Stock Pointer. ZF Steering Gears (India) Ltd. CMP Rs 450 P/E 7.3x FY2012E BUY. Key Investment Highlights

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1 Stock Pointer ZF Steering Gears (India) Ltd. CMP Rs 450 P/E 7.3x FY2012E BUY ZF Steering Gears (India) Limited, a pioneer in manufacturing and supply of Steering Gears for commercial vehicle (CV) space in India, is expected to gain from the rising demand for the steering gears. Apart from the positive business outlook, ZF also has significant liquid investments in its balance sheet which at the current prices is valued of Rs 115 per share. This provides much needed cushion to the stock. Over the next two years ZF is expected to exhibit a CAGR of 29% & 40% in its revenues & profitability respectively. At CMP of Rs 450, the stock is available at 9.1x & 7.3x its estimated earnings of Rs 49.4 & Rs 61.3 respectively. We recommend a BUY at CMP for a price target of Rs 615 an upside of 37% for a time horizon of 12 to 15 months. PRICE TARGET Rs 615/- (15 Months) Index Details Sensex 18,799.7 Nifty 5,640.0 Small Cap 10,249.3 Industry Auto Ancillary Scrip Details Mkt Cap (Rs in crore) Book Value (Rs) Eq Shares O/s (Cr) 0.9 Avg Vol 34, Week H/L 494 / 145 Dividend Yield (%) 1.9 Face Value (Rs) 10.0 BSE Code NSE Code ZFSTEERING Shareholding Pattern (30 th June, 2010) Shareholders % holding Promoters 73.2 Indian Institutions 0.0 FII s 0.0 Non Promoter Corporate 2.3 Public 24.5 Total ZF Steering vs. Sensex Key Investment Highlights Favourable Industry Outlook The Indian CV industry, after facing a severe demand slowdown in the second half of , has bounced back strongly, reporting a strong demand recovery across most segments. After posting a drop of 24% in the production of CV for the fiscal , the CV industry achieved an impressive 36% growth in The trend has even continued in the first quarter of the current fiscal (Q1FY11) with growth coming in at a robust 36.4% growth. Although the medium to longer term outlook remains strong given the expectations of continued economic revival, the growth in volumes is likely to see some moderation & is expected to be at around 19-20% for FY11 & 7-8% for FY12. Commands a significant market share ZF Steering commands a strong market share in the domestic CV space with nearly 45% market share. Its only competitor with similar market share is Rane TRW Steering Systems Limited. The balance 10% of the CV Steering Gears market is met by imports from China. Almost 65% of the Tata Motor s requirement in the CV space is met by ZF whereas in case of Ashok Leyland, it meets nearly 35% of its requirements. Further 100% of the requirement for Eicher Motors & Man Force is met by ZF. Investment Value per share provides cushion Besides its core business of manufacturing steering gears, ZF has significant portion of income coming from its investments in liquid funds. The cash value per share of these investments is valued at Rs 115 per share and provides significant cushion. Better Capacity Utilization to enhance its operating margins Currently ZF has installed capacity of 270,000 power steering gears & 180,000 mechanical steering gears. The capacity utilization in FY10 stood at 51% & 69% for power & mechanical steering gears respectively. With the volume growth expected at 24% & 15% for FY11 & FY12 respectively capacity utilization would improve leading to higher operating margins at 22.8% in FY12 from 20.4% witnessed in FY10, an increase of 240 bps. Key Financials Y/E Mar Net EPS Growth RONW ROCE EV/EBIDTA (Rs Crore) Revenues EBIDTA PAT EPS (%) (%) (%) P/E (x) (x) FY FY11E FY12E Monday, 13 th September, 2010

2 Company Background ZF Steering Gears India Limited, a Joint Venture with ZF Lenksysteme Gmbh is a pioneer in manufacturing and supply of Power & Mechanical Steering Gears in India. It has its plant located at village Vadu Budruk, Taluka-Shirur, 30 Km away from Pune on Ahmednagar - Pune Highway. The present installed capacity stands at 180,000 units of Mechanical Steering Gears and 270,000 units of Power Steering Gears. The company s Product Range includes: Hydraulic Power Steering Gears for Heavy Commercial vehicles Hydraulic Power Steering Gears for Medium and Light Commercial vehicles Power Steering Gears for SUV and off road vehicles Worm and roller Mechanical Steering Gears for Tractor and Light Commercial Vehicles Power Rack and Pinion Steering System for Passenger Car. Mechanical Rack and Pinion Steering System for One Toner Passenger and Goods Carrier Milestones & Achievements Rack & Pinion (Mechanical) launched Power Steering Gear launched 2007 Rack & Pinion (Power) launched 2004 ISO Certification 2002 TS Certification 1995 ISO 9001 Certification Power Steering Gear Model M033 launched (MUV) Power Steering Gear Model 8043 launched (LCV) 1986 Power Steering Gear Model 8033 launched (HCV) 1983 Started production of Mechanical Steering Gears Source: Company Monday, 13 th September, 2010

3 Investment Arguments Favourable Industry Outlook The Indian Commercial Vehicle (CV) industry, after facing a severe demand slowdown in the second half of , has bounced back strongly, reporting a strong demand recovery across most segments. After posting a drop of 24% in CV production for the fiscal , the CV industry achieved an impressive 36% growth in The trend has even continued in the first quarter of the current fiscal (Q1FY11) reporting a robust 36.4% growth. The turnaround has been aided by a number of factors including improving economic activity, favourable impact of Government aided stimulus package & an overall improvement in the financing environment. In the recent months the growth has also been supported by some pre-buying ahead of changes in emission norms. Trend in CV volumes vis-à-vis IIP growth IIP (%) Jan-08 Feb-08 Mar-08 Apr-08 May-08 Jun-08 Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Feb-10 Mar-10 Apr-10 May-10 Jun (50.0) (100.0) CV Volume growth (%) IIP CV Volume Growth The above chart depicts that the growth in IIP has a direct correlation with the CV volume growth. With the IIP turning negative from Oct 08 onwards on account of global economic turmoil, the CV segment too suffered a severe demand slowdown as shown in the above chart. However from Aug 09 onwards, the CV segment has shown a remarkable volume growth commensurate with the economic recovery as displayed by the surge in IIP numbers. Although the medium to longer term outlook for the CV segment remains strong given the expectations of continued economic revival along with faster infrastructure development, the growth in volumes (which was higher on account of lower base effect) is likely to see some moderation & is expected to be at around 19-20% for FY11 & around 7-8% for FY Monday, 13 th September, 2010

4 Commands a significant market share ZF Steering commands a strong 45% market share in the domestic CV space and its only significant competitor (with similar market share) is Rane TRW Steering Systems Limited. The balance 10% of the CV Steering Gears market is met by imports from China. Almost 65% of the Tata Motor s requirement in the CV space is met by ZF whereas in case of Ashok Leyland, it meets nearly 35% of its requirements. Further 100% of the requirement for Eicher Motors & Man Force is met by ZF. Strong growth from Tata Motors & Ashok Leyland augurs well for ZF Tata Motors & Ashok Leyland constitute more than 90% of the domestic CV market. With both these players displaying strong growth in the CV space, this augurs well for ZF which meets substantial requirements for steering gears from both these companies. Tata Motors: Volume growth in FY10 & Q1FY11 41% 300, ,000 39% 100,000 - FY09 FY10 Q1FY10 Q1FY11 LCV 151, ,640 45,583 56,936 MHCV 113, ,202 26,633 43,250 MHCV LCV Ashok Leyland: Volume growth in FY10 & Q1FY11 70,000 60,000 50,000 40,000 30,000 20,000 10,000-17% 178% FY09 FY10 Q1FY10 Q1FY11 MHCV - Trucks & Buses 54,431 63,926 7,693 21,400 MHCV - Trucks & Buses Monday, 13 th September, 2010

5 Investment value per share provides cushion Besides its core business of manufacturing steering gears, ZF has significant portion of income coming from its investments into liquid funds. Currently ZF has investments into following liquid schemes, the market value of which at current NAV (as on 31 st August, 2010) stands at Rs crore. Scheme Name NAV (Rs) Units Mkt Value of Investments AIG World Gold (D) ,955,990 26,288,505.6 Birla SL FRF-LT-Inst (G) ,997,951 62,317,451.8 Fidelity India Spl. Situations (D) ,955,990 32,400,974.4 HDFC Arbitrage-Ret (MD) ,959,687 51,218,687.7 HDFC FRF-LT (G) ,391,049 54,751,877.2 HDFC High Interest-STP (D) ,561,618 69,588,583.5 HDFC Top 200 (D) ,843 22,623,211.8 ICICI Pru Long Term Plan (G) ,535, ,929,094.6 IDFC Hybrid PF-1 (G) ,000,000 50,593,000.0 Kotak Flexi Debt-Reg (G) ,481, ,175,660.7 Reliance Infrastructure-Ret (G) ,000,000 22,669,200.0 Reliance Reg Savings-Debt-Inst (D) ,887, ,124,032.5 Reliance Reg Savings-Equity (D) ,032 21,799,562.5 Sundaram BNPP Fin Serv Opp (G) ,563 19,468,627.9 Sundaram Balanced Fund Divd ,095 10,510,758.7 Sundaram BNPP PSU Opp (D) ,975,309 22,441,880.6 Sundaram BNPP S.M.I.L.E (D) ,000,000 13,379,800.0 Sundaram BNPP Select Mid cap (D) ,191,838 22,865,650.4 Templeton India Income (G) ,693, ,275,746.5 Total Market Value (In Rs) 1,289,422,306.4 Computation of Cash per share Particulars Rs in crore Market Value of Investments Cash lying in Balance Sheet 3.8 Less: Loan Liability 28.4 Liquid cash available Cash value per share With the cash value per share being as high as Rs 115 per share, this provides significant cushion to the shareholders thereby capping the downside to a limited extent Monday, 13 th September, 2010

6 Better capacity utilization & lower fuel cost to enhance operating margins Currently ZF has installed capacity of 270,000 power steering gears & 180,000 mechanical steering gears. The capacity utilization in FY10 stands at 51% & 69% for power & mechanical steering gears respectively. With the demand expected to remain strong over the next two years, the company has enough headroom for growth without incurring any additional capex. It may be noted that ZF had increased the installed capacity of its Mechanical Steering Gears segment from 140,000 units to 180,000 units per annum in FY10. Capacity Utilization to improve Installed Capacity (Units) 500, , , , , , , , ,000 50, FY09 FY10 FY11e FY12e Capacity Utilization (%) Capacity Volume CU (%) As shown above, over the next two years, with the volume growth expected at 24% & 15% for FY11 & FY12 respectively, the capacity utilization is likely to improve from 58.4% in FY10 to 83.3% in FY12e. Saving in power costs through setting up of windmills At the beginning of the last fiscal i.e. FY10, ZF had two wind turbine machines aggregating 1,700 KW. In FY10, the company successfully installed & commissioned four wind turbines of 1,250 KW at Satara, Maharashtra at a cost of Rs 24.3 crore. The company now has windmills of total capacity of 6700 KW, which can generate 9.2 million units and would cater to approximately 90% of the power requirement of the company s plant. This would result into cost savings in terms of its power costs & thereby enabling the company to enhance its overall margins in the coming years. With the increase in capacity utilization on the back of higher volume growth coupled with the lower fuel costs, we expect the operating margins to improve by 240 bps from 20.4% in FY10 to 22.8% in FY12e Monday, 13 th September, 2010

7 Regular introduction of new products During the last fiscal, ZF had developed 8046 range of Power Steering gears for Heavy Commercial Vehicle application for Tata Motors, Ashok Leyland, Man Force Trucks, Volvo Eicher & Mahindra Navistar. Under mechanical steering gears segment, the company developed Rack & Pinion steering gears for Piaggio (after having successfully developed rack and pinion steering gears for Tata Motors Indica model). Further with the company looking at inventing new products / models, it has entered into a Joint Venture with ZF Lenksysteme Gmbh again with ZF India s share at 26% while the majority (74%) is being held by the German Parent. The JV Company ZF Lenksysteme India Private Limited is however yet to engage in any major revenue earning activity. Reputed list of Clientele ZF is a leading supplier of mechanical & power steering gears to most of the leading commercial vehicle manufacturers in India. Over the years, it has established a strong & a reputed list of clientele as enumerated below: Power Steering Gears Tata Motors Ashok Leyland Force Motors Diamler Eicher Motors Swaraj Mazda Volvo India Man Force Trucks M&M Mechanical Steering Gears Force Motors TAFE (Eicher Motors) Escorts International Tractors M&M New Holland Tractors Punjab Tractors SAME Tractors ACE Monday, 13 th September, 2010

8 Q1FY11 Results Review: Splendid Performance Particulars Q1FY11 Q1FY10 Var (%) CV Industry volume growth Production 163, , Sales 164, , ZF Volume Growth Power Steering Gears 38,898 21, Rack & Pinion Power Steering Gears 4,405 3, Mechanical Steering Gear 34,204 27, Total Volumes 77,507 52, Financial Snapshot Net Sales EBIDTA EBIDTA (%) bps Other Income Depreciation Interest PBT Tax PAT EPS Industry Review: During the quarter ended June 2010, the overall sale (domestic + exports) of CV segment registered a growth of 58% as compared to the same period last year. Medium & Heavy Commercial Vehicles (M&HCVs) registered a growth of 81% & Light Commercial Vehicles (LCV) grew at 42%. Passenger cars too registered a 29% jump over the corresponding period. ZF Results Review: On the back of strong industry performance, ZF too posted 68.8% growth in its net revenues on the back of strong volume growth of 47%. Operating profit (EBIDTA) too was up 125.6% at Rs 14.9 crore as against Rs 6.6 crore registered in Q1FY10. The surge in EBIDTA was attributed to impressive volume growth of 47%, better realization (up nearly 15%) & savings in power & other costs by 170 bps Monday, 13 th September, 2010

9 PAT consecutively was up 175.6% at Rs 11.8 crore on the back of strong operational performance & higher other income which was at Rs 4.3 crore as against Rs 1.4 crore, an increase of 218%. EPS for the quarter stood at Rs 13 as compared to Rs 4.7 registered in the corresponding quarter of the previous year. Financial Outlook With the demand expected to remain strong for the steering gears in the CV segment, ZF is expected to post a decent volume growth of 24% & 15% in FY11 & FY12 respectively. Apart from the positive business outlook, ZF also has significant liquid investments in its balance sheet which at the current prices is valued of Rs 115 per share. This provides much needed cushion to the stock. Over the next two years, on the back of better capacity utilization & margin accretion (by 240 basis points from 20.4% in FY10 to 22.8% in FY12), ZF is expected to exhibit a CAGR of 29% & 40% in its revenues & profitability respectively. EPS for FY11 & FY12 is pegged at Rs 49.4 & Rs 61.3 respectively. Key Concerns The Steering Gears industry does face competition from Chinese imports. Nearly 10% of the demand for steering gears in currently met by Chinese imports on account of its better pricing terms. However with Yuan expected to appreciate against the dollar in future, the price competitiveness of the Chinese manufacturers is likely to decline vis-àvis Indian manufacturers. Higher than anticipated input costs & customer s demand for price reductions may dent the margins of the company going forward which could have an adverse impact on the financials of the company. Adverse global events may again create uncertainty in the economic environment, thereby impacting the demand the company s products Monday, 13 th September, 2010

10 Valuation & Recommendation Considering strong demand outlook for the steering gears especially for the CV segment coupled with the underlying value of liquid investments & attractive dividend yield of above 2%, we maintain a positive outlook on the company. At CMP of Rs 450, ZF is attractively valued at 9.1x & 7.3x its FY11e & FY12e estimated earnings of Rs 49.4 & Rs 61.3 respectively. We recommend a BUY on the stock with a price target of Rs 615, an upside of 37% for a time horizon of 12 to 15 months. One Year Forward Rolling Bands P/E Chart X X 6X X 0 Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 EV/EBIDTA Chart X X X 2X 0 Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul Monday, 13 th September, 2010

11 Exhibit 01: Financials and Projections Profit & Loss Statement Y/E March, Fig in Rs. Cr FY2010 FY2011e FY2012e Net Sales % Chg Total Expenditure % Chg EBDITA EBDITA Margin % Other Income PBDIT Depreciation Interest PBT Tax Provisions Reported PAT PAT Margin (%) Raw Materials / Sales (%) Employee Exp / Sales (%) Other Mfr. Exp / Sales (%) Tax Rate (%) Balance Sheet Y/E March, Fig in Rs. Cr FY2010e FY2011e FY2012e Share Capital Reserves & Surplus Minority Interest Total Loans Deferred Tax Liability Total Liabilities Gross Block Less: Acc. Depreciation Net Block Capital Work in Progress Intangible Assets Investments Net Current Assets Deferred Tax Asset Total Assets Key Ratios Y/E March, Fig in Rs. Cr FY2010 FY2011e FY2012e Per Share Data (Rs) EPS Cash EPS DPS Book Value Capital, Liquidity, Returns Ratio Debt / Equity (x) Current Ratio (x) ROE (%) ROCE (%) Dividend Yield (%) Valuation Ratio (x) P/E P/BV EV/Sales EV/EBIDTA Efficiency Ratio (x) Inventory (days) Debtors (days) Creditors (days) Cash Flow Statement Y/E March, Fig in Rs. Cr FY2010e FY2011e FY2012e Profit After Tax Depreciation & W/o Working Capital Changes Others Operating Cash Flow Capital Expenditure Change in Investment Others Cash Flow from Investing Proceeds from equity issue Inc/(Dec) in Debt Dividend Paid Cash Flow from Financing Net Change in Cash Opening Cash Balance Closing Cash Balance Monday, 13 th September, 2010

12 Ventura Securities Limited Corporate Office: C-112/116, Bldg No. 1, Kailash Industrial Complex, Park Site, Vikhroli (W), Mumbai This report is neither an offer nor a solicitation to purchase or sell securities. The information and views expressed herein are believed to be reliable, but no responsibility (or liability) is accepted for errors of fact or opinion. Writers and contributors may be trading in or have positions in the securities mentioned in their articles. Neither Ventura Securities Limited nor any of the contributors accepts any liability arising out of the above information/articles. Reproduction in whole or in part without written permission is prohibited. This report is for private circulation Monday, 13 th September, 2010