Varroc Engineering Limited IPO - A Mixed Bag, in More Ways that One

Value investor- India mid & small caps

Bhaskar Chakraborty

Equity Capital Markets

Varroc Engineering Ltd / Equity Capital Markets

<ul><li><a href="https://www.smartkarma.com/entities/27172" target="_blank" data-smartkarma-citation="entities:27172:1">Varroc Engineering Ltd (934734Z IN)</a> is the 6<sup>th</sup> largest global passenger vehicle exterior lighting provider and is the second largest globally in the EV segment.</li><li>Headlamps that account for 63% of the total lighting by value has only 6% LED penetration providing long runway for growth</li><li>It enjoys high barrier to entry with significant R&amp;D spends, production facilities located in close proximity to clients and entrenched client relationships.</li><li>However, revenue growth has been volatile in both the global lighting and domestic 2 &amp; 3-W segments.</li><li>Despite the near oligopolistic nature of the global lighting market (91% controlled by 8 players), its EBITDA margin in the segment nearly halved over FY15-17. Profitability has been very volatile.</li><li>Assuming that Varroc grows PAT at 20% over FY19, it is being offered at 24.1x FY19 PE- at the same multiple at which <a href="https://www.smartkarma.com/entities/10662" target="_blank" data-smartkarma-citation="entities:10662:1">Motherson Sumi Systems Ltd (MSS IN)</a> and <a href="https://www.smartkarma.com/entities/10246" target="_blank" data-smartkarma-citation="entities:10246:1">Bharat Forge Ltd (BHFC IN)</a> are trading currently. Its return ratios are significantly inferior to both these comparable companies. We see limited upside to the IPO price.</li></ul>

Varroc Engineering Ltd (934734Z IN) is the 6th largest global passenger vehicle exterior lighting provider and is the second largest globally in the EV segment.Headlamps that account for 63% of the total lighting by value has only 6% LED penetration providing long runway for growthIt enjoys high barrier to entry with significant R&amp;D spends, production facilities located in close proximity to clients and entrenched client relationships.However, revenue growth has been volatile in both the global lighting and domestic 2 &amp; 3-W segments.Despite the near oligopolistic nature of the global lighting market (91% controlled by 8 players), its EBITDA margin in the segment nearly halved over FY15-17. Profitability has been very volatile.Assuming that Varroc grows PAT at 20% over FY19, it is being offered at 24.1x FY19 PE- at the same multiple at which Motherson Sumi Systems Ltd (MSS IN) and Bharat Forge Ltd (BHFC IN) are trading currently. Its return ratios are significantly inferior to both these comparable companies. We see limited upside to the IPO price.

Samvardhana Motherson International Ltd (MOTHERSO IN)

Varroc Engineering IPO: Too Volatile for Comfort