SGL enjoys better operating margins in comparison to other players in the industry due to better processes, captive power and low raw material risks.
Huge investments lined up by core industries like steel, cement, power etc have thrown up excellent growth opportunities for players in the industrial gears market.
Shanthi Gears Ltd (SGL) is one such company, which operates in this niche business of industrial gears. SGL enjoys better operating margins in comparison to other players in the industry due to better processes, captive power and low raw material risks.
SGL has passed the necessary tests required to become a global supplier of gears and gearboxes for Atlas Copco and is leveraging its relation with Atlas Copco to enter other manufacturing units and explore new export opportunities. It is also gearing up to capitalise on growing opportunities in the wind turbine gearbox market.
Business
Coimbatore, Tamil Nadu based SGL started out as a small gears manufacturer mainly catering to the textile industry. Currently, it manufactures gears like worm gears, helical & bevel helical gears spread across six plants in Tamil Nadu.
Gears are supplied to user industry like steel, cement, textiles , aerospace, power, natural gas transportation, material handling, construction and earth moving equipments to name a few.
A wide user industry insulates SGL from the sector specific cyclicality. SGL has an impressive client list that include Rolls Royce, Ingersoll-Rand, L&T, Atlas Copco, BHEL, BEML, SAIL and ACC. It exports to the US, UK, UAE, Germany, Canada, Malaysia, Singapore, Indonesia, Belgium, Netherlands, Taiwan and Nigeria. Exports account for 7.8% of its FY07 revenues.
The domestic gear market is Rs 1,500 crore (Rs 15 billion) compared to the global industrial gears market of Rs 200 billion, indicating the huge market potential.
The industrial gears market is dominated by organised players, with Elecon Engineering, Premium Energy Transmission and Shanthi Gears together controlling over 60% of the market.
A robust order book position of Rs 1 billion to be executed over a period of four months shows the buoyant demand in the user industry. SGL is envisaging a capex of Rs 200 million in order to cater to the market requirements.
Investment rationale
Demand for industrial gears is driven by the investment cycles of user industries. SGL has established itself as a preferred supplier with the OEM’s as supplies to OEM’s constitute over 75% of the total sales. Capacity expansion in steel, cement and power provide greater visibility.
While the steel industry is expected to attract investment worth Rs 3,00,000 crore in the next five years, the cement industry has announced a capacity expansion of over 110 MTA in the next 3-4 years.
Power industry also offers a similar opportunity as power generation is expected to increase by 60% from the present 1,35,000 MW to 2,13,600 MW.
Aerospace also provides growth opportunity to SGL as it is an exclusive supplier of engine gearboxes for light combat aircrafts and helicopters to Hindustan Aeronautical Ltd (HAL).
SGL’s exports are expected to grow to 10% from the present 7.8% by FY09. SGL is a global supplier of gears and gear boxes for Atlas Copco and it plans to leverage its relation with Atlas Copco to enter other manufacturing units of
Atlas Copco.
SGL enjoys better operating margins as compared to other players. Having its own foundry ensures quality and timely delivery. The shorter delivery periods of 3-4 months helps in passing the increase in raw material prices.
Apart from this, SGL with its 5.6 MW captive wind mill, is able to cut down on the power cost, thereby improving margins.
Value unlocking through development of an 18 acre land is on the cards. SGL is on the look out for a developer to develop this at an opportune time.
Risks
The only foreseeable risk to players in this sector is a slowdown in the user industries. While it passes on its raw material increase to its customers any fluctuation in US dollars will have a negative impact on the bottomline.
Valuation
At the current market price of Rs 86 the stock is available at 14.39x its estimated FY08 earnings and at 10.96x its estimated FY09 earnings.
We believe it is a good pick for a long term play as the investment cycle in the user industry is year to reach its peak. It is just the beginning. Investors can take a long term bet on this stock with a time horizon of one year.
Disclaimer: The author is not holding any shares in the company
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