Motherson Sumi Systems: A Sucess Story

The fortunes of the automotive ancillary sector are closely linked to those of the automotive industry. The automotive sector alone contributes nearly 84.3 per cent of the total turnover (OEM) and the rest belongs to the replacement market. The automotive component industry accounts for 22 per cent of the country’s manufacturing gross domestic product (GDP). In the past month, Motherson Sumi Systems (MSSL) faced heat due to concerns over emission problems faced by its key client, Volkswagen. MSSL has almost 44 per cent exposure to Volkswagen group of companies. We at Dalal Street Investment Journal have therefore analysed MSSL with some insights from the company.

MSSL is the flagship company of the Samvardhana Motherson Group, established in 1986. The company is a joint venture between Samvardhana Motherson Group and Sumitomo Wiring Systems (Japan). It operates primarily in the automotive and non-automotive segments. MSSL's broad range of products are manufactured in more than 170 facilities and 24 design centres across the globe by over 70,000 qualified professionals. The company is currently the largest automotive ancillary in India and also ranked 55^th among the global automotive component suppliers.

·         Wiring Harnesses: MSSL has complete vertical integration for manufacturing critical wiring harness components like wires, connectors, terminals, grommets, junction boxes, relay boxes, protectors, etc. which enables it to provide quality products with reduced time to market.

·         Rearview Mirrors: Interior mirrors, blind spot detection systems, side turn indicator lamps, assist system signal lights, telescopic trailer tow mirrors.

·         Plastic Moulding: MSSL has various moulding and post-moulding technologies.

·         Tooling: MSSL has tool rooms in India and the UAE.

·         Elastomer Processing: The company has various injection moulded rubber components, liquid silicone rubber components, bonded components, and extruded rubber profiles.

·         Modules and Systems: MSSL has presence across HVAC systems / vehicle air-conditioning systems, lighting systems, air intake manifolds, pedal assemblies and shock absorbers, cabins for off-highway vehicles, and waste recycling systems.

·         IT Services: MSSL provides ERP solutions and advanced technologies pertaining to mobile, analytics and cloud.

·         Engineering and Design: Product engineering, prototypes, jigs and fixture services, value-added services.

·         Metal Working: Cutting tools, gear cutting tools and forming racks, bimetal bandsaw blades, sintered metal parts, precision machined parts, thin film coating metals.

·         Manufacturing Support: Paint coating equipment, air compressors, automotive manufacturing engineering services, and auxiliary equipment for injection moulding machines.

The US Environmental Protection Agency (EPA) said on September 18, 2015 that the Volkswagen AG used software that deceived regulators measuring toxic emissions and could face penalties of up to USD 18 billion. MSSL, being a major supplier to the Volkswagen group of companies, has felt external heat because of feelings of loss of revenue from its key client. Its share price plunged by 30.70 per cent during less than a month period on BSE and touched a 52-week low of Rs 217.3 on October 5, 2015.

Earlier MSSL was in the limelight for its considerable new client acquisition and expansion of its old and new facilities in Europe, China and USA. In recent times, MSSL commenced its facility in the US for manufacturing and supplying of mirrors, dumpers and dashboards. MSSL is setting up 18 new facilities for different car makers for various programmes. The company is scaling up its operations in a much quicker way. Interestingly, most of its manufacturing facilities have been recently commissioned and some of them are going to be commissioned in the near future i.e. in FY16. MSSL’s philosophy is to expand its geography depending upon the order book from its customers. The company’s 60 per cent capex is for increasing growth capacity for new plants and the remaining 40 per cent is for replacement of augmenting new capacity for the programme.
[PAGE BREAK]

MSSL may face lower volumes due to regulatory action against its major OEM group in USA. Further, there may be overall investigations for emission issue on other OEMs, thereby making lower their productions in the US. This very fact will definitely impact MSSL as overall lower automobile production will lower demand for its automotive parts. Further, the recently increased production capacity may remain unutilized over the next few quarters, thus putting pressure on MSSL’s balance-sheet.

However, MSSL’s management is confident about its expansion and operational strategies. The company’s CFO, G N Gauba, explained about MSSL’s strong performance during volatile market conditions after the 2009 financial crisis. Gauba said that the company has developed a habit of adapting to changing market conditions and performing during the worst scenario also. More importantly, he added, MSSL has very less exposure to diesel engine parts; rather MSSL does not sell parts related to diesel and petrol engines and its supported parts. The company deals with most of the aesthetic and functional parts. Its focus is to reduce the weight of a vehicle.

According to the company’s CFO, there will be lesser impact on car sales as newer cars which are coming up in the market are more fuel-efficient and beating emission standards. In Europe Volkswagen fulfils emission standards of the next generation. Currently Volkswagen is using technology for petrol vehicles that is already beating the emission standards.

Considering MSSL’s latest quarter result, the company’s consolidated revenue increased by 11.84 per cent to Rs 9,385 crore in Q1 FY16 compared to the same period in the previous financial year. MSSL’s EBITDA got boosted by 14.58 per cent to Rs 833 crore in Q1 FY16 compared to the same period in the previous fiscal year. The company’s EBITDA margin expanded by 22 basis points to 8.88 per cent in Q1 FY16 on a yearly basis. The company’s net profit rose by 62.34 per cent to Rs 267 crore in Q1 FY16 compared to the same period in the previous fiscal year. Its net profit margin expanded by 88 basis points to 2.84 per cent in Q1 FY16 on a yearly basis.

MSSL’s financial performance over the past year is handsome. The company’s topline witnessed 33.15 per cent CAGR over the past five years. Its EBITDA also rose by 28.27 per cent CAGR during the past five years. MSSL’s net profit has increased by 17.01 per cent CAGR in the last five fiscal years.

MSSL’s consolidated net debt increased by 17.13 per cent and stood at Rs 3,794 crore in Q1 FY16 on a quarterly basis as Samvardhana Motherson Automotive System Group BV (SMRP BV) raised 10-year bonds of Euro 100 million at 3.7 per cent per annum in June 2015. According to the company’s management, MSSL is a minority shareholder in SMRP BV and going to consolidate 100 per cent of its debt. If the minority interest of the SMRP BV is reduced, MSSL’s debt to equity ratio will go down to 1.19, which falls in a comfort zone compared to international standards.

MSSL’s CFO further explained that the debt to EBITDA ratio for the industry traditionally remains at around 2.5 to 3.5 times, internationally. Surprisingly, in MSSL’s case, the debt to EBITDA ratio is at just 1x. Gauba also stated that the maximum part of MSSL’s debt was utilized for working capital requirements and the remaining small part of debt remained repayable after seven to eight years. Up to 60 per cent of MSSL’s free cash flow was deployed back into the business for capital expenditure. Hence, we too believe that MSSL remains financially strong despite the debt burden in its books.

While explaining MSSL’s growth projection, Gauba said that MSSL always focuses on improving the ROCE. He also made it clear that the capital employed does not get impacted due to external conditions. MSSL has also been trying to reduce inventory and receivables to generate positive cash flows in the near term future. The company also has projections for ROCE of 26 per cent in the current financial year and 40 per cent in FY20. MSSL has set a goal to achieve topline of USD 18 billion in the year 2020.

When asked for impact on volumes due to the stopping of Polo car sales by Volkswagen, which has also halted diesel car sales in the US, the management of MSSL said that none of its OEMs has informed them to stop or reduce production volume till date. The company is expecting to increase sales volume in the near term as the festive season would experience Big Bang car sales.
[PAGE BREAK]

MSSL’s shareholding pattern indicates that the promoter and promoter group has 65.59 per cent, institutional holdings are to the extent of 23.79 per cent and non-institutional holdings are 10.62 per cent as of June 2015. The company’s FII holdings expanded by 31 basis points to 18.61 per cent and DII holdings contracted by 1 basis point to 5.19 per cent during Q1 FY16 compared to the last quarter.

MSSL continues to be a success story. The company has been adapting according to the changing market conditions. It has 18 new capacities lined up and is also going ahead with its organic development action plan. The company has faced some stock correction due to Volkswagen’s fiasco. However, an automobile being a necessity in today’s life, the overall automotive production is likely to remain strong despite small headwinds in the short term.

MSSL is also having a comfortable debt position and the company’s management does not see any issue on that front despite a bit of turbulence in the near future. Considering the worries over the Volkswagen scandal, MSSL’s stock price corrected considerably and its shares are available at a price earning (PE) multiple of 33x to its trailing 12-month EPS. Considering MSSL’s leadership position in the automotive ancillary market, the valuation looks attractive against the industry PE of 24.04x. We expect this correction will be an opportunity to benefit from the ever growing automobile industry.