Varroc Engineering IPO Note (May apply)

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Review By Rudra Shares & Stock Brokers Ltd on June 25, 2018

VALUATION

The company claims to be the second largest Indian auto component group and a leading tier-1 manufacturer and supplier to Indian two-wheeler and three-wheeler OEMs.

Overall domestic two-wheeler production is expected to grow at a robust pace of 8-10% CAGR in the next three years. Higher GDP growth and lower inflation will lead to better affordability, measured by an increase in disposable incomes.

Further, the government is backing the sector with several initiatives like Emission norms compliance to impact demand in 2021.

Though drivers such as increased LED penetration rate, technology innovation, Increased lighting content per vehicle , improving financial scenario, Anticipated improvement in rural demand would enhance the share and business looks attractive but high valuation at current level fails to infuse optimism in company

On the upper price band of Rs 967 with annualized EPS Of Rs 30.45 for FY18, Estimated P/E works out at 32xs.

We recommend being 'NEUTRAL' for this IPO.

THE OFFER

• Issue Open: 26 June 2018 to 28 June 2018
• Issue Type: Book Built Issue IPO
• Issue Size: 20,121,730 Equity Shares @ 1 aggregating up to Rs 1945.77 Cr
• Face Value: Rs 1 per Equity Share
• Issue Price: Rs 965 - Rs 967 per Equity Share
• Market Lot: 15 Shares
• Minimum Order Quantity: 15 Shares
• Listing At: NSE, BSE

CAPITAL STRUCTURE

The share capital of Company, is set forth below (Amount in Rs except share data)

• Authorized Share Capital: 250,000,000 Equity Shares @1 Aggregate value 250,000,000
• Issued, subscribed and paid up capital before the Issue: 134,811,530 Equity Shares @1 Aggregate value 134,811,530
• Present Issue: 20,121,730 Equity Shares @ 1 aggregating up to Rs 77 Cr

OBJECT OF THE OFFER

• To carry out the Offer for Sale by Selling Shareholders.
• To achieve the benefits of listing the Equity Shares on the Stock Exchanges.

Further, Company expects that the listing of the Equity Shares will enhance visibility and brand image and provide liquidity to Shareholders.

COMPANY OVERVIEW

The company incorporated in 1988 is a manufacturer of auto component and supplier of exterior lighting systems, plastic and polymer components, electricals and electronics components, metallic components to passenger car and commercial vehicles with two and three wheelers and off highway vehicle ('OHV') OEMs directly worldwide.

The company has 36 manufacturing facilities spread across seven countries, with six facilities for Global Lighting Business, 25 for India Business and five for Other Businesses with 16 R&D centers in 10 countries.

Plans lined up

Company continue to expand its manufacturing and R&D footprint, and intend to set up one manufacturing facility in Brazil and one manufacturing facility in Morocco, as well as two manufacturing facilities in India which is expected to commence production in FY2019.

Also, VEL is in discussions to acquire an exterior automotive lighting company in Turkey in FY2019.

On February 13, 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 two wheelers and three-wheelers.

In particular, the Ministry of Road Transport and Highways, India has mandated the adoption of the Bharat Stage VI ('BS VI') emission standards by April 1, 2020, as part of which two and three-wheelers in India are expected to introduce electronic fuel injection systems

Strong Clientele

VLS has long-term relationships with marquee auto manufacturers across the premium, mid-range and mass market pricing spectrum, including Ford, Jaguar Land Rover, the Volkswagen Group (the 'VW Group'), Renault-Nissan-Mitsubishi, Group PSA, FCA, a European multinational car manufacturer and an American electric car manufacturer.

Other key two wheeler customers in India include Bajaj, Honda, Royal Enfield, Yamaha, Suzuki and Hero. It also exports to global two-wheeler manufacturers from facilities in India, namely KTM and Volvo.

ROAD MAP AHEAD

Company objectives are to expand their market share and aim to accomplish this through the following strategies:

• Focus on high growth markets for Global Lighting Business.
• Focus on increasing customer revenue for India Business
• Pursue strategic joint ventures and inorganic growth opportunities
• Focus on operational efficiency
• Continue to invest in R&D

STRENGTHS

• Strong competitive position in attractive growing markets.
• Strong, long-standing customer relationships
• Low cost, strategically located manufacturing and design footprint
• Robust in-house technology, innovation and R&D capabilities
• Consistent track record of growth and operational and financial efficiency

FINANCIAL PERFORMANCE

Consolidated Revenue from operations for the FY 2016, FY 2017 and 9M FY 2018 stood at Rs 8218.90 crores, Rs 9608.54 crores and Rs 7393.91 crores, respectively with-

Rs 4430 crores from Global Lighting Business, Rs 2660 crores from India Business (Rs 1220 crores for polymers/plastics, Rs 770 crores for electrical/electronics/lighting, Rs 480 crores for metallic components and the remainder from other sources) and Rs 300 billion from Other Businesses, for 9M FY18.

EBITDA stood at Rs 591.57 crores, Rs 6,75.48 crores and Rs 654.79 crores, for the FY 2016, FY 2017 and 9M FY 2018 respectively.

For 9M FY2018, ROE was 17.1% and RoCE was 15.5%,(both annualised)

Net debt to equity ratio as of December 31, 2017 was at 0.54.

Cash flow from operations increased from Rs 128.34 crore in FY15 to Rs 1,074.85 crore in FY18, i.e. a growth of 103.1 % CAGR over FY15-18.

Total debt declined by 11.3 % CAGR to Rs 980.07 crore in FY18.

Revenue- Geographical Distribution

Company received 36.6% of revenue in FY2017 from customers in Europe (39.8% in 9M FY2018), 32.7% from customers in India (35.7% in 9M FY2018), 20.4% from customers in the United States of America (17.0% in 9M FY2018), 0.6% from customers in the Asia Pacific region (0.6% in 9M FY2018) (excluding India and China JV, which we account for via the equity method), and 9.7% from customers in other geographies (6.8% in 9M FY2018).

INDUSTRY OVERVIEW

Outlook on export and domestic markets

According to SIAM and CRISIL Research, overall domestic two-wheeler production is estimated to grow at a robust pace of 8-10% CAGR in the next three years to reach around 26.3 million units by FY2020. Domestic sales, which forms approximately 85% of total production, is also estimated to grow at a similar pace of 8-10% during the period. Manufacturers' focus on urban markets, expansion in the distribution network in semi-urban and rural areas, model launches, and better product positioning, will drive up volumes.

In FY2019, CRISIL Research expects the two-wheeler industry to grow 6-8%, assuming normal monsoons and improved rural demand, State Pay Commission pay-outs, and a pick-up in infrastructure activities. Further, improvement in government spending is likely to boost demand in the second half, pushing demand upwards by 1-3%.

Key Growth drivers for domestic sales and export sales

Outlook of the Indian three-wheeler industry

• Strong demand from international markets.
• Issuance of fresh permits for passenger three-wheeler vehicles.
• Availability of funding, especially through organised channels.
• Replacement demand - an important growth driver, improving network of CNG fuel stations is driving the replacement of older petrol- or diesel-powered vehicles with the CNG-based vehicles.
• Cab aggregators are aggressively expanding their three-wheeler transportation to provide affordable and last-mile connectivity, thus acting as another growth driver.

RISK FOR THE BUSINESS

• Pricing pressure from customers may adversely affect gross margin, profitability and ability to increase prices, which in turn may materially adversely affect business, results of operations and financial condition.
• Expiry of intellectual property rights could lead to increased competition.
• The cyclical and seasonal nature of automotive sales and production can adversely affect business.
• Political instability, changes in economic policy, changing laws, rules and regulations and legal uncertainties, including adverse application of tax laws and regulations, may adversely affect business and financial performance.
• Currency exchange rate fluctuations could have an adverse effect on reporting of results of operations.