Auto Ancillaries - A high growth manufacturing and consumer play

Introduction

We are witnessing strong demand revival of auto ancillaries (ancs) driven by not only domestic demand but from China+1 (export opportunity), and government mandate for localisation of content. This has sparked our interest in the sector, leading us to conduct a study of 13 auto ancillary companies representing a wide range of products and services.

Prior to delving deeper into auto ancillaries, a fundamental question arises: why pick auto ancs over OEMs (original equipment manufacturers like Maruti, Honda etc)? Particularly considering that the growth and profitability of auto ancillaries are intricately linked with OEMs? However, we found that over a 10-year horizon, auto ancillaries have outperformed OEMs by more than 4% annually, achieving an annualized return of 24% compared to 20% for OEMs. Therefore, our study of auto ancs is based on a its own merit too and not necessarily a proxy position or a contra call.

Note: Olectra Greentech has been excluded from our analysis due to its exclusive focus on the electric bus segment, which makes it less directly comparable to traditional auto companies.

Exhibit 1: Average stock return profile of Auto Ancs vs. OEM

Source: Screener.in and exchange data

Key drivers

China+1 and localization

Indian auto ancs are benefiting from China+1 sourcing of products by US and global auto majors. Given the low cost of manufacturing, government incentives & policies, auto ancs can provide value to global OEMs for a long time. Consequently, auto ancillaries are poised to capitalize not only on domestic growth but also from rising exports.

RACL recently won a contract to supply gears to ZF, the world’s largest gear manufacturer. This is an exemplary demonstration of the cost-effectiveness and quality prowess of an Indian auto ancillary. In addition, several other auto ancillaries have expanded their exports over the past 2-3 years.

Within India, the government’s directive to increase local content per vehicle which helps benefit entire value chain. This policy also encourages large international auto companies entering the Indian market to procure components from local suppliers.

Rising Value of Vehicle Content and Product Diversification

The trend towards premiumization, electrification, and vehicle light weighting is driving an increase in the value of content per vehicle. Simultaneously, many companies are expanding their product portfolios by introducing new offerings such as telematics, electric chargers, and motor control units.

Resulting Operating Leverage

The rise in content value and higher export volumes is enhancing margins across the industry. Even a modest improvement in revenue is generating a significant impact on Profit After Tax (PAT). The 13 companies covered in our study are likely to grow revenues by 17% over the next three years, while earnings growth will exceed 20%.

Study overview

Our analysis encompassed 13 auto ancillary companies specializing in a diverse range of products including metal sheets, aluminum castings, gears, lighting, TFT displays & clusters, aesthetics, smart locks, plastic moulds, chassis, switches, and alloy wheels.

Market cap distribution

We examined a mix of companies, comprising 3 mid to large caps with market capitalizations exceeding ₹30,000 crores, alongside smaller caps ranging from ₹1,000 to ₹7,000 crores in market cap.

Ranking and Assessment Criteria

Our evaluation criteria were predominantly structured around earnings growth (50%) franchise strength (40%) and less on valuation considerations (10%). Franchise strength included gross margins (15%), asset turnover (10%), capital efficiency (5% each for 3 sub-factors), and financial leverage (10%).

Story in charts

Earnings growth – Sandhar due to operating leverage is likely to lead earnings growth at over 30%

SJS has highest gross margins closely followed by RACL and Suprajit

ZF commercial exhibits highest asset turnover followed at distance by Lumax auto and Uno Minda

Fiem Industries, SJS and Pricol have good ROCEs of 20% and above

ROE of RACL is highest owing to higher leverage on its balance sheet. SJS with negligible debt is able to have a relatively high ROE of 17%

RACL has highest debt on its book with debt to equity ratio of 1.4x vs. average of 0.5x as of FY24

Outcome of study

Among the 13 companies analyzed (Exhibit 2), SJS Enterprise achieved the top ranking due to its robust fundamental score driven by promising growth prospects and strong franchise score reflected in its high gross margins and efficient capital utilization. Despite being ranked 7th in terms of valuation, the high weightage assigned to growth (50%) and franchise strength (40%) outweighed the valuation factor.

It should be noted that companies ranking low does not necessarily mean bad companies. The rank is reflective of our preference of growth at highest level. For example Fiem Industries ranks best on valuation and return metrics, however, our higher weightage on growth and gross margins ranks Fiem overall in mid-level rankings. Hence, anyone who prefers valuations can rank Fiem much higher.

 
Exhibit 2: Summary for fundamental and valuation rankings along with final overall rankings

Source: Korman Capital workings and estimates

Conclusion: We believe that auto ancs provide industry growth plus exposure owing to export opportunity and reasonable valuations. Hence, select auto ancs can be good portfolio bets.

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