Setco Automotive Ltd (SAL) who is the market leader in manufacture of MHCV
clutches (about 65% market share) is likely to reap rich benefits of upcycle in both
the OEM (30% of sales) as well as replacement markets (70% sales).
Direct beneficiary of MHCV upcycle
After two consecutive years (FY2013 and FY2014) of a steep double-digit decline,
the MHCV segment is on course for a cyclical upturn. The uptrend in the MHCV
space is clearly visible with the segment reporting a growth of 13% in YTD
FY2015 (April 2014 to January 2015) period. We believe the MHCV segment is
well poised to maintain the double-digit growth over the FY2015-FY2017 period
on account of a) Better economic outlook which is likely to generate freight
revenues, b) Firming of freight rates and improvement in fleet operators’
profitability, c) Expected reduction in interest rates which would revive the
investment cycle, and d) Budgetary focus to increase road network which would
enhance usage of commercial vehicle (CV)s. Setco Automotive (SAL) would be the
direct beneficiary of uptick in MHCV demand as it commands 85% market share in
the MHCV OEM space, drawing about 30% of its total revenues from the space.
Aftermarket and export focus to be growth drivers
Improved fleet utilization due to higher freight availability is likely to propel the
replacement demand for clutches. SAL previously used to cater to replacement
market only through the OEM authorized distribution channels. However, SAL is
now teaming up with multi branded distributors (network partners other than the
OEM authorised outlets) to independently tap the replacement market. These
distribution channels provide huge opportunity as SAL can effectively tap the third
and fourth replacement cycle for clutches which are typically done outside the
OEM authorized dealerships. We expect SAL to gain further market share in the
replacement space and expect the segment to post a CAGR of ~18% over the
next two years. Also, SAL is aggressively tapping the export markets in America
and Europe. It is into negotiations with overseas OEMs to commence supplies to their
authorized aftermarket channels. SAL is already supplying to these OEMs in India and is
now aiming to initiate supplies to their overseas arms. We expect exports (contributing
about 9% of the revenues) to register a healthy 25% CAGR over the FY2015-FY2017.
Outlook and valuation: SAL is likely to clock a 24% CAGR in revenues over the
next two years given the improvement in the MHCV OEM space and market share
gains in the replacement segment. Also, SAL’s operating margin is also expected
to improve by 200bp over the next two years, given the operating leverage,
enhanced capacity utilization and procurement of captive castings. Given the healthy
top-line growth and margin improvement, SAL is expected to post a robust 49%
CAGR in earnings. SAL’s return ratios are also likely to expand due to improved
profitability and moderate capex. We initiate coverage on the stock with a Buy
recommendation and target price of `286 (based on 15x FY2017E earnings).

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