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Edelweiss Securities Limited

SKF India’s (SKF) 2.5% YoY revenue growth in Q1FY18 came 7% lower than estimate due to pressure in the automotive replacement segment, but in line with peer FAG. However, the company outperformed in auto OEM sales led by new product development. EBITDA jumped 11.9% YoY, in line with estimate, on account of robust 372bps gross margin jump with improved sales mix and 120bps EBITDA margin expansion. We believe, SKF’s position will be fortified with: (a) new product development; (b) moving up the value chain (generation 3 bearings in 4W & pinion bearings in CV); and (c) demand improvement in auto and industrial segments. Hence, we estimate PAT CAGR of 19% (CY11-15 at -0.5%) and 557bps RoCE expansion to 27% over FY17-19. We perceive the doubling of capex over the next 3 years to INR1.0bn on an average (versus average of INR0.5bn in past 5 years) in the listed entity (SKF India) as a key positive. Consequently, we revise up our target multiple to 28x (from 25x), in line with peer FAG, and maintain ‘BUY’ with a target price of INR1,876. Key takeaways: Auto OE sales outperform industry Revenue grew 2.5% YoY led by spurt in auto OE, while replacement declined 12%. Strong sales in PVs (up 27%), CVs (up 12% versus 45% industry decline), 12% growth in 2W and 15% in tractors were driven by better solutions to OEMs versus peers. Exports catapulted 49% YoY. Within the industrial segment, while railways grew 12% YoY & off highway 8%, renewable energy declined double digit. Overall industrial sales along with auto replacement felt the GST heat, leading to sales dip. Going forward, we expect traction in automotive to sustain led by supplies beginning from generation 3 wheel bearings plant in PVs (commence from July; secured Maruti & Tata Motors orders). We envisage huge opportunity for the industrial segment led by freight within railways, which contributes <10% to SKF’s railway sales. Outlook and valuations: Healthy prospects; maintain ‘BUY’ We maintain ‘BUY’ led by SKF’s strong position fortified by new product development and moving up the value chain, with demand improvement in auto and industrial, is likely to lead to PAT CAGR of 19% (CY11-15 earnings at -0.5%) over FY17-19E. We revise up our target multiple to 28x (from 25x), in line with peer FAG, and maintain ‘BUY’. At CMP, the stock is trading at 28.0x and 23.1x FY18E and FY19E EPS, respectively.

RESULT UPDATE

SKF INDIA Moving up the value chain

EDELWEISS RATINGS

Absolute Rating BUY Investment Characteristics Growth

MARKET DATA (R: SKFB.BO, B: SKF IN)

CMP : INR 1,550

Target Price : INR 1,876 52-week range (INR) : 1,749 / 1,191

Share in issue (mn) : 52.7 M cap (INR bn/USD mn) : 82 / 1,275

Avg. Daily Vol. BSE/NSE (‘000) : 22.4

SHARE HOLDING PATTERN (%)

Current Q4FY17 Q3FY17 Promoters *

52.3 53.6 53.6 MF's, FI's & BKs 21.2 20.8 20.0

FII's 12.0 11.9 12.6 Others 14.5 13.7 13.9 * Promoters pledged shares (% of share in issue)

: NIL

PRICE PERFORMANCE (%)

BSE Midcap

Index Stock Stock over

Index

1 month 5.6 (1.0) (6.6) 3 months 4.5 (9.2) (13.6)

12 months 21.6 11.7 (9.9)

Shradha Sheth +91 22 6623 3308 shradha.sheth @ed elweissfin.com Sanyam Jain +91 22 4040 7412 sanyam.jain @ed elweissfin.com

India Equity Research| Bearing

August 1, 2017

Financials (INR mn)Year to March Q1FY18 Q1FY17 % change Q4FY17 % change FY17 FY18E FY19ENet revenues 6,665 6,512 2.4 6,537 1.9 26,314 28,821 33,528EBITDA 936 836 11.9 795 17.7 3,362 3,942 4,764Adjusted Profit 643 604 6.4 579 11.0 2,439 2,842 3,439Adj. EPS (INR) 12.5 11.5 9.3 11.0 14.0 46.3 55.4 67.0Diluted P/E (x) 33.5 28.0 23.1EV/EBITDA (x) 22.2 17.9 14.5ROAE (%) 14.0 15.7 17.9

Bearing

2 Edelweiss Securities Limited

Q1FY18 conference call: Key highlights • Sales growth led by auto OE outperformance: SKF reported 2.5% YoY growth in sales

led by robust spurt in 4W OEM, CVs and exports. The company has been gaining market share across segments.

• Segment-wise contribution and mix: Overall, automotive contributed 50% (exports 10%) to sales. Within 40% of sales from domestic automotive, contribution of replacement sales fell from 13-14% to 11% due to GST impact towards June end. Traded and manufactured revenues accounted for 41% and 59% of overall revenue (45% & 55% in Q1FY17 and 44% & 56% in last full year), respectively.

• Automotives—4W, CVs, exports strong show: Segment-wise, 4W jumped 27%, trucks grew 12% YoY (versus industry decline of 45%) led by supplies of pinion bearings, tractors grew 15% YoY and 2W grew 12%. While auto replacement market fell 12% YoY affected by GST, according to management, this segment has recovered only in the last 10 days of July, feeling the heat for 40 days from June end. Exports, which are primarily from automotive segment, did well during the quarter growing 49% for Q1FY18 and 14% for FY17.

• Industrial, a mixed bag: The industrial segment posted a mixed show led by decline in replacement sales (23% of sales within 50% of industrial sales) led by GST slowdown and double digit decline in renewable energy (sales contribution fell from 6% to 4% of sales) within industrial OEMs. Within industrials, sales slowed to 12% and 8% YoY in railways and off highways, respectively.

• Railways–Tenders in freight delayed, but strong opportunity ahead: Railways contributes ~7-9% to total sales. Tenders in freight were delayed. However, management perceives huge opportunity going forward, which is less than 10% if its sales.

• Generation 3 bearings supply to commence from July: The generation 3 bearings line has been commissioned. Management expects deliveries to begin from July 1. SKF has secured orders from Maruti and Tata Motors for generation 3 bearings.

• GST impact: According to management, GST rollout led to slowdown in the replacement segment due to destocking by distributors from June end and had an impact for 30-40 days on its sales till mid-July. However, over the long term, it expects GST to facilitate pan-India presence versus regional supplies for bearings companies.

• Capex-doubling in listed entity: Capacity utilisation is running at 90% in the automotive segment with mere 10% headroom. SKF has laid out a significant change in capex and will be doubling capital layout to INR1bn per year, versus an average of INR0.5bn in past 3 years, on capacity expansion and new product lines in the listed entity. Higher capex will be on account of capacity expansion in existing plants for developing some new and old products.

• Traction ahead: Going ahead, management highlighted traction led by Hub 3 bearings in PV, pinion bearings in CVs, enhanced sensorisation for 2W for value-added sales, growth in transmission, bearings for steel mills for caster rolling mills, bearings for freight TBU and material handing to start picking up.

• SKF’s India Distribution Centre (IDC): According to management, SKF’s IDC will reduce the cycle time for customers dramatically and lead to savings with shipping versus earlier air freight. Further, this will help rationalise inventory and lower costs.

SKF India

3 Edelweiss Securities Limited

Table 1: Segment-wise growth in Q1FY18

Source: Company

Segmentwise growth (%)AutomotivePV-OEM 27.0 Trucks-OEM 12.0 Tractors-OEM 15.0 2W-OEM 12.0 Automotive-Replacement (12.0) Exports 49.0 IndustrialRailway 12.0 Offhighway 8.0

Bearing

4 Edelweiss Securities Limited

Financial snapshot (INR mn) Year to March Q1FY18 Q1FY17 % change Q4FY17 % change FY17 FY18E FY19E Net revenues 6,665 6,512 2.4 6,537 1.9 26,315 28,821 33,528 Raw material 3,958 4,109 (3.7) 4,011 (1.3) 16,252 17,469 20,228 Staff costs 581 548 6.1 551 5.4 2,222 2,415 2,790 Other expenses 1,190 1,019 16.8 1,180 0.8 4,478 4,996 5,746 Total expenditure 5,729 5,676 0.9 5,742 (0.2) 22,953 24,879 28,765 EBITDA 936 836 11.9 795 17.7 3,362 3,942 4,764 Depreciation 115 123 (5.9) 115 0.0 479 567 640 EBIT 820 714 15.0 680 20.7 2,884 3,374 4,123 Other income 171 219 (21.7) 196 (12.7) 873 918 1,071 Interest Add: Prior period items Add: Exceptional items Profit before tax 992 932 6.4 876 13.2 3,756 4,292 5,195 Provision for taxes 349 328 6.3 297 17.5 1,317 1,451 1,756 Minority interest Associate profit share Profit- Discontinued Ops Reported net profit 643 604 6.4 579 11.0 2,439 2,842 3,439 Adjusted Profit 643 604 6.4 579 11.0 2,439 2,842 3,439 Diluted shares (mn) 51 53 53 53 51 51 Adjusted Diluted EPS 12.5 11.5 9.3 11.0 14.0 46.3 55.4 67.0 Diluted P/E (x) - - - 33.5 28.0 23.1 EV/EBITDA (x) - - - 22.2 17.9 14.5 ROAE (%) - - - 14.0 15.7 17.9 As % of net revenues 1 1 1 1 1 1 Raw material 59.4 63.1 61.4 61.8 60.6 60.3 Employee cost 8.7 8.4 8.4 8.4 8.4 8.3 Other expenses 17.9 15.6 18.1 17.0 17.3 17.1 EBITDA 14.0 12.8 12.2 12.8 13.7 14.2 Reported net profit 9.6 9.3 8.9 9.3 9.9 10.3

SKF India

5 Edelweiss Securities Limited

Company Description SKF is part of Sweden’s AB SKF Group, a leading global supplier of bearings with revenue of ~EUR7bn (as of CY12). SKF, Sweden, holds 53% stake in the company. In India, SKF is the largest player with market share of ~28% and ~45% in overall bearings industry and ball bearings segment, respectively. SKF’s exposure to the auto segment is ~45% and industrial bearings contribute to ~50% to sales. ~8% of sales are catered to by exports (mainly automotives). While the company manufactures automotive bearings and part of industrial bearings (~15%), balance 85% of industrial bearings are imported. As a result, traded (industrial) goods constitute 41% of overall revenue, which are majorly imported from overseas SKF Group companies. Investment Theme SKF is expected to deliver strong earnings growth of 17% in FY18E alongwith strong RoCE of 23.3%. SKF’s position will be fortified with new product development, movement up the value chain (generation 3 bearings in 4W & pinion bearings in CV) and demand improvement in auto and industrial segments. SKF has laid out a significant change in capex and will be doubling capital layout to INR1bn per year, versus an average of INR0.5bn in past 3 years, on capacity expansion and new product lines in the listed entity. EBITDA margin of the company is likely to expand owing to better product mix (new products with higher profitability) and higher operating leverage led by increasing capacity utilisation. Key Risks Delay in recovery in key segments can impact our sales growth projections since 2W constitute ~55% of SKF’s auto OEM revenues and 4W and CV the balance. Forex fluctuation

SKF buys 52% of traded goods from group company, SKF GmbH, Germany. As a result, INR depreciation against EUR may negatively impact margin on these EUR-denominated imports. Overall imports constitute 32% of net sales. This also includes currency headwinds on ~27% of raw material costs (~7% of net sales) which are imported. Netting exports, which are 7% of sales, SKF’s net imports are at 25% of sales.

Royalty rate increase

Currently, royalty, trademark and service fees as a percentage of overall sales stand at 2.7%. Any further increase in the same could pose a risk. Delay in ramping up Ahmadabad facility

Execution delay in ramping up SKF Technologies’ Ahmadabad plant could impact our growth as well as earnings estimates.

Bearing

6 Edelweiss Securities Limited

Financial Statements

Income statement (INR mn)

Year to March FY16 FY17 FY18E FY19E Net revenue 29,973 26,314 28,821 33,528 Materials costs 18,717 16,252 17,469 20,228 Gross profit 11,255 10,062 11,353 13,300 Employee costs 2,541 2,222 2,415 2,790 Other Expenses 5,100 4,478 4,996 5,746 Operating expenses 7,640 6,700 7,411 8,536 Total operating expenses 26,358 22,953 24,879 28,765 EBITDA 3,615 3,362 3,942 4,764 Depreciation 684 479 567 640 EBIT 2,931 2,883 3,374 4,123 Add: Other income 1,013.8 873.3 917.96 1,071.49 Profit Before Tax 3,945 3,756 4,292 5,195 Less: Provision for Tax 1,386 1,317 1,451 1,756 Reported Profit 2,559 2,439 2,842 3,439 Adjusted Profit 2,559 2,439 2,842 3,439 Shares o /s (mn) 53 53 51 51 Adjusted Basic EPS 48.5 46.3 55.4 67.0 Diluted shares o/s (mn) 53 53 51 51 Adjusted Diluted EPS 48.5 46.3 55.4 67.0 Adjusted Cash EPS 60.6 55.0 66.4 79.5 Dividend per share (DPS) 15.0 10.0 14.0 18.0 Dividend Payout Ratio(%) 37.2 25.3 29.6 31.4

Common size metrics Year to March FY16 FY17 FY18E FY19E Operating expenses 25.5 25.5 25.7 25.5 Gross margin 37.6 38.2 39.4 39.7 EBITDA margins 12.1 12.8 13.7 14.2 EBIT margins 9.8 11.0 11.7 12.3 Net Profit margins 8.5 9.3 9.9 10.3

Growth ratios (%)

Year to March FY16 FY17 FY18E FY19E Revenues 24.2 (12.2) 9.5 16.3 EBITDA 28.6 (7.0) 17.3 20.9 PBT 28.8 (4.8) 14.3 21.0 Adjusted Profit 26.2 (4.7) 16.5 21.0 EPS 26.2 (4.7) 19.7 21.0

Key Assumptions

Year to March FY16 FY17 FY18E FY19E Macro GDP(Y-o-Y %) 7.2 6.5 7.1 7.7 Inflation (Avg) 4.9 4.5 4.0 4.5 Repo rate (exit rate) 6.8 6.3 5.8 5.8 USD/INR (Avg) 65.0 67.5 66.0 66.0 Sector Auto OEM(2W) vol. growth 2.3 5.9 10.0 10.0 Auto OEM PV vol. growth 6.0 11.0 9.0 10.0 Auto CV ind. vol. growth 30.0 1.7 8.0 9.0 Company Auto 2W OEM vol. growth 17.0 (15.0) 12.0 14.0 Auto PV OEM vol. growth 15.0 (6.9) 25.0 20.0 Auto CV OEM vol. growth 30.0 2.5 15.0 18.0 Auto aftrmkt sale growth 5.0 10.0 10.0 8.0 Industrial sales growth 16.0 70.0 10.0 20.0 Export revenue growth 5.0 (14.0) 10.0 10.0 Industrial sales growth 28.1 (11.5) 5.9 15.3 Manufactured 57.7 57.4 58.5 58.9 Traded 42.3 42.6 41.5 41.1 Mfg. gross margin (%) 54.6 56.6 56.6 56.0 Traded gross margin (%) 12.9 13.4 13.4 13.4 Raw Material (% net rev) 62.4 61.8 60.6 60.7 Employee (% of net rev) 8.5 8.4 8.4 8.3 Admin exp(as % of rev) 17.0 17.0 17.3 17.1

SKF India

7 Edelweiss Securities Limited

Peer comparison valuation Market cap Diluted P/E (X) EV / EBITDA (X) ROAE (%) Name (USD mn) FY18E FY19E FY18E FY19E FY18E FY19E SKF India 1,275 28.0 23.1 17.9 14.5 15.7 17.9 Schaeffler India Limited - - - (2.4) (2.6) 15.7 16.4 Median - 14.0 11.6 7.7 6.0 15.7 17.2 AVERAGE - 14.0 11.6 7.7 6.0 15.7 17.2

Source: Edelweiss research

Cash flow metrics

Year to March FY16 FY17 FY18E FY19E Operating cash flow 262 1,150 4,922 2,381 Investing cash flow (1,739) 1,471 (998) (1,000) Financing cash flow 491 (1,262) (2,015) (10) Net cash Flow (985) 1,359 1,910 1,372 Capex (304) (405) (998) (1,000) Dividend paid (159) (952) (841) (1,081)

Profitability and efficiency ratios

Year to March FY16 FY17 FY18E FY19E ROAE (%) 16.6 14.0 15.7 17.9 ROACE (%) 25.1 21.0 23.3 26.6 ROA 16.0 13.4 15.2 17.3 Inventory Days 61 84 77 62 Debtors Days 52 69 57 45 Payable Days 61 67 65 61 Cash Conversion Cycle 52 87 69 46 Current Ratio 4.6 4.6 4.4 4.4 Debt/EBITDA (x) 0.2 0.1 0.1 0.1 Debt/Equity (x) - - - - Adjusted Debt/Equity - - - - LT debt /Cap empl. (%) 3.7 1.8 1.8 1.6 Debt / Cap employed (%) 26.0 24.7 25.5 25.0

Operating ratios Year to March FY16 FY17 FY18E FY19E Total Asset Turnover 1.9 1.4 1.5 1.7 Fixed Asset Turnover 9.0 8.5 8.8 8.9 Equity Turnover 1.9 1.5 1.6 1.7

Valuation parameters Year to March FY16 FY17 FY18E FY19E Adj. Diluted EPS (INR) 48.5 46.3 55.4 67.0 Y-o-Y growth (%) 26.2 (4.7) 19.7 21.0 Adjusted Cash EPS (INR) 60.6 55.0 66.4 79.5 Diluted P/E (x) 31.9 33.5 28.0 23.1 P/B (x) 4.9 4.5 4.4 3.9 EV / Sales (x) 2.5 2.8 2.4 2.1 EV / EBITDA (x) 20.9 22.2 17.9 14.5 Dividend Yield (%) 1.0 0.6 0.9 1.2

Balance sheet (INR mn)

As on 31st March FY16 FY17 FY18E FY19E Share capital 527 527 513 513 Reserves & Surplus 16,119 17,585 17,508 19,866 Shareholders' funds 16,646 18,112 18,021 20,379 Short term borrowings 650 340 340 340 Total Borrowings 650 340 340 340 Long Term Liabilities 275 293 293 293 Sources of funds 17,571 18,746 18,654 21,012 Gross Block 3,973 4,254 5,404 6,404 Accumulated depreciation 806 1,266 1,834 2,474 Net Block 3,168 2,987 3,570 3,929 Capital work in progress 119 352 200 200 Intangible Assets - 2 2 2 Total Fixed Assets 3,287 3,341 3,771 4,131 Cash and Equivalents 6,973 7,403 9,428 10,800 Inventories 3,350 4,166 3,207 3,713 Sundry Debtors 4,829 5,143 3,790 4,409 Loans & Advances 2,333 2,036 2,036 2,036 Other Current Assets 627 836 836 836 Current Assets (ex cash) 11,139 12,181 9,869 10,994 Trade payable 2,929 3,040 3,159 3,658 Other Current Liab 986 1,255 1,255 1,255 Total Current Liab 3,915 4,295 4,413 4,912 Net Curr Assets-ex cash 7,224 7,887 5,455 6,082 Uses of funds 17,571 18,746 18,654 21,012 BVPS (INR) 315.7 343.5 351.0 397.0

Free cash flow (INR mn)

Year to March FY16 FY17 FY18E FY19E Reported Profit 2,559 2,439 2,842 3,439 Add: Depreciation 684 479 567 640 Others (832) (720) (918) (1,071) Less: Changes in WC 2,150 1,048 (2,431) 627 Operating cash flow 262 1,150 4,922 2,381 Less: Capex 304 405 998 1,000 Free Cash Flow (42) 745 3,925 1,381

Bearing

8 Edelweiss Securities Limited

Holding Top -10Perc. Holding Perc. Holding

Franklin Resources 7.21 SBI Funds Management 2.01HDFC Asset Management 5.17 New India Assurance 1.10Templeton Asset Management 5.12 Commonwealth Bank of Australia 1.07Pinebridge Investment 4.30 Royal Bank of Scotland 0.99UTI AMC 2.38 Reliance Capital 0.75

*as per last available data

Insider Trades Reporting Data Acquired / Seller B/S Qty Traded No Data Available

*as per last available data

Bulk Deals Data Acquired / Seller B/S Qty Traded Price

No Data Available

*as per last available data

Additional Data

Directors Dat a Rakesh Makhija Chairman Shishir Joshipura Managing Director Prakash M. Telang Director Prasad R. Menon Director Hema A. Hattangady Director Bernd Stephan Director

Auditors - Price Waterhouse & Co.

*as per last available data

SKF India

9 Edelweiss Securities Limited

`

Edelweiss Securities Limited, Edelweiss House, off C.S.T. Road, Kalina , Mumbai – 400 098. Board: (91-22) 4009 4400, Email: research@edelweissfin.com

Aditya Narain

Head of Research

aditya.narain@edelweissfin.com

Coverage group(s) of stocks by primary analyst(s): Bearing Schaeffler India Limited, SKF India

Distribution of Ratings / Market Cap

Edelweiss Research Coverage Universe

Rating Distribution* 161 67 11 240 * 1stocks under review

Market Cap (INR) 156 62 11

> 50bn Between 10bn and 50 bn < 10bn

Date Company Title Price (INR) Recos

Buy Hold Reduce Total

Recent Research

30-May-17 SKF India Sales trajectory intact; strong capex ahead; Result Update

1,565 Buy

24-Apr-17 Fag Bearings

Healthy sales growth coupled with margin spurt; Result Update

4,913 Buy

01-Mar-17 Fag Bearings

Aftermarket drags sales; uptick in offing;

4,154 Buy

Rating Interpretation

Buy appreciate more than 15% over a 12-month period

Hold appreciate up to 15% over a 12-month period

Reduce depreciate more than 5% over a 12-month period

Rating Expected to

One year price chart

1,000

1,200

1,400

1,600

1,800

2,000

Jul-1

6

Aug-

16

Sep-

16

Oct

-16

Oct

-16

Nov-

16

Dec-

16

Dec-

16

Jan-

17

Feb-

17

Feb-

17

Mar

-17

Apr-

17

Apr-

17

May

-17

Jun-

17

Jul-1

7

Jul-1

7

(INR)

SKF India

Bearing

10 Edelweiss Securities Limited

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SKF India

11 Edelweiss Securities Limited

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