Auto-ancillary space constitutes some very good companies that have delivered exceptional returns in the past. Though, it’s never been a cake-walk for the companies and their shareholders on account of automobile demand (both passenger and commercial vehicles) being cyclical, however the long term prospects of the Indian Automobile industry seem promising especially with India gaining acceptance as the manufacturing hub with the multinationals.
Now, as the title suggests, in this short note we would like to share some preliminary research on ZF Steering Gear India Ltd (NSE Code – ZFSTEERING; BSE Code – 505163), which is a Joint Venture with ZF Lenksysteme Gmbh and manufactures and supplies Hydraulic Power and Mechanical Steering systems in India.
Disclaimer: Our Alpha and Alpha + members may/may not be holding the stock in their respective portfolios. This note should in no way be construed as buy/sell advice on the stock and should only be referred for the purpose of basic information on the company.
ZF Steering Gear India is a joint venture with ZF Lenksysteme Gmbh. The Indian promoters hold 47.48% stake in the company while the Joint Venture partners from Germany hold 25.79% stake in the company.
Some details on foreign JV Partner: It’s important to note here ZF Group from Germany specializes in design, research and development, and manufacturing activities in the automotive industry with annual revenue in excess of 15 billion Euros.
Further, the Steering systems division of ZF Group commenced production in 1932 and is currently known by the name of ZF Lenksysteme Gmbh with equal equity contribution from ZF Friedrichshafen AG and the well known Bosch group.
Coming back to ZF Steering India, the product portfolio of the company includes: Hydraulic Power Steering Gears including components/spares and Mechanical Steering Gears including components/spares.
The company supplies its Steering gear systems primarily in the Commercial vehicles segment including tractors and off-roaders with minuscule contribution from Passenger vehicles segment.
As per the various reports and the below illustration, ZF Steering leads the domestic commercial vehicle segment with more than 45% market share and its only significant competitor (with similar market share) is Rane TRW Steering Systems Limited, while about 10% of the sales is accounted for by the imports. Almost 65% of the Tata Motor’s requirement in the CV segment is met by ZF whereas in case of Ashok Leyland, it meets nearly 35% of its requirements. Further, ZF is the sole supplier of steering gears for Eicher Motors & Man Force.
In the above illustration the data for the last 7 years adequately covers the good and the bad of the commercial vehicle sales cycle. Over the same period, the performance of ZF Steering has been stable with consistent growth except for FY 09 when the commercial vehicles sales itself dropped by 22% in comparison to FY 08.
The good point about the above performance is that the company has been able to maintain 46-48% market share in the commercial vehicles segment while retaining high profitability. On absolute basis and even on comparing the performance of the company with other auto ancillary companies including steering gear manufacturers, ZF Steering probably commands the highest operating and net profit margins and enjoys good terms of payment with both creditors and debtors enabling it to generate high cash flows from operations.
On excluding other income (largely dividends, interests on surplus funds), the company has consistently been able to maintain operating margins in the range of 19-21%, which points towards the fact that management has been good with cost control and has also been able to pass on the increase in the cost of raw materials to the OEMs.
The operating efficiency and strong cash flows also reflect in the robustness of the Balance sheet of ZF Steering as the company retains only 17 crore short term borrowings pertaining to business operations, while the remaining long term borrowings are in the form of deferred sales tax loans and the loans pertaining to the solar project of the company.
Even though company holds ~100 crore in equity and debt funds, it may have opted for Solar power project loan as the first quarterly installment is payable from 30th Apr’13 and the management may consider prepaying the loan once the installments start.
As mentioned above, the company has invested ~100 crore in equity and debt funds and has been consistently earning 5-6 crore annually by the way of profits on sale of investments and dividends.
Though, such kind of liquidity lends strength to the balance sheet and help overcome tough economic conditions, it also points to the fact that management has been finding it tough to invest such large sums of money at higher rate of return.
Some other important details
ZF Steering has 26% stake in ZF Lenksysteme India Pvt Ltd (ZFLI) which has recently set up a new manufacturing plant for steering systems.
The plant has the initial production capacity of 70,000 commercial vehicles steering systems and approximately 400,000 passenger car steering systems which can be further ramped up, based on market requirements.
As long as ZFLI focuses on passenger car steering systems, there won’t be conflict of interest between ZF Steering and ZFLI. In case ZFLI ramps up production capacity of commercial vehicles steering systems, it could be a cause of concern for the shareholders of ZF Steering since the foreign JV partner would like to promote ZFLI over ZF Steering on account of its 74% holding in ZFLI against 25.79% in ZF Steering.
Growth prospects and Valuations
Since ZF Steering supplies steering systems to commercial vehicles segment, its future prospects are directly linked to the sales trend of commercial vehicles in India and its ability to maintain or further grow its market share.
As far as sales trend of commercial vehicles in India is concerned, the 28% annualized growth (from the small base of FY 09) achieved during the last 3 years may not get repeated at least for the next 2-4 years, however on the back of strong demand originating from the rural segment for the light commercial vehicles the commercial vehicles industry is expected to sustain 13-15% annual volume growth over the next 5 years.
Besides 13-15% volume growth, ZF Steering can also benefit from the increasing use of hydraulic power steering systems in the M&HCV segment and also in the LCV segment as the realizations for the hydraulic power steering systems are ~3.7 times that of mechanical steering systems.
Valuations: ZF Steering is currently quoting at a market cap of Rs 280 crores. After accounting for debt and investments in equity and debt funds, the surplus fund available with the company is ~30 crores and thus the approximate enterprise value of the company is Rs 250 crores.
On ignoring the effect of other income, the company recorded a net profit of Rs 35 crore for FY 12. Considering the operating efficiency, association with a reputed German company, 45% market share in the area of operations and the ability to pass on the cost inflation to OEMs; the current valuations seem to offer a reasonable medium to long term investment opportunity.
Disclosure: I am not invested in the stock at the moment and the same has not been recommended to Alpha and Alpha + members.
Ekansh Mittal [firstname.lastname@example.org]