RAIL – Diversification and Value addition to drive growth and profitability
Rico Auto Industries Ltd (RAIL) is a key manufacturer of ferrous and aluminium casting and machining components used in the automotive space. RAIL manufactures over 400 components and is the sole supplier of these for the various models across leading automobile OEMs in the Indian and international markets. Over the past 3 years, RAIL transformed from a two-wheeler (2W) component manufacturer into a diversified casting and machining component provider across different sectors. It also underwent significant process restructuring that improved its profitability. With healthy user industry tailwinds, coupled with the rising demand for aluminium casting business and company’s strong fundamentals we believe RAIL is ready to capture the opportunity in the coming few years.
Diversifying across products, markets and clients:
RAIL is a leading player in the domestic aluminium and ferrous casting space. Over the past few years, it increased its presence in the export market and also bagged orders from industrial-equipment OEMs, thus opening up huge opportunities not only in the domestic automotive space, but also in global automotive and non-automotive spaces.
Over the past three years, RAIL focused on diversifying across segments in the automobile industry. Until 4-5 years ago, the Indian 2W industry supported little less than two third of company’s business and Hero Honda was its main customer. However, the Hero and Honda split prompted RAIL to diversify its offerings and clientele. Currently, passenger vehicle (PV) OEMs contribute 55% to RAIL’s overall revenue. Company was able to attract the attention of global OEMs like BMW and Renault through constant improvement in product quality and ability to scale up in the value chain. RAIL’s success with global OEMs can be gauged from the fact that business from BMW and Renault, which formed 3–4% of the overall revenue pie in FY13, rose to over 15% in FY17. Also, RAIL’s content share in its product category across all BMW models is close to 30%; in fact, for some BMW models, RAIL is the sole components supplier.
Also, during the past few years, the company significantly increased its exports business, from 22% of its revenue in FY13 to ~28% in FY17. Going forward, RAIL would continue its diversification into new products like aluminium and non-engine components that would place it on the right side of technology curve.
Developing capabilities in complex aluminium casting products opens up significant market opportunities for RAIL on a global scale in both the automotive and non-automotive spaces. RAIL is gradually diversifying its business mix towards non-engine components, especially in the transmission space, which now comprises ~46% of the overall revenue (~35% in FY13). Developing capability in manufacturing complex aluminium casting products has opened up avenues for RAIL in the non-engine casting market.
Strong order book growth with higher share from PV segment:
RAIL was struggling to arrest the sharp slide in revenue after the Hero Honda demerger during FY13-FY15. New orders during the period were scarce. With its new focus on value addition and diversification, RAIL’s yearly order book clocked a staggering growth rate over the past 2 years; the annual order book as of March 2018 stood at more than INR 500 cr. Further RAIL has bid for more than INR 700 cr incremental orders out of which ~INR 300 cr order is at a very advance stages of negotiation.
RAIL’s increased capability in manufacturing products for PVs and heavy equipment throws open a much bigger market. The company can now serve the domestic as well as export markets. Identifying this significant opportunity, RAIL has focused on aggressively enhancing its footprint in the global PV industry. This can be deduced from the fact that ~60% of the upcoming yearly order book of more than INR 500 cr comprises orders from PV OEMs.
Focus on cost reduction and value addition to improve fundamentals further:
During the past 2 years, RAIL has been reducing costs and improving processes, such as rationalizing labor force, enhancing automation in the production process and reducing wastages. The changes boosted the EBITDA margin, raising it from 6% in FY15 to 10.3% in FY17. Concentrating on the high-margin PV and exports businesses also pushed up margins over the past 2 years. Going forward, with increasing share of its high-margin export business and continuous efforts towards cost reduction, we expect margins to improve further by 2-3%.
RAIL anticipates incurring a limited capex of INR 80-100 cr in FY18 and INR 50-60 cr each for subsequent two years i.e. FY19-FY20E. This capex would mainly fund new foundry and machine shop in Pathredi, new machine shop at Bawal and new aluminium casting and machine shop at Chennai, while some portion of capex will also go in automation of the existing facility and process improvements. The healthy increase in cash accruals and limited capex from current fiscal would bring down RAIL’s debt levels and thereby boost its ROCE.
Last Quarter Performance and Valuations:
RAIL’s Q3FY18 results proved it the best quarter of this fiscal; the top line grew ~21% YoY while the EBITDA margin improved by 80 bps to 10.2% YoY. The benefit of the higher EBITDA percolated to the bottom line too, as the PAT margin rose 70 bps to 4.4% during the period. Growth in the top line indicates some execution of the expanding order book position, an encouraging scenario. Also, we believe RAIL’s efforts in cutting costs and improving efficiencies have started showing results, especially seeing the improved profitability in Q3FY18.
RAIL anticipates healthy growth in earnings in the next 2–3 years, driven by improvement in both top line and margins. This growth is expected to push up valuation from these current levels as well as in the near-to-medium term. We estimate EPS to grow by a 30% CAGR during FY17–FY20E. The stock currently trades at decent valuations of 19x and 15x of the FY18E and FY19E earnings, respectively.