FAG Bearings India (NSE – FAGBEARING): A high quality company. Can it also deliver high returns on investment?
A few days back we closed a special situation opportunity in NRB Bearings; however while looking at the details of NRB Bearings, we started checking out details of other bearing manufacturers and were positively surprised by the quality of the companies in the bearings segment.
In this article, let’s look at FAG Bearings India, which is the second largest player in the Indian Bearings industry with ~15% market share and ~29% market share in the organized segment. Yes, as can be observed from the market share details, organized and un-organized players account for almost equal share of the Indian bearings industry.
If FAG is the second largest, then which is the largest player?
Well, the largest player is SFK India and is again a listed company like FAG, however based on some preliminary research; we found FAG better and would therefore like to share the details on the company. Besides FAG and SKG, Timken India and NRB are two other prominent players in the organized segment.
Note: Please don’t construe this note on FAG Bearings as buy/sell advice. The readers are suggested to carry out their own due diligence.
Basic details on FAG Bearings and the bearings industry in India:
The total size of the bearings industry in India is estimated at Rs 8,500 crores at the end of Mar’12, of which organized players accounted for Rs 4,500 crores, while the small scale companies and imports accounted for the rest.
FAG Bearings India is the second largest player in the Indian bearings industry with Schaeffler Group, Germany as the promoters of the company with 51.33% stake.
The Schaeffler Group is a privately owned major manufacturer of rolling element bearings for automotive, aerospace and industrial uses. It is a supplier to the automotive industry and one of the world‘s leading manufacturers of rolling bearings and linear products under the brands – INA, FAG and LuK for more than 120 years.
We believe, the association of Schaeffler Group is extremely critical in the success of FAG Bearings India, as all (yes, all) the large and successful players of the Indian Bearings industry are dependent on the technology provided by their foreign collaborators.
This probably also acts as an entry barrier to the growth of number of bearing manufacturers in India in the organized segment. Though, there are numerous players in the unorganized segment, however, they primarily cater to the replacement market and continue to serve the very low-end market as well as form the core of the counterfeit products in the market.
With a renewed focus on quality & reliability and with the quality of bearings manufactured by unorganized players being much inferior, the replacement market is increasingly turning to the organized sector which augurs well for companies like FAG, SKF, etc.
This shift towards organized segment can also be gazed from the below numbers:
As can be observed from the above illustration, the company’s performance has been very good over the years and consistently delivered return on equity in excess of 20%.
During the last 5 years, both Automotive and capital goods industries (bearings are used in almost all the industries) witnessed good and bad periods, however FAG consistently delivered higher sales (even during FY 09) at the rate of 19% annualized. Similarly, the profits of the company have also grown at the same rate of 19% annualized on the back of consistently improving operating income and interest income on ~200 crore surplus funds with the company.
Yes, FAG Bearings is a debt free company, with surplus funds, as it has been able to consistently generate very good cash flows from operations.
In the very beginning we mentioned that even though SKF is the largest player, on the basis of preliminary research we find FAG Bearings a better company. Well, the various reasons behind the same are as below:
- Over the last 5 years, FAG’s rate of growth has been much higher in comparison to SKF.
- We found a striking difference in the operating margins of the two companies. While FAG has been able to maintain its operating margins in the range of 18-21% (very good), SKF’s operating margins have hovered in the range of 12-13%.
- Besides operating margins, considering the rate of increase in depreciation, FAG’s been generating higher sales on its fixed assets.
Well, for the last 2 years FAG’s been running its plants at more than 100% capacity utilization and in order to overcome capacity constraints, during the calendar and financial year 2011 it spent more than 150 crores on expanding its capacities:
The performance of FAG Bearings has been excellent without being very aggressive. Yes, sometimes managements are over ambitious and become aggressive to the extent of jeopardizing the interest of all the stakeholders and therefore from the point of view of minority shareholders, it’s important that people at the helm of affairs are able and conservative at the same time.
The increasing market share of organized players is a very good sign and since unorganized players still account for ~48-50% market share, there’s enough room for companies like FAG Bearings to grow at a good pace and garner a larger pie of the overall bearings industry in India.
The holding company, FAG Group, Germany, is one of the oldest and the leading company in advance bearing technologies. With their support, FAG India should be able to maintain its competitive advantage in technology over its peers.
The long term outlook for bearings industry in India is very good on the back of growth of the Indian middle class which will accelerate demand from the automotive industry and other sectors including steel, power & heavy engineering.
Areas of concern
The automotive industry is the single largest consumer of bearing products and over the past few months, the growth’s been flat.
Over the last few years, there have been regular increases in the prices of bearing steel which constitute a major portion of bearing costs. While FAG has been able to pass on the increased cost of raw materials and maintain its operating margins in the range of 19-20%, there’s a certain period of lag before which it is able to re-negotiate prices with its customers. Thus, in case of sharp increase in cost of raw materials or a sudden drop in demand (refer FY 09), the margins can go for a toss in a particular year.
Even though FAG is a debt free company with surplus funds in its kitty, the dividend payout has been low in the range of 8-10%.
Considering the operating performance of the company, efficient capital allocation, debt free status with surplus funds to the tune of Rs 200 crores, overall growth prospects and collaboration with FAG Group, we believe the valuations are in the fair zone (CMP – 1600) at ~10 times FY 11 (Dec ending) profit before tax.
This is not to say that the stock cannot witness any short term corrections, however 10-15% correction to ~Rs 1350-1400 will make the stock attractive for long term investment.
Ekansh Mittal [email@example.com]
We would like to share with you details on the Straight equity + Special situation opportunity on NRB Bearings (NSE Code – NRBBEARING).
This opportunity was shared at Rs 39.50 with around 6-7% portfolio allocation recommendation to Alpha + members and we finally closed it on 20th Sep’12 at around Rs 46.50 (inclusive of Rs 2/- per share dividend), a moderate gain of ~17% in 6 months.
Yes, finally, because we missed booking profits in Jul’12 when the stock reached a high of Rs 48 (before going ex-dividend) in mid Jul’12.
Note: The stock is now trading on ex-demerger basis and therefore the opportunity stands closed, however we hope that the attached report helps you in identifying and participating in such special situation opportunities in future.
Anyways, besides the de-merger of industrial bearings unit, there was also a straight equity investment perspective considering the operating performance of the company and the fact that at Rs 39.5 NRB Bearings was offering a dividend yield of more than 5%.
In case of any queries, please contact the undersigned.
Ph.: 0120-4109766, Mob: +91-9818866676
This is to inform you that the report on the Stock recommendation for the month of Aug’12 has been shared with all the Alpha and Alpha + members.
Like the previous two recommendations for the month of May’12 (Amara Raja Batteries @ 300) and Jul’12 recommendation (up ~30% since recommendation), Aug’12 recommendation is again a very high quality company run by one of the most investor friendly and ethical management. Over the last 50 years, they have walked the talk of growing their business with dignity and respect and therefore it should not come as a surprise that they are now the largest company in India in their area of operations.
Brand equity of Aug’12 recommendation: It commands the similar level of recognition in its industry in India, as Fevicol in Adhesives, Asian Paints in Paints, Cadbury in confectionery, Exide in batteries, Titan in Jewellery etc.
Here, if we disclose the segment in which the company operates, it would be too easy to guess the company for anyone and everyone and thus this itself speaks so much about the brand equity.
We believe, most of the readers would have bought the products of the company for some purpose or the other and would have still not considered investing in this easy to understand, simple, omnipresent company that’s been consistently growing at 25-30% and still available at very reasonable valuations. For some reason or the other investors tend to ignore simple investment ideas whose products they themselves may have used and against all odds end up investing in companies operating in fancy and complex industries.
Frankly speaking, you can perform much better than 99% of the investor community by searching for simple investment ideas from your surroundings, your own home. These investments may not make you rich overnight, but stocks of such companies have appreciated 10-100 times over the years and made their patient investors super-rich with time.
Some basic details on Alpha/Alpha + Stock for the month of Aug’12
We believe a lot can be determined about the quality of the company from its cash flows and its ability to pass on increase in cost of raw material.
Cash Flows: There’s no substitute to cash in being able to run a business efficiently and more than often companies have run into bankruptcy on account of their inability to maintain liquidity. In case of Aug’12 recommendations, its cash flows from operations have mostly been in excess of reported profits as the company enjoys very favorable terms with its suppliers and customers. Consider this: Company is in the process of expanding its manufacturing capacity and the management is confident of funding the same through internal accruals and supplier’s credit .
Here it’s important to note that Supplier’s credit is an interest free source of fund. Had it been some other mediocre company, it would have resorted to debt or equity, and therefore either way lowered earnings per share.
Margins: As far as its ability to pass on increase in cost of raw materials is concerned, over the years the company has consistently been able to improve its gross and operating margins along with pretty decent volume growth on the back of constant innovation and inclusion of premium, value added products.
Management: The good point about the company is that the management does not sit back on the past achievements and does not become complacent. They constantly strive to move away from competitive segments into those where it can have the first mover advantage and this is probably what has led to the company achieving the numero uno spot in its area of operations.
Shareholder friendly: In the beginning we mentioned that the company is run by one of the most investor friendly and ethical management and this can be well understood from the fact that besides being extremely good in their business operations, the company has consistently maintained a dividend payout in excess of 30% and did not dilute equity in the preceding 10 years and more.
Ph.: 0120-4109766, Mob: +91-9818866676
We would like to share with you details on the stock recommendation to our Alpha and Alpha + members in the month of Jul’12 – Bajaj Corp Ltd (NSE Code – BAJAJCORP) at Rs 130.
Note: This report is being shared only for the purpose of information; do not construe the same as buy/sell advice. Our Alpha and Alpha + members are invested in the stock and we therefore have a vested interest. In case you invest in Bajaj Corp Ltd, please carry out your own due diligence.
Key Investment highlights of Bajaj Corp Ltd
Brand Equity – The greatness of a brand lays in its ability to raise prices in an inflationary environment while still retain or further gain market share. As far as Bajaj Corp Ltd is concerned, it’s brand equity has enabled the company to benefit from the inflationary environment and thus grow its Sales and profits both on account of volume and price expansion, as the company has been able to consistently increase the prices of its products and thus pass on the hike in the prices of raw materials and the overall operating cost.
Further, you may draw your own conclusions about the affinity for the company’s products from the fact that over the last 5-6 years the company has been able to garner an additional 20% market share and now commands a leadership position.
Very asset light business with large amount of free cash flows – As with other great businesses, the company has its own sweet problem of deploying excessively large (considering capital requirement for business operations) annual free cash flows from the business operations of the company.
Yes, the free cash flows generated by the company annually is ~3 times the net tangible assets required to run the operations of the company and the gap is expected to widen further in the ensuing years, as has been the case with See’s Candies. I can bet you, every company would love to face such a sweet problem, than be in the asset heavy business, run out of capital every now and then and then resort to debt based funding.
Growth – In a rapidly expanding market, the company has outpaced its peers in terms of growth with more than 30% annualized growth rate over the last 5 years on account of both volume and price expansion.
Valuations – As Warrant Buffett says, “Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results.” Thus, in order to generate decent returns on one’s investments, finding a Great company is only half the job done as it’s also important to invest in the company at fair valuations.
As far as the valuations of Bajaj Corp are concerned, at a stock price of Rs 130 the market expects the company to grow its earnings at only 1.35% p.a. over the long term for this debt free and cash rich company. We believe, given the trajectory of growth at which the company’s business happens to be, this valuation does not seem to capture expected future growth in earnings.
Dividend yield – Based on the dividend declared for FY 12, the stock is currently offering a dividend yield of more than 3%.
Ph.: 0120-4109766, Mob: +91-9818866676
Please find below the note on Bajaj Finserv Ltd (NSE Code – BAJAJFINSV): Rights issue – Special situation opportunity shared with Alpha + members on 4th Sep’12.
The stock was originally bought on cum right basis @ Rs 805 with ~10% allocation and sold after ex-date in the range of Rs 790-795.
With a 2-3% loss, we have positioned ourselves for Rights issue shares of Bajaj Finserv at Rs 650/- per share in the ratio of 1:10. In case there’s excess allotment, the gains could be good on this rights issue opportunity.
The detailed note on Bajaj Finserv that was shared with Alpha + members has been produced below for your reference.
Alpha Plus: Special situation for Sep’12 – 4th Sep’12
Dear Alpha Plus Members,
We would like to bring to your notice a Special situation opportunity on Rights issue of Bajaj Finserv Ltd (NSE Code – BAJAJFINSV).
Bajaj Finserv Ltd – Basic details
Bajaj Finserv, the financial services arm of the Bajaj group is engaged in life insurance, general insurance, consumer finance and other financial products.
The portfolio of the company includes 74% in the two insurance companies, namely Bajaj Allianz Life Insurance Company Ltd and Bajaj General Insurance Company Ltd, 50% holding in Bajaj Allianz Financial Distributors Ltd, 40.53% in Bajaj Auto Finance Ltd and 100% holding in Bajaj Financial Solutions Ltd.
The company is engaged in life and general insurance through their joint ventures with Allianz SE namely Bajaj Allianz Life Insurance Company Ltd and Bajaj Allianz General Insurance Ltd. Bajaj Allianz Financial Distributors Ltd is a 50:50 joint venture company between the company and Allianz SE, which is engaged in the business of financial products.
Without getting deep into details, on a TTM basis, Bajaj Finserv is trading at a P/E of 8.3x its trailing 12 month EPS of Rs 97. Consolidated return ratios are strong with RoA of >2.4% and RoE of ~30%. Further, on account of the strong brand equity of the group, stable and experienced management and visible growth potential in all financial services where it exists, Bajaj Finserv is a good company available at reasonable valuations.
Rights Issue details
Bajaj Finserv is currently quoting at a price of Rs 805/- per share.
The Rights issue committee of the company has approved the following:
Post rights issue the diluted TTM EPS of the company will be ~ Rs 88.18.
As Bajaj Finserv is a good company available at reasonable valuations, we would suggest the following allocation strategy:
Allocate 10% of your portfolio towards Bajaj Finserv (minimum 10 shares).
We have suggested high allocation as the holding period is small and to have meaningful allocation on ex-right basis. Please do not buy after 5th Sep’12 as the stock will be ex-right.
Note: If one buys only 10 shares of Bajaj Finserv, he would still receive the Rights Issue application form (CAF) and is eligible to apply for as many additional shares, as he/she wishes over and above his entitled rights of 1 share. The allotment of such additional Rights Equity Shares is made on an equitable basis with due regard to the number of Equity Shares held by the shareholder on the Record Date, provided there is an under-subscribed portion.
To put it simply, for two investors applying for equal number of additional shares, higher allotment is made to the one who had more number of shares in his account on the record date.
On 7th Sep’12, sell your entire holding in Bajaj Finserv in early trading hours.
On the ex-date the stock will get adjusted to slightly lower levels. We expect the stock to correct to Rs 785-795 (assuming 806 to be the closing price on 5th Sep’12). Thus, on selling on ex-date one would be incurring a loss of 2-3% on his/her initial allocation and will be entitled for rights issue shares of Bajaj Finserv @ Rs 650 in the ratio of 1:10.
Return on Investment and Probability of excess allotment
Considering the operating performance, corporate governance and the brand equity of Bajaj Group, it’s unlikely that the stock price will correct all the way down to Rs 650 and below, unless there’s some exceptional situation.
So, if there’s no excess allotment, the cost of acquisition of rights issue shares would be ~ Rs 800/- per share and the loss would be to the tune of 3-4% (inclusive of transaction cost) of the initial portfolio allocation if the price corrects all the way down to Rs 650 by the time we are able to sell rights issue shares.
As far as excess allotment is concerned, the shareholding pattern of Bajaj Finserv is somewhat similar to EPC Industries in which we received ~120% excess allotment i.e. if one was entitled for 10 rights issue shares; he/she received 22 shares on applying for excess allotment. At 120% excess allotment, the cost of acquisition of rights issue shares would be ~ Rs 750/- per share.
This is not to say that in Bajaj Finserv the excess allotment will be 120% as well. There may not be any excess allotment or there could even be full excess allotment, EPC was just being used as an example.
Since the company is good and the valuations are reasonable, the downside risk is limited, while depending on excess allotment there could be good gains in a matter of 1-2 months.
In case of any queries, please feel free to drop a mail or call us.
Ph.: 0120-4109766, Mob: +91-9818866676