Daily India: Swaraj Engines: Positive Outlook But Growth Is Slowing and Valuation Is Rich and more

In this briefing:

1. Swaraj Engines: Positive Outlook But Growth Is Slowing and Valuation Is Rich
2. Changing Lanes

1. Swaraj Engines: Positive Outlook But Growth Is Slowing and Valuation Is Rich

Swaraj Engines (SWE IN) (SEL)is primarily manufacturing diesel engines for fitment into Swaraj tractors manufactured by Mahindra & Mahindra Ltd. (M&M). The Company is also supplying engine components to SML Isuzu Ltd used in the assembly of commercial vehicle engines. SEL was started as a joint venture between Punjab Tractor Ltd (now acquired by M&M Ltd) and Kirloskar Oil Engines Ltd. M&M holds 33.3% stake in SEL and is its key client.  

We are positive about the business because:

• SEL’s growth is correlated with M&M’s tractor business growth. SEL supplies engines to the Swaraj division of M&M. M&M expects tractor growth to be around 12% YoY in FY19E. We forecast SEL’s tractor engine volumes will grow at a CAGR of 12% for FY18-21E.
• The growth of the company is dependent on the monsoon and rural sentiments. We expect the profitability to improve with normal rainfall and government initiatives towards the rural sector. We expect the revenue/ EBITDA/ PAT CAGR for FY18-21E to be 14%/ 15%/ 14% respectively.
• SEL is debt free and a cash generating company. It has a healthy and stable ROCE and ROE. SEL has increased its capacity from 75,000 engines in FY16 to 120,000 engines in FY18. We expect the capacity utilisation to reach 97% by FY20E from 90% in 1HFY19. SEL funds its capex through internal accruals. We forecast a capex of Rs 600 mn for FY19E to FY21E considering the requirement of the additional capacity, R&D and testing costs for new and higher HP engines & for upgradation of engines according to the TREM IV emission norms for >50 HP engines.

We initiate coverage on SEL with a fair value objective of Rs 1,655/- over the next 12 months. This represents a potential upside of 15% from the closing price of Rs 1,435/- (as on 26-12-2018). We arrive at the fair value by applying PE multiple of 18x to EPS of Rs 87/- to the year ending December-20E and add cash of Rs 82/- per share. While the business outlook is good, we think the upside in the share price is limited due to rich valuation.

2. Changing Lanes

The hyper-competitive Indian payments industry is changing. New regulations are increasing the cost operations, NPCI (National Payments Corporation of India) & Reserve Bank of India (RBI) are breaking all barriers to entry enabling a level playing field that ensures no competitive moats exist. Although there are volumes, profitability remains a distant dream and likely to remain so making Indian payments a bad business to be invested in.