Tube Investments of India: Buy

Shares of diversified engineering conglomerate Tube Investments of India (TI) appear attractive for investors with a long-term perspective. The company is well-poised to capitalise on expected growth in its core segments such as bicycles and auto-ancillaries, with dominant market position and economies of scale in most of the segments it operates in. While the current share price of Rs 154 values the company at a reasonable 14.2 times consolidated FY11 earnings, its standalone core businesses also looks attractively priced relative to peers in the auto ancillaries space. The consolidated operations include subsidiaries such as NBFC major Cholamandalam Investment and Finance Company (60 per cent stake) and its unlisted general insurance venture with Japanese bank Mitsui (74 per cent stake).

SOLID FRAME

The company's standalone business is split into three major categories: Cycles and fitness equipment, engineering division, which produces electric resistance welded (ERW) tubes and cold-rolled steel strips and the metals forming division, which produces car door frames and chains for bikes. The latter two segments largely cater to the Indian automotive segment and account for 60 per cent of the company's sales.

The Indian automotive segment has seen demand for two- and four-wheelers grow at breakneck speed, clocking growth of 26 and 30 per cent, respectively, in FY 11. This has boosted TI's sales, which during FY11 grew by around 26 per cent to around Rs 3,000 crore.

The company's ERW tubes, which are used in two- and three-wheeler chassis and suspension parts, registered 17 per cent growth in volumes in FY 11. The company is reported to control around half the market share in this.

The metal forming segment registered 16 per cent growth in volumes with the company selling over a million units of door-frames. Driven by the pricing power the company enjoys, the engineering and metal forming segments saw operating profits grow by 26 and 30 per cent.

The company's stellar run over the last two years may moderate, with SIAM (Society of Indian Automobile Manufacturers) expecting automobile sales growth to to moderate from 25 per cent, but remain at a reasonable 12 per cent in the ongoing fiscal. The difficulty faced by auto-ancillary companies in ramping-up output also bodes well for TI's metal forming and engineering businesses. TI with its slack capacity (utilisation at 62 per cent) in the ERW and cold rolling space could expand sales volume at rate exceeding that of the industry.

TI's most visible business is its bicycle segment (a third of the domestic market share) which has a strong roster of brands such as Hercules and BSA and wide distribution reach. The company is also a strong player in the premium cycle segment as it distributes international brands such as Cannondale and Bianchi among others. The company's bicycle sales volumes grew by nine per cent in FY11.

This segment also includes treadmills and other fitness equipment sold through the company's outlets. The company's product mix and distribution reach in the category enables it to compete more effectively against well-entrenched fitness equipment providers. The fitness business saw turnover grow at a rapid clip of 39 per cent during the last fiscal.

While pricing power has been hard to come-by in the ‘regular' bicycle segment, the company's position in the premium segment (which is estimated to grow at over 50 per cent) along with its wide distribution reach put the company in a better competitive position against peers such as Firefox.

INPUT COSTS

TI's single largest input by cost and volumes is steel which accounts for 65 per cent of the company's total raw material bill (and over a third of sales).

Steel is also an input for several other components purchased by the company. Indian steel production was up four per cent in the five months ended May 2011, however prices have remained tight with global and domestic steel consumers showing little appetite or ability to absorb price hikes.

Barring macroeconomic shocks, the price of steel is expected to hold steady at current levels. This augurs well for TI for whom stable input costs translates into lower levels of volatility and cost pressure.

NBFC PLAY

TI also holds a 60 per cent stake in Cholamandalam Finance and Investment. Ascribing a holding company discount of 30 per cent to Cholamandalam's current market cap, TI's stake in the NBFC company is valued at around Rs 850 crore. The company also holds 74 per cent in its unlisted general insurance venture with Japanese major Mitsui.

The two financial subsidiaries conservatively account for a third of the company's market cap. By this yardstick, the company's (residual) core business is currently valued at around Rs 2,000 crore (PE ratio of 11) which seems cheap compared with peers.

Stable financials

Overall, the company's net profit growth, excluding exceptional items, grew by 83.5 per cent in FY 11 to Rs.149 crore. During FY 08 to FY 11, the company's sales and profit grew at an impressive annualised rate of 19 and 38 per cent respectively.

The company's debt to equity ratio of 0.7 and interest cover of 6 times is comfortable. The company's operating margins have hovered between 8.5 and 12.5 per cent over the last three fiscals.

RISKS

With heavy steel capacity additions over the next three years, domestic steel producers are looking to improve margins through forays into niches such as ERW tubes and cold rolled products.

This could translate into higher competition for TI which depends on external sources for its steel and does not have the cost-advantage inherent for steel producers.

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