Highlights:
- Stock down 45 percent from 52-week high amid weakness in demand
- Increasing content per vehicle due to BS VI and EVs favour the company
- Ramp-up of new plants to improve operating margin
- Business outlook is weak for short term, positive for long term
- Available at reasonable valuations
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The stock of Motherson Sumi Systems Limited (MSSL), India’s largest automotive wiring harness company and one of the largest auto ancillary players, has been witnessing sharp correction and declined 45 percent from its 52-week high level. This was due to slowdown in demand both in domestic and international markets and is evident from Q1 FY20 numbers as well.
The most obvious question then is, is this an opportunity to accumulate the auto ancillary firm?
First, let us understand why the stock is doing so badly. The company has been facing multiple headwinds in its domestic as well as international businesses.
Domestic passenger vehicle industry has been operating under a tough environment because of multiple challenges such as increase in the total cost of ownership stemming from mandatory long-term insurance and implementation of safety regulations and higher cost of retail finance. Subdued consumer sentiment has forced major original equipment manufacturers (OEMs) to cut production, impacting auto ancillary companies, including MSSL.
There has been a slowdown in the global automobile market too, affecting MSSL’s performance. The slowdown was further aggravated by the implementation of WLTP (worldwide harmonised light vehicles test procedure).
Moreover, sales of Class 8 trucks (heavy trucks with 15-tonne plus weight limit) in North America have also slowed. These trucks contribute more than 45 percent of group company PKC’s revenue. PKC Group is a subsidiary which is into wiring harness for commercial vehicles. It's focused on the truck market in China, which too is on a shaky ground.
The slowdown is clearly visible in the company’s quarterly performance. It posted a year-on-year (YoY) growth of 13.7 percent in consolidated net revenue in Q1 FY20. Earnings before interest, tax, depreciation and amortisation (EBITDA) margin contracted 210 bps due to poor operating performance of SMP (Samvardhana Motherson Peguform).
Part of Samvardhana Motherson Group (SMG), SMP is into modules and polymer component business and is a leading global supplier of door and instrument panels and bumpers.Segment-wise, standalone business revenue fell 8 percent YoY, hit by 10.2 percent decline in domestic business owing to subdued consumer sentiment. Export business, however, remained flat. EBITDA margin came off 10 bps to 17 percent.
SMP business revenue grew 35 percent in euro terms, driven by consolidation of Reydel which the group acquired in 2018. EBITDA margin took a beating of 550 bps, primarily due to startup costs of a greenfield project and Reydel consolidation.
Business revenue of SMR, a major global supplier of exterior mirrors, remained flat in euro terms and its EBITDA margin contracted by 30 bps on a YoY basis. SMR (Samvardhana Motherson Reflectec) is a member of Samvardhana Motherson Group and has a mandate to develop, produce and distribute rear vision systems for the international automotive industry.
The Finland-based PKC's business revenue jumped 8.1 percent in euro terms on the back of healthy demand coming in from North America, which got partially offset by muted demand in China. EBITDA margin expanded by 60 bps.
What could act as a key trigger for the company is the implementation of BS VI emission norms, which would lead to complexity in wiring harness and consequently, the value. This is expected to increase content per vehicle, thereby helping MSSL.
Focus on EVs (electric vehicles) across the globe will be another important growth driver, going forward. According to the company’s management, the battery-driven vehicles will need more wiring component which would increase the content per vehicle by close to 10-20 percent. And that's good news for MSSL. Other businesses related to polymer and mirror-based products are immune to the shift to EVs.
Additionally, the management has highlighted that all the key greenfield projects are now complete and in a ramp-up phase. Once the scale-up is done, operating leverage will kick in and startup costs would go away, contributing to margin expansion.
Furthermore, MSSL has a very strong order book, which gives earnings visibility. SMRPBV’s order book was at euro 18.2 billion at the end of FY19. The management has suggested that the pace of existing order is not down. However, if OEMs delay new launches, then MSSL may see weakness in new orders.
SMRPBV is a joint venture between MSSL, the flagship company of SMG, and Samvardhana Motherson International Ltd (SAMIL), the principal holding company of SMG through their subsidiaries.
Last, we believe that the slowdown is cyclical and the long-term demand scenario in India will no doubt remain intact on the back of relatively strong growth.
Debt position – A concern?What has been a matter of concern for MSSL is the rising debt level on the back of its ambitious capex plans and the quest to grow business inorganically. With the capex cycle coming to an end, the company has started paying off its debt. Net debt at the end of Q1 FY20 was Rs 8,400 crore, a little higher than Rs 8,000 crore at the end of Q4 FY19 due to currency fluctuations. The debt to equity ratio stands at around 1.05x.Valuations – at a very reasonable levelIn light of weak demand outlook, the stock has corrected quite significantly and is down 45 percent from its 52-week high. It trades at 14.4 times FY21 projected earnings. We advise investors to accumulate this business in a staggered manner.
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