Stock Market

FAG Bearings India: Is there light at the end of the tunnel?

Madhuchanda Dey
Chillicious Research
With BSE Mid Cap Index soaring to dizzying heights and a few midcap managers sounding cautious, a section of investors might be asking themselves whether or not it is a good time to look at investing ideas. While a section of the markets have run up, certain pockets have underperformed significantly due to near-term headwinds. We decided to do a bit more research into laggards to see if there is light at the end of the tunnel. Here are our findings.

The bearing industry is one such pocket which faced twin headwinds of demand pressure (flat IIP and automobile on a slow lane) and cost push (rising steel prices, a key raw material) in 2016.

Bearing Industry – Quick Facts

Bearings are critical components in automobiles and many other industrial applications as they reduce friction between moving parts and thus enhance the life of an engine, transmission and other components.

The Indian bearings industry heavily leans towards the organised players – about 65 percent market share is with the top five players — and only a minuscule portion of the market is unorganized. Nearly 52 percent of the sales come from the automotive segment and the industrial segment accounts for the remaining 48 percent.

Although the industry faced near-term pressure in 2016, some of the medium-term tailwinds warrant attention and the weakness in stock price might present an opportunity of stocking up on high quality companies for the long term.

FAG Bearings India (CMP: Rs 4111, Market Cap: Rs 6837 crore) is the subsidiary of Germany-based Schaeffler Group (51 percent holding), which is the world’s largest bearing manufacturer for the automobile sector. The Indian subsidiary is the second-largest player with 15 percent market share, well-diversified across segments and is the market leader in the passenger vehicle segment. After showing revenue and profit CAGR of 11 percent and 27 percent between 2013 and 2015, the performance in 2016 was disappointing – revenue grew 5 percent and profit de-grew 2 percent. Consequently, the stock has significantly underperformed the benchmark.

However, the long-term growth drivers remain in place. The company has net cash balance sheet and should generate strong free cash flow in the long term.

Growth outlook of user industries: The long overdue capex revival coupled with the ‘Make in India’ initiative launched by the government should support manufacturing activities and hence bearings consumption in the forthcoming years. On the automotive side, India not only has a vibrant and growing domestic market but is also becoming a sourcing hub for global OEMs especially for fuel efficient smaller vehicles. To put the opportunity in perspective- the size of the bearing industry is USD 1.4 billion in India compared to USD 25 billion in China.

Increase in content per vehicle: India is likely to adopt stricter emission norms and safety regulations in the automobile industry soon which will require more complex and technologically advanced bearings. The content per passenger vehicle in India is one-third of developed markets. A major driver of growth could from adoption of third-generation bearings that are priced 2X the first generation bearings as they offer additional functions (total cost of bearing currently is 1 percent-1.5 percent of the cost of the vehicle).

Capex plans for Indian Railways: India plans to upgrade railway infrastructure – dedicated freight corridors, high-speed trains and metros in big cities are some of the initiatives at various stages of implementation.  Higher load carrying capacity of wagons and increase in train speed would be drivers of demand for ‘Class K’ railway bearings (more expensive than the presently used ‘Class E’ bearings) leading to an increase in content per vehicle.  The introduction of higher-speed passenger trains and metro rail will lead to higher demand for Linke Hofmann Busch (LHB) coaches; the bearing content in these coaches is 2-3X more than in normal passenger train coaches.

Unorganised sector to lose out due to lack of technical prowess: While the OEM (original equipment manufacturer) market is served mostly by organised players, unorganised players still have presence in the after-market segment. The increase in the use of more complex and technologically superior bearings augurs well for organised player like FAG.

The stock trades at 25.5X CY18 (P) earnings and the current weakness could be a decent opportunity for the long-term investor looking for ‘safety with reasonable return’.