Saturday, July 22, 2017

Business Analysis: Precision Camshafts


Background:

Precision Camshafts Ltd. (PCL) is a Solapur based manufacturer and supplier of camshafts. Camshaft is heart of an engine and significantly affects the engine’s performance. A new entrant may need 2.5 to 3 years to develop industry acceptable camshaft product.

PCL supplies over 150 varieties of camshafts for passenger vehicles, tractors, light commercial vehicles and locomotive engine applications from the manufacturing facilities in Solapur, Maharashtra. PCL has around 8-9% market share in automobile engines  of size 1-2 litres
Exports to OEMs contribute 70-75% of the revenue with Europe alone contributing ~64% of the revenue. Ford and General Motors are PCL’s largest customers contributing ~70% of the revenues. PCL mainly supports the small and medium size car segments of Ford and GM which are doing well. PCL’s client base includes OEM’s like Hyundai, Maruti Suzuki, Tata Motors, Mahindra and Mahindra among others. 


Camshaft Market:

Global market for personal vehicle camshafts is estimated to be ~100 mn units worth Rs. 7,000 cr per annum. The market for camshafts is oligopolistic in nature with only 4-5 major players. Key players are ThyssenKrupp, Federal Mogul Goetze, Linamar, and Mahle AG. 

Historically, OEMs used to cast and machine camshafts in-house. With increasing volumes and focus on lowering costs, OEMs have majorly outsourced casting. Around 33% of camshaft casting & machining is still done in-house by OEM’s. 



Mahle  and Riken Corp are the main competitors for PCL in domestic market. 

Camshaft Technologies: 

There are 3 technologies prevalent for manufacturing camshafts:

1. Chilled iron cast (40% of market)
2. Assembled camshafts (30% of market) 
3. Chilled ductile iron cast (30% of market)

PCL mainly caters to the chilled iron cast segment and has only recently forayed into the other value added technologies.

Production Capacity: 

PCL has two manufacturing facilities, an EOU (export-oriented unit) unit and a domestic unit – both situated at Solapur, Maharashtra. Management is planning to de-notify the EOU since there is no benefit accruing from EOU tag anymore.

EOU unit consists of 4 foundries and 2 machine shops. The domestic unit consists of 1 foundry and 1 machine shop. PCL’s total manufacturing capacity is 13.38 million camshaft castings from foundries and 2.22 million machined camshafts from machine shops per annum. PCL also has a 2 JVs in China - NIgnbo and Huzou for machine shop and foundry. 

PCL has raised capacity for both foundry and machine shop over the years. Foundry & machine capacity has increased annual capacity from ~2.2 mn to ~15.5 mn (excl. China capacity) camshafts since 2001.  




Offshore presence / Strategic investments: 

PCL has two joint ventures - Ningbo Shenglong PCL Camshafts Company Limited (22.5% stakes) for machining of camshafts and PCL Shenglong (Huzhou) Specialised Casting Company Limited (40% stakes)  for setting up a foundry in China.

1. PCL signed a JV Contract in 2012 with Shenglong Automotive Power Train Co. to set up machining facility for production of camshafts for FORD in China. The facility was commissioned in January 2013 with capacity to manufacture 0.6 million camshafts per annum in the first phase. The existing capacity is ~1.5 million camshafts per annum.

2. PCL signed another JV Contract in 2013, with Shenglong Automotive Power train Co. and ZMM Technologies, to set up a foundry for manufacturing 4 million camshaft castings per annum in Huzhou. The capacity will be enhanced to 8 million camshaft castings per annum in the second phase.

3. Precision Camshafts will set up its base in the Netherland as PCL (International) HOLDING.

4. PCL is also setting up a plant in Brazil for machining of camshafts to General Motors at a cost of Rs 80 crore & is expected to be operational by end of July 2018.

5. PCL has entered into an exclusive agreement with EMAG, a German machining and tooling process company, for transfer assembled camshafts technology. PCL has exclusive rights to this new technology worldwide. Assembled camshafts are mainly used by manufacturers in Europe and China and are stronger and lighter than conventional camshafts. They improve automobile fuel efficiency and reduce emission.

Future Expansion plans:

PCL’s goal is to be the world leader in camshafts manufacturing, with ~20% share in the global camshaft market for passenger cars.

PCL is in the process of setting up a new machine shop at Solapur for ductile iron camshafts with capacity of 2 million camshafts per annum for which ~INR 230 cr was raised via IPO. Management expects the contribution to top line to be ~Rs. 350 cr annual at full capacity utilisation by 2019. This expansion is backed by a new order worth Rs 550 crore from Ford Motor Company for the delivery of 8 million camshafts over the life of the program. Realization from this order is expected to be Rs. 690 per camshaft, which is more than current realisation of Rs. 535 per camshaft. 

PCL has bagged Rs 580 crore order from GM for supply of 6.0 mn camshafts over the contract period. PCL may set up a unit Brazil as part of its near-to-the-market strategy. Realization from this order is expected to be Rs. 966 per camshaft, which is more than current realisation of Rs. 535 per camshaft. 

PCL also aims to enhance capacity for assembled camshafts. Management is also planning foray into manufacturing and supply of sliding cams and cam modules as a part of expansion strategy.
PCL is also actively looking to acquire an extremely niche component manufacturer in Europe from internal accruals. Management expects the debt to come down to zero by next year.

Financials: 

PCL’s revenues have grown at CAGR of 10% over last 5 years at consolidated level. PAT growth has been higher at ~27%. The primary reason for PAT growth is the shift towards higher margin machine cast camshafts. Machine cast camshafts yield operating margins of ~35% against 18% from forged cast camshafts. The contribution of machine camshaft is around 20% to overall mix in terms of volume. This is expected to increase to 45% as per management, which should push the operating margins closure to 30%. PCL has the reputation of the highest operating margin auto-ancillary business. 


Operating profits reduced in FY2017 due to the following factors:

1. VRS compensation given to employees for Rs. 3.7 crores due to process automization
2. Erosion of investment of Rs. 1.10 crores in China subsidiary due to devaluation of Yuan for which provisioning was provided in Q4 FY 2016-17.
3. Power cost increased Rs. 1.50 cr as due to revision in tariff by MSEDCL.

The contribution to bottomline from JVs is small ~Rs. 11 cr per annum. Management expects the contribution from from JVs to increase going forward. 

Operating Parameters:

PCL has operating parameters have remained at shown improvement. Sales growth has remain muted ~10% over last 5 years. Investor should carefully watch these ratios since management expects good sales growth going forward. 



Utilization Levels:

The realisation was Rs. 531 per camshaft in FY2016 which marginally increased to Rs. 535 in FY2017. Realization for casting and machined camshafts were Rs. 346 and Rs. 1030 respectively in FY2017. 



With increase of machine contribution from 20% to 45% and assuming realisation of Rs. 350 for casting and Rs. 1000 for machined camshafts - the blended realisation is expected be Rs. 640. This would be an increase of ~20% in realisation over realisation of Rs. 535 in FY2017. 

The utilisation levels of Foundry shop was 57%, while machine shop was at ~74% in FY2017. Management expects to increase the capacity of machine shop from existing 2.2 mn to 4.2 mn which will help improve its realisation and margins. 



Raw Material Expenses:

Resin coated sand, pig iron and industrial metal scraps forms the majority of raw material for the company. These three items  forms ~80-85% of raw material expenses. Any adverse movement in prices may impact the margins of the company. 

PCL’s expenditure on raw materials consumed represented 34% of total expenses for FY2016.



Compensation:

Management has handsomely renumerated itself over last few years, especially in FY2015. PCL’s net profit increased from Rs. 29 cr to Rs. 46 cr in FY2015. 

Renumeration reduced in FY2016 due to muted performance. Some investors doesn't prefer such high management compensation. Others don’t mind management getting their due for a strong performance.




Related party transactions:

1PCL did sales of Rs. 58 cr to its JV Ningbo Shenglong PCL Camshafts in FY2016. PCL holds 22.5% stake in the JV. The receivable from Ningbo Shenlong is Rs. 11 cr as on 31st Mar 2016. Investors should understand the reason for such high receivables outstanding with the JV. 




2. Cams Technology holds ~13% shares in PCL. PCL has in-turn invested Rs. 6.2 cr in Cams Technology as preference shares. PCL also has payable of Rs. 52 lakhs to Cams Technology. The nature of contract is mentioned as Jobwork charges & purchase of goods in the annual report. The management of the company is same. It’ll be interesting to know what goods has company purchased from Cams Tech.   




Valuation: 

PCL is available below its IPO price due to subdued Q4-2017 results. Another reason for fall in stock price is 6 months delay in project for which funds were raised via public offering. 

The current valuations are still expensive at PE of ~20. 

Assuming the overall utilisation increases to 75% in FY2018 as indicated by management.

- Camshafts produced / sold: 75% of 15.5 mn = 11.625 mn
- Expected avg realisation: Rs. 640 per camshaft
- Expected Revenue: 11.625*640/10 = 744 cr - an increase of 48% over FY2017 revenue. 

The existing net margin is ~13%, lets assume this increases to 15% with increase in contribution from machined camshafts:

Net Profit = ~Rs. 111 cr or EPS of Rs. 11.7

EPS of 11.7 may bring current valuation to reasonable levels. However, PCL need to increase its revenue by ~48% for the same!

Conclusion: 


PCL is a niche auto ancillary company in a oligopolistic business with relatively high margins. Company needs to reduce its dependency on GM and Ford. PCL got headway in Japanese market with chilled ductile camshaft technology. 

The current valuations are not attractive but certain set of investors don’t mind paying up for a good business if the growth in the business is certain or close to certain. PCL may be a strong candidate to qualify the certainty test since its expansion is backed by firm orders. The black swan events like contract termination is always a possibility, however most of the contracts in auto ancillary space have a termination value to the contract to cover up the capex in case of contract termination.  

Disclaimer:

All data has been taken from public sources. I don't have any interest in PCL or related businesses. I don't own PCL shares at the time of writing this article. I may buy PCL shares in future. An investor should do her own analysis before making an investment decision. The views expressed are personal and doesn't represent that of my employer’s.

This article is just a collection of my thoughts about the company.

I am not registered with SEBI under SEBI (Research Analysts) Regulations, 2014. As per the clarifications provided by SEBI: “Any person who makes recommendation or offers an opinion concerning securities or public offers only through public media is not required to obtain registration as research analyst under RA Regulations.

Please refer to 'Disclaimer' page for further details

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