SCHAEFFLER INDIA. Industrials rebound; robust domestic demand. Strong industrial rebound drives growth

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1 RESULT UPDATE SCHAEFFLER INDIA Industrials rebound; robust domestic demand India Equity Research Bearing Schaeffler India s (Schaeffler) Q1CY18 sales grew 13% YoY (in line with estimate) led by strong rebound in industrial (up ~14% YoY) and spurt in automotive OEM (up ~26% YoY) segments. Distribution segment (~30% of sales) clocked strong double digit growth. Overall EBITDA margin contracted 145bps YoY due to higher raw material cost and dip in share of exports, leading to mere ~4.5% EDITDA growth. We believe, Schaeffler is well placed to gain from the structural and cyclical uptick in both industrial and automotive segments. Hence, we estimate 21% PAT CAGR over CY Maintain BUY with TP of INR5,851 (valued at 28x CY19E). Strong industrial rebound drives growth Sales grew in line with estimate at 13% YoY. This was driven by strong rebound in industrial (up ~14% YoY; growth was flat YoY in CY17) and automotive OEM (jumped ~26% YoY). The distribution segment, accounting for ~30% of sales, posted strong double digit growth led by stabilisation post GST led disruption. Management expects the growth momentum to sustain in ensuing quarters. Sales of the combined entity grew ~16 YoY with LuK India and INA Bearings growing at ~30% YoY (driven by strong CV and tractor sales) and~11% (despite PV sales growing mere ~6%), respectively. Robust domestic demand; margin contracts on mix change While global demand continues to be strong, domestic demand was even stronger across segments leading to increase in share of own manufacturing (domestic). Own manufacturing (domestic) accounted for 58% (55% in Q1CY17), own manufacturing (exports) 15% (17% in Q1CY17) and traded products 27% (28% in CY17) of overall sales. EBITDA margin contracted 145bps YoY to 17.8% due to mix change and higher raw material cost (gross margin dipped 168bps YoY). The company has hiked prices by ~4% (effective April 1) across products to offset impact of rising input cost. EDELWEISS RATINGS Absolute Rating Investment Characteristics BUY Growth MARKET DATA (R: SCHE.BO, B: SCHFL IN) CMP : INR 5,261 Target Price : INR 5, week range (INR) : 5,989 / 4,128 Share in issue (mn) : 16.6 M cap (INR bn/usd mn) : 87 / 1,329 Avg. Daily Vol. BSE/NSE ( 000) : 6.4 SHARE HOLDING PATTERN (%) Current Q3FY18 Q2FY18 Promoters * MF's, FI's & BKs FII's Others * Promoters pledged shares (% of share in issue) PRICE PERFORMANCE (%) BSE Midcap Index Stock : NIL Stock over Index 1 month 3.4 (2.4) (5.8) 3 months (4.9) (7.4) (2.5) 12 months (5.0) Outlook and valuation: Positive; maintain BUY Schaeffler is well poised to gain from structural and cyclical uptick in both its segments. Also, we believe the merger will improve growth of the combined entity with higher exposure to fast growing auto industry, focus on new product development and higher capex. We maintain BUY with TP of INR5,851 (valued at 28x CY19E). Due to impending merger approvals, we have not considered financials as a combined entity. At CMP, the stock trades at 31.0x CY18E EPS and 25.2x CY19E EPS. Financials (Standalone) Year to December Q1CY18 Q1CY17 % change Q4CY17 % change CY17 CY18E CY19E Net rev. (INR mn) 5,212 4, , ,187 21,690 25,074 EBITDA (INR mn) ,013 (8.8) 3,665 4,226 4,948 Adj. PAT (INR mn) (2.8) 2,380 2,818 3,473 Adj. Dil. EPS (INR) (2.8) Diluted P/E (x) EV/EBITDA (x) ROAE (%) Edelweiss Research is also available on Bloomberg EDEL <GO>, Thomson First Call, Reuters and Factset. Shradha Sheth shradha.sheth@edelweissfin.com Shanmuganandam T shanmuganandam.t@edelweissfin.com April 18, 2018 Edelweiss Securities Limited

2 Bearing Key Highlights Standalone entity Revenue growth Overall sales grew in line with estimate at 13% YoY to INR5.2bn. Growth was driven by a strong rebound in industrials (up ~14% YoY; growth in CY17 was almost flat over CY16) and automotive OEM (up ~26% YoY). Further, distribution business, which accounts for ~30% of sales, clocked strong double digit growth led by stabilisation post GST led disruption. PAT grew 15% YoY to INR660mn, lower than our estimate by 3%, led by higher other income (5% of revenue versus 3% in Q1CY17). Outlook: Management believes the growth is sustainable led by improving industrial activity as implied by IIP numbers and recovery in GDP leading to strong domestic sales growth in automotive and industrial divisions. Further, GST triggered disruptions are fully behind and the company has a good order book in the distribution business. Hence, management expects the strong double digit growth clocked in current and previous quarter to sustain in ensuing quarters. Margin and pricing Gross margin dipped 168bps YoY to 39.7% leading to gross profit growth of 8% YoY. Higher raw material cost and relatively unfavourable sales mix with the share of exports declining to 15% (17% in Q1CY18) led to EBITDA margin contracting 145bps YoY to 17.8% (19.5% estimate). As a result, EBITDA grew a mere 4.5% (9% below estimate). Price hike: The company has effected a price hike of ~4% (effective April 1) across product categories to offset the impact of rising input cost. However, actual impact on numbers in the next quarters will be a function of inventory levels with customers, price negotiations with key customers, etc. Sales mix In Q1CY18, own manufacturing (domestic) accounted for 58% (55% in Q1CY17), own manufacturing (exports) accounted for 15% (17% in Q1CY17) and traded products accounted for 27% (28% in CY17) of overall sales. While global demand continues to be strong driving exports revenue, domestic demand was even stronger in industrial & automotive OEMs and distribution segments leading to increase in share of own manufacturing (domestic). Share of automotive : industrial stands at 19% : 81% and of aftermarket (distribution) : OEM at 30% : 70%. INA Bearings and LuK India: Key highlights The combined entity grew ~16.5% YoY led by LuK India (LuK) which posted robust revenue growth of 30.2% YoY in Q1CY18 driven by strong tractor and CV sales. INA Bearings grew 10.6% YoY in the current quarter, relatively lower than the 14% YoY growth in CY17. INA has ~75% exposure to the automobile segment and is primarily driven by the PV cycle. Lower growth was on account of the PV industry growing by 2 Edelweiss Securities Limited

3 Schaeffler India mere ~6% in Q1CY18 and a couple of customers having delayed their off take volumes. While INA s growth hinges on the PV cycle, management is hopeful of outperforming PV industry growth. Consistent revenue growth in both the businesses was driven by engine systems, transmission applications and clutch systems. Further, improvement in operational performance aided profitability growth. For the combined entity, the share of automotive : industrial for the current quarter stands at 57% : 43% (in line with CY17 mix as both the segments clocked strong growth in Q1CY18). Table 1: Merged entity Schaeffler India INA LuK Combined CY17 Q1CY18 CY17 Q1CY18 CY17 Q1CY18 CY17 Q1CY18 Net revenue 19,867 5,458 11,951 3,157 8,575 2,558 40,216 11,130 Growth (%) EBITDA 3, , , ,885 1,869 EBITDA Margin (%) PBT 3, , , ,902 1,654 PBT Margin (%) PAT 2, ,896 1,111 PAT Margin (%) Source: Company information Others Capex At the combined entity level, the company is planning to invest ~EUR40mn each in 2018 and In each of the next two years, ~EUR20mn will be for the standalone listed entity and ~EUR10mm each for LuK and INA. At its Maneja plant, most of the lines are well loaded and the overall plant operates at ~90%. At the Savli plant, capex will be incurred to expand large sized bearings which are used in steel mills and the wind sector. Also, at the Pune plant, the company is incurring capex on setting up a production facility which will manufacture engine and transmission components, serving domestic and exports markets and will also have a R&D unit. Construction is expected to be completed by end of current calendar year. Localisation Management reiterated its strategy of maximising domestic production for the domestic market and improving profitability. While LuK has higher rate of localisation at ~90%, INA has over ~60% and the combined entity has ~70% localisation. 3 Edelweiss Securities Limited

4 Bearing Impact of Electric Vehicles Schaeffler does not see any significant impact from EVs till 2030, post which it sees 15 20% penetration of EVs in the Indian market. Even with higher penetration of EVs, though the volume requirement of bearings may reduce, impact will not be very significant in value terms because of higher value and advanced bearings Hike in custom duty The impact of hike in custom duty and cess on imported auto components announced in the current Union Budget will be ~1% of sales of the combined entity as the company imports raw materials and semi finished components that are used in domestic manufacturing and finished components that are traded. Pro forma forecast of the combined entity Table 2: Proforma Forecast merger will be ~1% EPS accretive in CY19, and further up (~8%) going forward due to synergies Schaeffler India INA LuK Combined CY17 CY18E CY19E CY20E CY17 CY18E CY19E CY20E CY17 CY18E CY19E CY20E CY17 CY18E CY19E CY20E Revenue 19,187 21,690 25,074 28,709 11,951 13,983 16,500 19,634 8,575 9,931 12,065 14,263 39,713 45,603 53,638 62,606 Growth (%) EBITDA 3,665 4,226 4,948 5,531 1,668 2,399 3,190 4,122 1,478 1,788 2,292 2,824 6,811 8,412 10,430 12,477 EBITDA Margin (%) PAT 2,381 2,818 3,473 3, ,090 1,595 2, ,387 1,676 3,897 4,901 6,620 8,050 PAT Margin (%) PAT Growth (YoY) No. Of Shares EPS EPS Growth Source: Edelweiss research Merger status Table 3: Merger timeline Status/expected Key events completion Requisite applications submission to BSE, NSE and SEBI for approvalscompleted BSE, NSE and SEBI approvals Completed Applications to NCLT (Mumbai and Chennai benches) in India Completed Notice to shareholders and creditors Completed Shareholder approvals Completed NCLT approvals Q2CY18 BSE, NSE and SEBI approvals for listing Q3CY18 Closing of transaction Q3CY18 Source: Company information 4 Edelweiss Securities Limited

5 Schaeffler India Financial snapshot (INR mn) Year to December Q1CY18 Q1CY17 % change Q4CY17 % change CY17 CY18E CY19E Net revenues 5,212 4, , ,187 21,690 25,074 Raw material 3,145 2, , ,056 12,466 14,376 Staff costs ,531 1,676 1,907 Other expenses (7.9) 2,935 3,322 3,843 Total expenditure 4,288 3, , ,522 17,464 20,126 EBITDA ,013 (8.8) 3,665 4,226 4,948 Depreciation EBIT (11.8) 2,954 3,457 4,120 Other income ,073 Interest 1 4 (71.4) Profit before tax ,018 (3.6) 3,623 4,269 5,183 Provision for taxes (5.3) 1,243 1,451 1,710 Add: Prior period items Add: Exceptional items Minority interest Reported net profit (2.8) 2,380 2,818 3,473 Adjusted Profit (2.8) 2,380 2,818 3,473 Diluted shares (mn) Adjusted Diluted EPS (2.8) Diluted P/E (x) EV/EBITDA (x) ROAE (%) As % of net revenues Raw material Employee cost Other expenses EBITDA Reported net profit Edelweiss Securities Limited

6 Bearing Company Description Schaeffler is part of the Schaeffler Group of Germany, a leading global supplier in bearings with revenues of EUR11bn (as of CY12). Schaeffler, Germany, holds 51% stake in the company. In India, Schaeffler is the second largest player with market share of ~17% and ~45% in overall bearings industry and roller bearings segment, respectively. In India, Schaeffler s exposure to the auto segment is 35% and industrial bearings contribute to 51% of sales. 14% of sales are catered to by exports. While the company manufactures automotive bearings and part of industrial bearings (~35%), balance 65% of industrial bearings are imported. As a result traded (industrial) goods constitute 30% of overall revenue, which are majorly imported from overseas Schaeffler Group companies. Investment Theme Schaeffler is expected to deliver strong revenue and profit CAGR of 14% and 16% CAGR, respectively over CY17 19 along with core ROCE of ~25%+ by CY19E. Over CY13 17, the company has grown at 8% sales CAGR and ~17% operating margin. High exposure to four wheelers (~70%+ of auto OEM sales) will drive Schaeffler s revenues led by cyclical uptick. Historically company has averaged fixed asset turn of 1.8x. EBITDA margin of the company is likely to expand owing to gross margin expansion led by substituion of traded sales (imported) with manufacterd sales (localization) and higher operating leverage. Key Risks Delay in recovery in key segments can impact our sales growth projections since four wheelers and commercial vehicles together contribute ~75% to SCHAEFFLER s auto OEM revenues. Forex fluctuation SCHAEFFLER buys traded goods from group company (Schaeffler Tech AG, Germany). As a result, INR depreciation against EUR may negatively impact margin on these EURdenominated imports. Imports constitute 33% of net sales. This also includes currency headwinds on ~34% of raw material costs (~11% of net sales) which are imported. Royalty rate increase Currently, royalty, trademark and service fees as a percentage of overall sales stand at 2%. Any increase in the same could pose a risk. Delay in ramping up Savli facility Any execution delay in ramping up the Savli plant could impact growth as well as our earnings estimates. 6 Edelweiss Securities Limited

7 Schaeffler India Financial Statements Key Assumptions Macro GDP(Y o Y %) Inflation (Avg) Repo rate (exit rate) USD/INR (Avg) Sector Auto OEM(2W) vol. growth Auto OEM PV vol. growth Auto CV ind. vol. growth Company Auto 2W OEM vol. growth Auto PV OEM vol. growth Auto CV OEM vol. growth Auto aftrmkt sale growth (9.8) Industrial sales growth 6.0 (2.0) Export revenue growth (0.9) Industrial sales growth 2.1 (1.9) Manufactured Traded Mfg. gross margin (%) Traded gross margin (%) Income statement (INR mn) Net revenue 18,139 19,187 21,690 25,074 Materials costs 10,826 11,056 12,466 14,376 Gross profit 7,313 8,131 9,223 10,697 Employee costs 1,513 1,531 1,676 1,907 Other Expenses 2,840 2,935 3,322 3,843 Operating expenses 4,353 4,466 4,997 5,750 Total operating expenses 15,179 15,522 17,464 20,126 EBITDA 2,961 3,665 4,226 4,948 Depreciation EBIT 2,320 2,954 3,457 4,120 Add: Other income , Less: Interest Expense Profit Before Tax 2,985 3,607 4,269 5,183 Less: Provision for Tax 1,040 1,226 1,451 1,710 Reported Profit 1,945 2,381 2,818 3,473 Adjusted Profit 1,945 2,381 2,818 3,473 Shares o /s (mn) Diluted shares o/s (mn) Adjusted Basic EPS Adjusted Diluted EPS Adjusted Cash EPS Dividend per share (DPS) Dividend Payout Ratio (%) Common size metrics Operating expenses Gross margin Interest Expense EBITDA margins EBIT margins Net Profit margins Growth ratios (%) Revenues Adjusted Profit (1.5) EBITDA (3.0) EPS (1.5) Edelweiss Securities Limited

8 Bearing Balance sheet (INR mn) As on 31st December CY16 CY17 CY18E CY19E Share capital Reserves & Surplus 14,359 16,488 18,911 22,034 Shareholders' funds 14,525 16,654 19,077 22,200 Long Term Liabilities Def. Tax Liability (net) 17 Sources of funds 14,815 16,950 19,373 22,496 Gross Block 8,786 9,435 10,386 11,186 Net Block 3,861 3,799 3,982 3,954 Capital work in progress Intangible Assets Total Fixed Assets 4,103 4,199 4,382 4,354 Uses of funds 14,815 16,950 19,373 22,496 BVPS (INR) , , ,335.7 Cash and Equivalents 6,406 8,184 10,323 13,015 Inventories 2,740 2,736 2,417 2,758 Sundry Debtors 3,318 3,199 3,588 4,105 Loans & Advances 1,808 2,118 2,118 2,118 Other Current Assets Current Assets (ex cash) 8,060 8,248 8,317 9,175 Trade payable 2,803 2,868 2,836 3,236 Other Current Liab Total Current Liab 3,754 3,681 3,649 4,049 Net Curr Assets ex cash 4,306 4,567 4,669 5,127 Free cash flow (INR mn) Reported Profit 1,945 2,381 2,818 3,473 Add: Depreciation Interest (Net of Tax) Others (561) (660) (819) (1,070) Less: Changes in WC 109 (16) Operating cash flow 1,928 2,454 2,673 2,779 Less: Capex Free Cash Flow 997 1,647 1,722 1,979 Cash flow metrics Operating cash flow 1,928 2,454 2,673 2,779 Investing cash flow (1,387) (807) (951) (800) Financing cash flow (218) Net cash Flow 323 1,953 2,242 2,693 Capex (931) (807) (951) (800) Dividend paid (200) (331) (292) (350) Profitability and efficiency ratios ROAE (%) ROACE (%) ROA Debtors Days Payable Days Cash Conversion Cycle Current Ratio Net Debt/Equity (0.4) (0.5) (0.5) (0.6) Interest Coverage Ratio Debt / Cap employed (%) Operating ratios Total Asset Turnover Fixed Asset Turnover Equity Turnover Valuation parameters Adj. Diluted EPS (INR) Y o Y growth (%) (1.5) Diluted P/E (x) P/B (x) Dividend Yield (%) Adjusted Cash EPS (INR) EV / Sales (x) EV / EBITDA (x) Peer comparison valuation Market cap Diluted P/E (X) EV / EBITDA (X) ROAE (%) Name (USD mn) CY18E CY19E CY18E CY19E CY18E CY19E Schaeffler India Limited 1, SKF India 1, Median AVERAGE Source: Edelweiss research 8 Edelweiss Securities Limited

9 Schaeffler India Additional Data Directors Data Avinash Gandhi Chairman Dharmesh Arora Managing Director Klaus Rosenfield Director Dietmar Heinrich Director R Sampath Kumar Director Frank Huber Director Sanak Mishra Director Renu Challu Director Rakesh Jinsi Director Auditors B.S.R & Co Holding Top 10 Perc. Holding Perc. Holding Templeton Asset Mgmt 4.27 UTI AMC 2.26 SBI Funds Management 3.29 IDFC Mutual Fund 2.26 HDFC Asset Management Co ltd 2.98 Sundaram Asset Management 2.23 Kotak Mahindra 2.85 Aditya Birla Sun Life Asset Management 1.78 HDFC Life Insurance 2.39 Shree Capital Services Ltd 1.33 *as per last available data Bulk Deals Data Acquired / Seller B/S Qty Traded Price No Data Available *as per last available data Insider Trades Reporting Data Acquired / Seller B/S Qty Traded No Data Available *as per last available data 9 Edelweiss Securities Limited

10 Bearing Edelweiss Securities Limited, Edelweiss House, off C.S.T. Road, Kalina, Mumbai Board: (91 22) , Aditya Narain Head of Research ` Coverage group(s) of stocks by primary analyst(s): Bearing Schaeffler India Limited, SKF India Recent Research Date Company Title Price (INR) Recos 14 Feb 18 SKF India Automotive drives growth; margin surges; Result Update 14 Feb Nov 17 Schaeffler India Schaeffler India Margin expands on healthy sales mix; Result Update One Schaeffler India: Strong merger ; Result Update 1,805 Buy 5,340 Buy 5,201 Buy Distribution of Ratings / Market Cap Edelweiss Research Coverage Universe Rating Interpretation Buy Hold Reduce Total Rating Distribution* * 1stocks under review > 50bn Between 10bn and 50 bn < 10bn Market Cap (INR) Rating Buy Hold Reduce Expected to appreciate more than 15% over a 12 month period appreciate up to 15% over a 12 month period depreciate more than 5% over a 12 month period One year price chart 7,000 6,000 (INR) 5,000 4,000 3,000 2,000 Apr 17 May 17 Jun 17 Jul 17 Aug 17 Sep 17 Oct 17 Nov 17 Schaeffler India Dec 17 Jan 18 Feb 18 Mar 18 Apr Edelweiss Securities Limited

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