Varroc Engineering

Caters to the global auto industry

Supplies exterior lighting systems, plastic and polymer components, electrical-electronics components, and precision metallic components to most segments of the auto industry worldwide

CM RATING

45/100

Incorporated in 1988 by Tarun Jain and other Jain family members, Varroc Engineering (VE) is a global tier�]1 automotive component group. It designs, manufactures and supplies exterior lighting systems, plastic and polymer components, electrical-electronics components, and precision metallic components to passenger car (PC), commercial vehicle (CV), two-wheeler(2W), three-wheeler (3W) and off highway vehicle (OHW) original equipment manufacturers (OEMs) directly worldwide.

VE is the second largest Indian auto component group with a global footprint. It is the 6^th largest global exterior automotive lighting manufacturer and one of the top three independent exterior lighting players (by market share in 2016) (Source: Yole).

It has two primary business lines:

1. Design, manufacture and supply of exterior lighting systems to passenger cars OEMs worldwide (its global lighting business), which is undertaken through its subsidiaries forming part of the VLS group.
2. Design, manufacture and supply of a wide range of auto components in India (its India Business), primarily to 2Ws and 3Ws, OEMs, including exports.

After commencing the business with polymers and growing organically by adding new business lines such as electrical divisions and metallic divisions, VE diversified its product offerings and expanded production capacity through various investments, joint ventures and acquisitions. VE acquired Triom, a manufacturer of high end lighting systems for global motorcycle OEMs, with operations in Italy, Romania and Vietnam in FY 2011. VE expanded its global lighting business by acquiring in FY 2013 Visteon's holding in a 50/50 joint venture with BesteMotor Co to manufacture automotive lighting in China. VE in FY 2018 entered into a joint venture with Dell'Orto S.p.A., one of its customers, in India, for the development of electronic fuel injection control systems for 2Ws and 3Ws. The company has entered an agreement to acquire an exterior automotive lighting company based in Turkey was signed on May 30, 2018, with the sale scheduled to complete by the end of June 2018.

VEL�fs Global Lighting Business (GLB) has a broad portfolio of lighting technologies, including halogen, xenon/high�]intensity discharge, Led, Matrix Led, high definition MEMS and DMD, surface Led and OLed module, Flex Led and Led pixel headlamp, covering the five automotive external lighting product lines. Its India business (IB) offers a diverse range of products including polymers/plastics, electrical�]electronics and precision metallic components. VEL�fs comprehensive product portfolio is engine agnostic as it is capable of being used across all fuel types.

VEL has a global footprint of 36 manufacturing facilities spread across seven countries, with six facilities for GLB, 25 for IB and five for other businesses. For IB, it has 25 manufacturing facilities and five R&D centres spread across India. End March 2018, VEL�fs GLB had 185 patents and had filed 14 applications with the Controller General of Patents, Designs and Trade Marks in India and two applications with the World Intellectual Property Organization for 16 patents in various stages of grant.

VE expects its new plants in Morocco and Brazil to be completed in FY2019, following which the company will be in a position to target 85% of the global automotive market.

VEL�fs customers include Ford, Jaguar Land Rover, FCA, Groupe PSA, the VW Group, Bajaj, Royal Enfield, Yamaha, Suzuki, Honda, Hero, Piaggio and Harley Davidson. It recently included a few more world giants in automobile sector, especially in the EV arena. Bajaj accounted for 18.6% of the revenues and Honda 4% end March 2018.

Around 62.9% of the total revenues came from the 4W segment, 34% from the 2- and 3-W segments and rest from other segments including earth moving and oil drilling end March 2018.

Around 35% of the revenues were from India and rest from international markets including North America (around 22%), Asia Pacific (around 1%) and rest from other nations (around 42%) in FY 2018.

Around 60% of the revenues were derived from the lighting segment, 16% from polymer, 10% from electrical, 6% from metallic and rest 8% from other segments in FY 2018.

The Offer and the Objects

The offer comprises offer for sale of 202 lakh shares by the selling shareholders consisting of promoter Tarun Jain (17.52 lakh shares), Omega TC Holdings (entire 169.17 lakh shares) and Tata Capital Financial services (entire 15.52 lakh shares). At the lower price band of Rs 965 per share, the size works out to Rs 1951.40 crore and, at the higher price band of Rs 967, the size works out to Rs 1955.44 crore. The minimum bid lot is 15 equity shares and in multiples.

The objects are divestment and get the benefits of listing to enhance its visibility and brand image and provide liquidity to the existing shareholders.

The promoters and group will own 85% of total paid-up equity share capital post listing.

Strengths

A well diversified global auto component business across multiple geographies, vast product portfolio and large customer base.

Low-cost strategically located global manufacturing facilities and pan-India presence near major auto hubs. Proximity to OEMs leading to cost effectiveness and quicker turn-around times

Has a diversified product portfolio with end-to-end capabilities across the segments. The company caters to the 2W, 3W, PV, CV and OHV segments across the globe. Good presence in the fast-growing India 2W and Global PV lighting segments.

One-stop shop for customers enables cross-selling.

A strong balance sheet.Net debt-equity stood at 0.3 end FY 2018.

There are strong, long-lasting and growing customer relationships with marquee global and domestic auto OEMs. The diversified customer relationship means no customer has more than 20% share. VEL�fs relationships with seven of its top 10 customers have lasted longer than 10 years. The top three customers for GLB account for 33.8% of the total invoiced amounts and the top three customers for IB account for 25.1% of the total invoiced amounts.

The auto exterior lighting market was around US $ 17 billion worldwide end CY 2016 and is a fast growing product segment due to increasing lighting content per car. VE has seen its exterior lighting business revenues recording the fastest CAGR in the world of 18% from CY 2014 to CY 2017 compared with 10.2% CAGR in revenues from CY 2014 to CY 2017 of its competitors. VE growth is driven by new customer wins and increasing business with existing customers and increasing penetration of products with key customers

The increasing trend towards autonomous driving and connectivity between cars augurs well for future lighting technologies, playing a critical role in safety requirements apart from role in energy efficiency, signalling functions, projection systems and electronics.

The focus is on increasing customer revenues of IB. In the past, VEL supplied Hero with painted parts and plastic parts. In FY 2017, it also started supplying crank pins, head lamps, tail lamps and lighting parts. In the past, VEL supplied Honda with seats, painted body parts and moulded body parts. In FY 2017, it also started supplying plastic parts, pufoam parts, speedometer assemblies, starter motors, transmission assemblies and gears to them. Overall domestic two�] wheeler production is expected to register a robust 8�]10% CAGR in the next three years to reach around 26.3 million units by FY2020 (Source: Crisil).

VE brings to the market new technologies such as surface Led, 3D lighting, adaptive front lighting systems, matrix Led and laser. These have higher margins as well as higher growth and are expected to grow faster due to the transition to electric and autonomous vehicles.

Weaknesses

Pricing pressure from OEMs is a characteristic of the industry in which VE operates. All auto makers pursue aggressive but systematic price reduction initiatives and objectives each year with their suppliers.

The capital-intensive business requires a large fixed cost base. It needs large volumes to get the benefit of leverage of higher fixed cost. Else, the higher fixed cost can affect the profitability. The company incurred capex of Rs 505 crore in FY 2016, Rs 671.65 crore in FY 2017 and Rs 603.92 crore in FY 2018.

There is heavily dependence on the global automotive industry, particularly on the performance of the global PV market and 2Ws and 3Ws in India. Any decrease in demand or changes in government policies, economic conditions, demographic trends and interest rates will have negative impact on the company�fs business.

Being a global player, with around 65% of the revenues coming from the international market, increasing local manufacturing motion across the globe and changes in duty structure can significantly affect the business and make manufacturing locations unviable and result in loss of cost-competitiveness and other benefits. Developments can also force strategic decisions of setting up manufacturing base globally or forced acquisitions, affecting the overall financials.

The effects of global trade wars, going on currently, are difficult to predict on the company�fs prospects.

Earnings are prone to forex risks. Any sharp movement of the Indian currency in the short term can significantly affect profitability.

It will remain closely held post listing as promoters will control 85% stake.

Valuation

Consolidated net sales for FY 2018 were up 11% to Rs 10278.83 crore and the OPM increased 220 basis points to 8.5%, leading to OP growth of 51% to Rs 877.57 crore. Other income was down by 59% to Rs 38.61 crore. Interest cost stood down 5% to Rs 86.17 crore, while depreciation increased 15% to Rs 386.47 crore. Thus, profit before tax was up 79% to Rs 443.54 crore. Total tax jumped 160% to Rs 61.79 crore. After providing profit from share of profit from associates of Rs 69.03 crore and minority interest of Rs 0.52 crore, consolidated profit after tax (Pat) could rise 49% to Rs 450.26 crore. However, the jump is on a deflated base of FY 2017, when consolidated Pat had fallen 18% to Rs 303.01 crore.

At the higher price band of Rs 967, the P/E on FY 2018 EPS (on current diluted equity of Rs 13.48 crore) of Rs 33.4 works out to 29. Currently, all the comparable listed players are trading at very high P/E multiples.

Minda Industries, Motherson Sumi Systems and Endurance Technologies are some of the comparable listed peers. Minda Industries reported consolidated net sales of Rs 4470.56 crore and Pat of Rs 310.19 crore in FY 2018, giving an EPS of Rs 35.6. At the current market price of Rs 1262, the stock trades at around 35.4 times its FY 2018 consolidated earnings.

Motherson Sumi Systems reported consolidated net sales of Rs 56293.32 crore and Pat of Rs 1597.01 crore, giving an EPS of Rs 7.6. At the current market price of Rs 307, the stock trades at around 40.5 times its FY 2018 consolidated earnings.

Endurance Technologies reported consolidated net sales of Rs 6538.14 crore and Pat of Rs 390.75 crore, giving an EPS of Rs 27.8. At the current market price of Rs 1262, the stock trades at around 45 times its FY 2018 consolidated earnings.