business. The Railways increased budget allocations for new passenger trains every year also holds a favourable outlook for TI s sections business for passenger coaches. The sector wise distribution of revenue of the metal formed products division is presented in Chart-4 below: Chart 4: Sector-wise distribution of revenue of TI s metal formed products division Railways 21% Non-auto 19% Auto 60% We expect TI s metal formed products division to deliver above 10% CAGR growth in operational profitability over FY11-FY14E through good volume growth in the chains and railway sections business. We expect TI to achieve this growth by incurring a capex of ~`1.5bn over FY12E and FY13E, which would involve setting up a green-field chains capacity in the southern region, expanding chains capacity in existing locations and enhancing its fine blanked capacities. Bicycles/components/e-scooters/fitness equipment division Volume growth in the bicycle business to counter impact of contracting margins TI has exposure to the consumer sector through its bicycle retailing business. The Bicycles/Components/Electric scooters division of the company comprises (1) bicycles of the standard and special variety (including alloy bikes and specialty performance bikes), bicycle components sold as spares, (2) fitness equipment (motorised tread mills, elliptical, recumbent bikes etc.) and (3) electric scooters. Bicycles: The bicycles industry size is estimated at about 15mn units. TI is one of the major domestic bicycle players, owning the BSA and Hercules brands. It enjoys an overall market share of ~30%. Hero Cycles and Avon are its main competitors, with Hero Cycles being the market leader. In the specials segment of bicycles, however, TI has a dominant market share. The bicycles business involves less of manufacturing and more of painting, finishing, and marketing and distribution. Branding, new models and a strong distribution network are the keys in this business. TI s bicycles business strong brand recall, reach, product presence across segments and asset light business model make it highly scalable and profitable. The business has high RoCE (more than 50% over the last 2-3 years), contributes ~27% of TI s standalone EBIT (FY11) and provides stability to the overall business portfolio. Page No. 5

6 In FY11, the growth in bicycles of the standard variety has been negligent whereas in bicycles of the specials variety (road bikes, mountain terrain bikes, racing bikes, fitness cycles, children's bicycles, etc.) it has been over 10%. TI s aggressive positioning in the special segment of bicycles through aggressive expansion of its retail outlets, introduction of new models catering to different premium segments and cycling promotion events has played out well. In FY11, TI s bicycles volume grew 9% YoY to 4.1mn bicycles, led by strong growth in the special segment sales. 78 new models were launched in FY11 which contributed 23% to its revenue. Its retail outlets grew 34.2% from 482 in FY10 to 647 in FY11 and contributed 25% of TI s revenues in the bicycles category. TI has been conducting cycling promotion events like Cyclothons, Bikeathons, Fun Fitness, and Freedom rides. Apart from helping in promoting cycling as a fun and fitness activity and inculcating the habit of cycling, these cycling events and races help in bringing visibility for TI s cycling business. In FY11, TI s revenues and EBIT in the bicycles business grew 17.6% YoY and 13.7% YoY to `11.2bn and `781.1mn respectively. Going forward, TI s bicycles business is likely to see margins contracting on account of increased competition from China and raw material cost pressure. However, volume growth should continue to be decent on account of strong demand from the specials segment. Also, over the long term, cycling lanes might become a reality in Indian cities. Media reports indicate that the Tamil Nadu government is currently working on a plan to create cycling lanes in Chennai. The outlook for special segment is good with (1) rising consumer incomes, (2) large young population (3) consumer lifestyles increasingly focused on fun and fitness, and environment-friendly transportation and (4) TI s increasing retail footprint. To cater to the expected growth in demand, TI is setting up green-field capacities in the Eastern and Southern regions over FY12E and FY13E and expanding its retail outlets from 647 in FY11 to 1000 by FY12. This is likely to entail a capex of `1.5bn over FY12E and FY13E. E-scooters and Fitness Equipment: To leverage its strong distribution network and diversify its product portfolio in related segments, TI entered into (1) Electric scooters to cater to a growing market for environment-friendly and cost-effective transportation and (2) Fitness equipment to cater to the consumer lifestyles increasingly focused on health and fitness. In FY11, the Indian Electric scooters industry was estimated at about 40,000 scooters as against 60,000 scooters in the previous year. The industry suffered a demand contraction as a number of regional players/importers were unable to meet the required quality and service requirements of the customer, thereby reducing the customers confidence in product reliability and affecting overall industry penetration. However, this has also resulted in a significant consolidation in the industry with an exit of number of players by the end of FY11, leaving only three major national players in this segment. Going forward, the sustained focus of the national players on product quality and service, government support and rising fuel prices are expected to improve the off-take of electric scooters. The domestic fitness equipment business is estimated at ~`3.2bn and is growing at ~13% annually. The fitness equipment business caters to the home and commercial segments. TI s fitness business is presently restricted to the home segment, which comprises six national players, importers and regional players. TI s fitness equipment business grew its turnover by nearly 39% YoY in FY11. Going forward, (1) rising consumer incomes, (2) increasing consumer awareness on health and fitness and (3) TI s strong distribution through its retail outlets and dealer network hold buoyant prospects for TI s fitness equipment business. Page No. 6

7 Financial Services Business TI is also the promoter of the Muruguppa group s financial services businesses, which are gaining significant traction. It holds ~54.49% stake in the listed NBFC Cholamandalam Investment & Finance Company Ltd (assuming infusion of additional equity capital from private investors) and 74% stake in a general insurance JV with the Mitsui Sumitomo Insurance Group of Japan, the largest general insurance company in Japan and 5th largest insurance group globally. Cholamandalam Investment & Finance Company Ltd (CIFCL) CIFCL is engaged in the business of providing vehicle finance, home equity loans, business finance and wealth management through stock broking & distribution of financial products. The NBFC business is presently composed of 3 main segments: vehicle finance, home equity loans and business finance. As on 31 st December 2011, CIFCL s NBFC business had a loan book of `111.3bn, of which vehicle finance segment s share comprised 70.0%, home equity loans 22.7 % and business finance 7.2% (Refer Table-1) Table -1: CIFCL s loan book segment-wise as on 31/12/11 Particulars (in ` mn) Loan book (` mn) % of loan book Vehicle Finance % Home Equity Loans % Business Finance % Others - Personal Loans, Gold Loans % Total % Over FY10-9MFY12, CIFCL has seen strong growth in profits and RoE through strong business growth, lower provisioning (near elimination of its loss making personal loans book over FY09-FY11) and lower operational expenses. In Table-2 below, CIFCL s business performance is presented: PAT has grown from `154.2mn in FY10 to `1.2bn in 9MFY12 and RoE has expanded from 2% to 14% during the same period. For 9M FY12, the loan book grew 52.9% YoY to `111.3bn. The running down of the personal loan book over the last three years from `24.9bn in Q3FY09 to `1.6bn at the close of FY11 and `119mn in Q3FY12 has led to lower provisioning in FY12, leading to enhanced profitability. Provisioning was at 1.3% of average assets in 9MFY12 as compared to 3.7% in FY10 and 2.3% in FY11. Lower operational expenses enabled the operational expenses to the average assets ratio to decline from 2.3% in FY10 to 2.1% in 9MFY12, contributing to increased profitability. Table 2: CIFCL s business performance Particulars (in ` mn) FY10 FY11 9MFY12 Loan Book , ,301 Personal Loan book , GNPA 5.2% 2.6% 1.6% NNPA 1.5% 0.3% 0.3% OPEX to avg. assets 2.3% 2.2% 2.1% PBT PAT EPS (in `) RoE 2% 6.7% 14.0% (9M) Page No. 7

8 Table 3: CIFCL s NBFC Business Segment Overview YTD Dec NBFC Segments Description Loan book (` mn) % of loan book YoY% growth in loan book PBT (in ` mn) NIM (%) NCL (%) ROA (PBT) % Vehicle Finance Home Equity Loans Business Finance Provides vehicle financing for NEW and USED HCVs, LCVs, SCVs, MLCVs, MUVs and Cars Provides loans against residential property to self employed individuals Provides loans against collateral of equity shares, commercial/ residential property and combination of current assets and shares Vehicle Finance: For 9MFY12, CIFCL s vehicle finance loan book grew 56.4% YoY to `78.0bn (Refer Table-3 above). The strong growth in its vehicle finance business is underpinned by CIFCL s (1) reputation as a long term and stable player (2) strong dealer and manufacturer relationship (3) good penetration in Tier-2 and Tier-3 towns (90% of its branches) (4) well diversified portfolio across geography and product segments and (5) strong asset quality. During 9MFY12, geographically, 32% of disbursements have been from South India and balance wellspread across other parts of India; and product-wise, 29% of disbursements have been towards used CV s and the balance 71% well-spread across a variety of new vehicles - HCVs (15%), LCVs (34%), MLCVs (11%), MUVs (5%), tractors (3%) and cars/3 wheelers (3%). Home Equity loans: For 9MFY12, CIFCL s home equity loans business grew 64.4% YoY to `25.2bn (Refer Table-3 above). The strong growth in its home equity business has been underpinned by CIFCL s (1) strong underwriting process and (2) good penetration in Tier-2 and Tier-3 towns (90% of its branches) Business Finance: For 9MFY12, the business finance loan book grew 22% to `8.0bn (Refer Table-3 above). The division has product offerings catering to the wholesale segment and the retail segment. In the wholesale segment, CIFCL provides finance against shares/ Loan against property/ Corporate Finance to promoters, corporate and HNI s. In the retail segment, CIFCL provides ESOP funding and margin funding to retail clients. Going forward, we expect CIFCL to continue to show strong growth across its divisions on account of its (1) reputation as a long term and stable player (2) strong dealer and manufacturer relationship (3) good penetration in Tier-2 and Tier-3 towns across the country (90% of its branches) (4) excellent asset quality (5) foray into tractor financing in Q1FY12 and gold loans in Q3FY12 (6) adequate capitalisation to grow --CIFCL proposes to raise equity capital to the tune of `2.1bn by issuing mn per share on a private placement basis which will take its CAR to above 19.5% with Tier- 1capital around11.5%-- and (6) strong growth prospects in the automobile sector and rising entrepreneurship. Wealth Management: The wealth management business comprises two divisions: (1) Cholamandalam Distribution Services and (2) Cholamandalam Securities. Cholamandalam Distribution Services is into distribution of a wide range of financial products mutual funds, shares, bonds, corporate debt, structured products, life & general insurance, education & home loan and real estate services. Cholamandalam Securities, on the other hand, provides broking services to HNIs and institutional investors. On account of the (1) regulatory negatives in the distribution of mutual funds and insurance and (2) weakness in the capital markets, both the divisions in the wealth management business went into the red in FY12E. During 9MFY12, Cholamandalam Distribution Services registered a PBT of -`6mn as against `69mn in FY11. Cholamandalam Securities Ltd. recorded a PBT of `21mn as against `5mn in FY11. However, things have started to look better as the capital markets have staged a strong recovery in Q4FY12E and the regulatory environment for distribution of mutual funds and insurance is likely to get better. Page No. 8

9 Valuation of investment in Cholamandalam Investment and Finance Company (CIFCL) With its business concentration towards vehicle financing (~70% of the loan book), CIFCL s closest peers in the NBFC sector are Shriram Transport Finance Company Ltd. (STFCL) and Mahindra & Mahindra Financial Services Ltd. (MMFSL). As on 31/12/11, STFCL has a loan book of 237.2bn and a RoE of 23.5% whereas MMFSL has a loan book of 178.5bn and a RoE of 19%. CIFCL, on the other hand, has a loan book of `111.3bn and a RoE of 14%. On account of lower size and RoE, we have valued CIFCL at a 40% discount to the average FY12E P/BV of its vehicle financing peers MMFSL and CIFCL (Refer Table-4). Further, we have applied a 30% holding company discount to TI s 54.49% equity interest in CIFCL (assuming infusion of additional equity capital through issue of mn `160 per share on a private placement basis), which gives us an equity value of `7.6bn. This translates into a FY12E value per share of TI of `40.7. Table 4: Valuation of investment in Cholamandalam Investment and Finance Company Particulars Amount FY12E P/BV of MMFSL (x) 2.65 FY12E P/BV of STFCL (x) 2.05 Average FY12E P/BV of CIFCL's peers (x) 2.35 Discount assigned to CIFCL (%) 40 FY12E P/BV assigned to CIFCL (x) 1.41 FY12E BV of CIFCL post proposed equity infusion (in ` mn) Equity value of CIFCL (in ` mn) TI's equity interest post equity infusion (%) Value of TI's equity interest in CIFCL (in ` mn) Holding company discount (%) 30 Value of TI's equity interest in CIFCL post holding company discount (in ` mn) 7562 No. of TI shares (in `mn ) FY12E Value of CIFCL per share of TI (`) 40.7 Investment in Cholamandalam MS General Insurance TI holds 74% stake in a general insurance JV Cholamandalam MS General Insurance Company Ltd with the Mitsui Sumitomo Insurance Group of Japan, the largest general insurance company in Japan and 5th largest insurance group globally. Cholamandalam MS offers a wide range of products that include Accident, Engineering, Health, Liability and Marine, Motor, Property, Travel and Rural insurance for individuals, SME s and the corporate sector. It has been able to develop a robust distribution framework through establishing (1) 96 branches, (2) 7500 agents across the country and (3 business tie-ups with banks, NBFC s and autos. As a result, it has developed a market share of 2.7% and a customer base of above and 3000 intermediaries. Given the pre-eminent position of its JV partner as the largest general insurance company in Japan and 5th largest insurance group globally, Cholamandalam MS has been able to become the leading insurer for Japanese/Korean business interests in India. The company achieved a Gross Written Premium (GWP) of `9.7bn in FY11. We value TI s 74% equity interest in its general insurance JV Cholamandalam MS General Insurance Company Ltd at 1x equity investment, giving us a fair value of `2.3bn, which translates into a value per share of TI of `12.6 (Refer Table-5). Table 5: Valuation of investment in Cholamandalam MS General Insurance Particulars Amount Investment in Cholamandalam MS General Insurance (in ` mn) 2346 No. of TI shares (mn) FY12E Value of Cholamandalam MS General Insurance per share of TI (in `) 12.6 Page No. 9

10 Acquisition of Sedis In FY10, TI acquired a 77.13% stake in Financiere C10 SAS, the holding company of the French industrial chain manufacturing company called Sedis, which had been its customer for years, for `440mn. Sedis is a reputed brand in the chain industry in Europe and is known for producing custom-made solutions for a variety of engineering applications. Sedis has two operating plants in France, an experienced management team, wide industrial products range and sound technologies. Sedis has a 23% market share of the industrial chains market in France. The acquisition will provide the TI's chains business with access to new technologies to manufacture products that are currently being imported into India. In addition, TI s chains business will also be able to enhance its presence in the European market by leveraging the Sedis brand and its distribution network. From Sedis point of view, the range of products manufactured by Sedis can be effectively marketed in the growing industrial sector in India. Sedis made a PBT of Euro0.5mn for 6MCY11 as compared to Euro0.5mn for FY10. Assuming Sedis to earn TI s cost of equity, we arrive at a FY12E value of `557mn, which translates into a value of `3.0 per share of TI (Refer Table-6). Table 6: Valuation of investment in Sedis Particulars Amount FY10 investment in Sedis (In `mn) 440 CoE (%) 12.5 FY12E Fair value of Sedis (in ` mn) 557 No. of TI shares (mn) Value of Sedis per share of TI (in `) 3.0 Financial performance Volume growth across product segments to drive growth in earnings We believe that future growth in TI s standalone earnings would be driven by robust volume growth in product segments like precision welded tubes, automotive/industrial chains, railways sections and bicycle retailing (Refer Table-7). Earnings growth through price increases is likely to be difficult. In Q3FY12, TI was unable to fully pass the raw material cost increases on account of steep rupee depreciation in its product segments like precision welded tubes, chains, and cycles. Going forward, we expect TI to only recover its margins from part reversal of the rupee depreciation (already seen in Q4FY12E) and expected fall in raw material (steel) prices in FY13E. We estimate TI s standalone net sales to grow at CAGR of 12.1% over FY11-FY14E to `42.0bn on account of volume growth in its product segments. Over FY11-FY14E, we estimate a CAGR of 12.9% in standalone EBITDA to `4.9bn on account of growth in sales. We estimate TI s overall EBITDA margin to rise from 11.4% in FY11 to 11.6% in FY14E mainly on account of fall in both output and input prices (Refer Chart-5). On the earnings front, we estimate a CAGR of 15.0% in adjusted PAT over FY11-FY14E to `2.3bn on account of growth in EBITDA and higher dividend payouts from its subsidiary Cholamandalam Investment Finance Ltd. (Refer Chart-5) Table 7:TI s sales volume assumptions Particulars FY11 FY14E CAGR (%) Precision welded tubes (in tonnes) Chains (in lac ESS feet) Car doorframes (sets) Railway sections (sets) Bicycles (in mn nos) Page No. 10

11 Chart 5:TI s financial performance trend in ` bn % 11.5% 11.6% 11.1% 11.2% FY10 FY11 FY12E FY13E FY14E 15% 14% 13% 12% 11% 10% 9% 8% Net Sales (LHS) EBITDA (LHS) Adj. PAT (LHS) EBITDA % (RHS) Source: ABML Research, company data We estimate TI s core standalone RoE (excluding investments in financial services business) at 19.6%, 18.5% and 17.9% for FY12E, FY13E and FY14E respectively (Refer Chart-6). The slight downward trend in RoE in FY13E and FY14E is on (1) account of TI being in a capex mode over FY12E-FY13E s, the full benefits of which are likely to be realised in FY15E and (2) contraction of margins in the cycles business. We estimate 18%-19% to be the sustainable RoE for TI s standalone business. Chart 6:TI s RoE trend 20.0% 19.5% 19.6% 19.0% 18.5% 17.9% 18.0% 17.0% FY11 FY12E FY13E FY14E Core RoE Source: ABML Research, company data Page No. 11

12 Valuations Growth, value and diversification combined We like Tube Investments on account of its (1) diversified businesses in high growth sectors of automobiles, consumer and financial services, (2) market leadership in various product segments and (3) capacity expansion plans to capitalise on the robust growth in its diversified businesses. Though a significant portion of the standalone business has a high exposure to the automobile sector, TI s business is diversified through its (1) investments in its strongly growing financial services business, (2) consumer sector exposure through its bicycle retailing business and (3) expected expanding presence in the infrastructure sector in the future through the setting up of its large diameter tubes facility and promising railways products business. Tube Investments, on a consolidated basis, doesn t really have a comparable peer for a valuation benchmark on account of the diversified nature of its businesses. We have valued TI on a Sum-of-the-parts (SOTP) basis. We have valued standalone TI (adjusted for dividend payouts from CIFCL) at 12x FY13E, close to the average of one year forward P/E of auto-ancillary players of 12.4x (Refer Table-8), which gives us a FY12E value of `115.3 per share of TI (Refer Table-9). We estimate TI to have a CAGR of 15.0% in earnings over FY11-FY14E and earn a sustainable RoE of 18-19%. With such an earnings and RoE profile, our FY12E valuation for standalone TI of 12x FY13E compares quite well on a conservative basis with the trailing P/E of BSE-200 of 15.5x and the reciprocal of the government bond yield, i.e. P/E, of 12.1x. To our FY12E fair value of standalone TI, we add the value of its subsidiaries: CIFCL, Cholamandalam MS General Insurance and Sedis (Refer Table-10) to arrive at a FY12E SOTP fair value of consolidated TI of `171.6 per share. Multiplying our FY12E fair value by the cost of equity of 12.5% (Refer Table-11), our 1 year forward SOTP value for Tube Investments comes to `191 per share (Refer Table-10). This implies a potential upside of 37.1% from the last closing price. We initiate coverage on Tube Investments with a BUY Rating. Table 8: Average of one year forward P/E of auto-ancillary players Particulars FY13E P/E (x) Bosch 18.0 Wabco India 15.7 Exide Industries 16.7 Mothersun Sumi Systems 13.4 Apollo Tyres 7.4 Amara Raja Batteries 9.7 Innoventive Industries 6.4 ** Average FY13E P/E 12.4 Source: ABML Research, Bloomberg ** Assuming Innoventive Industries grows at a CAGR of 35% over FY11-FY13E Table 9: Valuation of TI s standalone business Particulars Amount FY13E adjusted standalone EPS (`) year forward P/E assigned to standalone TI (x) 12.0 FY12E valuation of standalone TI per share (`) Source: ABML Research Table 10: SOTP Fair Value of TI Particulars (in ` per share of TI) Amount Standalone business CIFCL 40.7 Cholamandalam MS General Insurance 12.6 Sedis 3.0 FY12E SOTP fair value of consolidated TI Cost of Equity (%) year forward SOTP fair value of consolidated TI 191 Source: ABML Research Page No. 12

13 Table 11: Cost of equity Cost of equity Risk free rate 8.25% Beta 0.85 Market risk premium 5.0% Cost of equity 12.5% Source: ABML Research, Bloomberg Risk Factors Lower than-expected volume growth Volatility in raw material prices that is not passed on to customers Slowdown in the automobile sector Rupee depreciation Page No. 13

14 Standalone Financials Tube Investments Profit & Loss Balance Sheet In ` mn FY10 FY11E FY12E FY13E FY14E In ` mn FY10 FY11E FY12E FY13E FY14E Net sales 23,589 29,811 34,636 36,447 41,990 Equity capital YoY (%) Reserves 7,800 9,543 10,697 11,966 13,376 Total expenses 20,969 26,417 30,771 32,270 37,112 Net worth 8,169 9,914 11,068 12,337 13,747 Inc/dec in stock (120) (475) Raw material cost 14,316 18,480 21,476 22,037 25,701 Total borrowings 7,058 7,238 8,988 11,288 10,088 Staff cost 1,781 2,416 2,682 2,977 3,364 Deferred tax Operating expenses 2,472 3,229 3,758 3,945 4,540 SG&A expenses 2,520 2,767 2,854 3,311 3,507 Total liabilities 15,640 17,670 20,689 24,385 24,735 EBIDTA 2,620 3,395 3,866 4,177 4,878 YoY (%) Asset Block 5,706 5,921 7,646 11,034 10,781 EBIDTA (%) Investments 7,494 9,106 9,476 9,476 9,476 Depreciation ,002 Non-operating income EBIT 1,982 2,811 3,355 3,650 4,220 Current assets 7,282 8,826 10,099 10,762 12,368 Interest Inventories 2,944 3,877 4,131 4,332 4,982 Extraordinary income/(expenses) (400) Debtors 3,258 3,734 4,156 4,374 5,041 PBT 1,295 2,413 2,665 2,921 3,232 Cash (-) Tax Loans and advances 994 1,079 1,552 1,633 1,882 Current Tax Deferred Tax (45) Current liabilities 4,367 5,647 5,607 5,880 6,763 Prior period adjustment (42) (56) Provisions ,006 1,127 Tax/ PBT (%) PAT 812 1,697 1,857 2,042 2,268 Net current assets 2,440 2,644 3,568 3,876 4,478 YoY (%) Miscellaneous exp Adjusted net profit 1,063 1,491 1,857 2,042 2,268 YoY (%) Total assets 15,640 17,670 20,689 24,385 24,735 Key Ratios FY10 FY11E FY12E FY13E FY14E Cash Flow (in ` mn) FY10 FY11E FY12E FY13E FY14E Diluted EPS (`) Net profit (before MI) 812 1,697 1,857 2,042 2,268 Adjusted diluted EPS (`) Depn and w/o ,002 CEPS (`) Change in working cap (632) (153) (800) (145) (563) Book value (`) Non-operating income Dividend per share (`) Others 355 (102) Net debt-equity (x) Operating cash flow 1,173 2,025 1,683 2,550 2,503 ROCE ROE Non-operating income Capex (773) (659) (2,488) (4,199) (750) Valuations Investments (2,951) (1,611) (370) 0 0 PE (x) Others (562) (41) Cash PE (x) Investing cash flow (4,255) (2,203) (2,606) (3,914) (405) Price/book value (x) Dividend (323) (639) (703) (773) (858) Dividend yield (%) Equity P/sales Debt 3, ,750 2,300 (1,200) EV/sales (x) Others (0) 0 (0) EV/EBITDA (x) Financing cash flow 3, ,047 1,527 (2,058) Net change in cash (35) Opening cash Closing cash Source: ABML Research, company data Page No. 14

15 Research Team Vivek Mahajan Hemant Thukral Head of Research Head Derivatives Desk Fundamental Team Avinash Nahata Head of Fundamental Desk Akhil Jain Metals & Mining / Midcaps akhil.jain@adityabirla.com Sunny Agrawal FMCG/Cement sunny.agrawal@adityabirla.com Sumit Jatia Banking & Finance sumit.jatia@adityabirla.com Shreyans Mehta Construction/Real Estate shreyans.m@adityabirla.com Dinesh Kumar Information Technology/Auto dinesh.kumar.k@adityabirla.com Pradeep Parkar Database/Production pradeep.parkar@adityabirla.com Quantitative Team Rizwan Khan Technical and Derivative Strategist rizwan.khan@adityabirla.com Jyoti Nangrani Sr. Technical Analyst jyoti.nangrani@adityabirla.com Raghuram Technical Analyst raghuram.p@adityabirla.com Rahul Tendolkar Derivatives Analyst rahul.tendolkar@adityabirla.com Amit Somani Derivative Analyst amit.somani@adityabirla.com Advisory Support Indranil Dutta Advisory Desk HNI indranil.dutta@adityabirla.com Suresh Gardas Advisory Desk suresh.gardas@adityabirla.com Sandeep Pandey Advisory Desk sandeep.pandey@adityabirla.com ABML research is also accessible in Bloomberg at ABMR Page No. 15

16 Our Rating Methodology Stock Ratings Absolute Returns (R) Buy R > 15% Accumulate 5% < R 15% Neutral -5% < R 5% Reduce -10% < R 5% Sell R -10% Disclaimer: This document is not for public distribution and is meant solely for the personal information of the authorised recipient. No part of the information must be altered, transmitted, copied, distributed or reproduced in any form to any other person. Persons into whose possession this document may come are required to observe these restrictions. This document is for general information purposes only and does not constitute an investment advice or an offer to sell or solicitation of an offer to buy / sell any security and is not intended for distribution in countries where distribution of such material is subject to any licensing, registration or other legal requirements. The information, opinion, views contained in this document are as per prevailing conditions and are of the date of appearing on this material only and are subject to change. No reliance may be placed for any purpose whatsoever on the information contained in this document or on its completeness. Neither Limited (ABML) nor any person connected with it accepts any liability or loss arising from the use of this document. The views and opinions expressed herein by the author in the document are his own and do not reflect the views of Limited or any of its associate or group companies. The information set out herein may be subject to updating, completion, revision, verification and amendment and such information may change materially. Past performance is no guarantee and does not indicate or guide to future performance. Nothing in this document is intended to constitute legal, tax or investment advice, or an opinion regarding the appropriateness of any investment, or a solicitation of any type. The contents in this document are intended for general information purposes only. This document or information mentioned therefore should not form the basis of and should not be relied upon in connection with making any investment. The investment may not be suited to all the categories of investors. The recipients should therefore obtain your own professional, legal, tax and financial advice and assessment of their risk profile and financial condition before considering any decision. Limited, its associate and group companies, its directors, associates, employees from time to time may have various interests/ positions in any of the securities of the Company(ies) mentioned therein or be engaged in any other transactions involving such securities or otherwise in other securities of the companies / organisation mentioned in the document or may have other potential conflict of interest with respect of any recommendation and / related information and opinions. Analyst holding in the stock: NIL Limited 2 nd Floor, Sheil Estate, Dani Corporate Park, 158 CST Road, Kalina, Santacruz (East), Mumbai Tel: Page No. 16