Tube Investments of India: Buy

Tube Investments of India (Tube Investments), a part of the Murugappa Group, has seen its core businesses — engineering, value-added metal products and cycles — come under pressure over the last year and a half. This has been mainly due to the slowdown in the automobile sector — the company’s major customer base. The stock has reacted adversely, losing more than 15 per cent over the last one year.

But this presents a good opportunity for investors with a long-term perspective. One, the company’s leadership position in most of the segments it operates in, places it in an advantage to benefit from a turnaround in the auto sector’s fortunes, when it happens.

Two, thanks to its financial services business, which has been doing well, the company has been able to weather tough times. The company’s consolidated profit has risen even as its standalone profit has suffered. At the current market price of Rs 165, the stock trades at a comfortable 8.9 times the FY15 core business estimated earnings, which is at the lower end of its valuation band (nine-12 times) of the last five years. This is after adjusting the stock price for the value of its investments in other businesses, which add Rs 110 a share to the stock value.

Unlocking value in these investments can provide significant upside to the stock in the long run.

In 2012-13, two-wheeler sales in the country slowed to 2.9 per cent and that of passenger cars fell 6.7 per cent.

This was reflected in Tube Investments’ sales volume of engineering products — tubes and strips — which were down 2 per cent. Lacklustre demand also prevented the company from passing on cost increases to customers.

The situation was similar in the company’s value-added metal products segment — which includes chains, car doorframes, auto components and rail wagon sections. The automotive chains business stagnated during 2012-13.

A slowdown in the overseas markets resulted in lower sales volumes of industrial chains used in the manufacturing, infrastructure and agriculture sectors. Fewer orders from car makers also took a toll on doorframe sales volumes (down 12 per cent). A delay in order release from the Railways affected the sales of the rail wagons section too.

However, the silver lining was the 30 per cent volume growth in auto components. This was due to the company’s participation in import substitution programmes and getting itself listed as a second supplier for products of car makers.

While pressure on the auto industry has continued in 2013-14, there has been some respite. The pick-up in two-wheeler sales (3.5 per cent growth in the first half) has resulted in a slight improvement in demand for some products.

Sales volumes of tubes were largely flat in the quarter ended September, while those of strips and auto components grew 5 per cent. Volumes of automotive chains also grew 19 per cent.

The growth in two-wheeler sales should hold the company in good stead. Weak car sales remain a drag in the near term. But when the cycle turns, Tube Investments will be poised to benefit from its strong product portfolio.

Under its other core business, cycles, Tube Investments markets the BSA and Hercules brand of cycles. It has around a third of the market share. Weak rural demand (for standard cycles) and increase in statutory levies and higher cost of imported inputs (for special cycles), saw the segment’s volumes fall 9 per cent in 2012-13. Better economic conditions should see demand for cycles pick up. Also, with the company having shifted to complete indigenisation, the business may see better days ahead.

As part of its strategy of diversifying into the non-auto sector, Tube Investments acquired (70 per cent stake) Shanthi Gears, a manufacturer of industrial gears and gear boxes, in November 2012.

During 2012-13, the company reported 45 per cent lower profit on account of lower demand from infrastructure industries and higher input costs.

But the half year ended September 2013 saw net profit grow 8.5 per cent, helped by better order flows. Shanthi Gears stands to benefit once the core sector industry growth picks up.

Even as its core business was struggling, Tube Investments’ holdings in the financial services space came to its rescue. Net profit from the company’s standalone operations declined 42 per cent during 2012-13. Despite improvement in some segments, standalone profit in the first half of 2013-14 fell 37 per cent.

In contrast, the strong showing by the financial services businesses — Cholamandalam Investment and Finance Company and Cholamandalam MS General Insurance Company — resulted in Tube Investments’ consolidated profit growing 7 per cent in FY13 and 4 per cent in the first half of 2013-14.

The prospects for the financial services business seem good. Among the positives are the easing of norms in the motor insurance space. Also, the company’s insurance venture may benefit from the hike in FDI limit from 26 to 49 per cent under the automatic route.

While the company’s standalone debt-equity ratio, as on September 2013, is at a reasonable 0.9 times, its interest coverage ratio at just 2.7 times is low. A possible easing of interest rates in the coming year should provide a respite.

With most steel makers having hiked prices recently, costs are expected to rise. This assumes importance in the light of the fact that steel accounts for more than 60 per cent of the company’s raw material costs.

This could impact margins in the near term, until a demand pick up enables pass through of costs.

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