Automotive Axles: Well-assembled - Buy

The market correction so far in 2018 has beaten down several mid- and small-cap stocks sharply. The Automotive Axles stock is one such. Even as prospects remain strong, the stock has corrected about 40 per cent from its one-year high of ₹1,826 touched in end-January this year. Thanks to the fall in price as well as the strong earnings growth recorded by the company over the last few quarters, the stock’s valuation (price-to-earnings ratio) has come down to a more attractive level right now.

Automotive Axles now trades at about 16 times its trailing 12-month earnings, down from 35 times in the beginning of 2018. Investors with a one- to two-year perspective can buy the stock. But given its small-cap status (market capitalisation of about ₹1,600 crore), it is advisable to take limited exposures.

Ride on CV sales

Automotive Axles makes drive and non-drive axles, front steer axles, drum and disc brakes for commercial vehicles (CVs). Axles are used to transmit the driving torque to the wheel and help maintain the position of the wheels. Axles also bear the weight of the vehicle as well as the cargo.

The company was established in 1981 as a joint venture between the Kalyani Group (whose flagship is Bharat Forge) and Meritor Inc, US. Its client base includes companies such as Ashok Leyland, Daimler India, Mahindra & Mahindra, Tata Motors, Volvo - Eicher and Asia Motor Works.

After derailing due to demonetisation, BS-IV and GST transition, CV sales are back in the fast lane. For the year-ended March 2018, sales volumes of medium, heavy, and light vehicles grew at 20 per cent. The run rate has improved this year, with CVs showing a strong 38 per cent growth in sales volumes in the first half of this fiscal.

Although private sector capital spends have somewhat subdued, government investments on housing, road building and allied infrastructure activities have had a spill-over effect on truck sales in this period. Besides, cargo offerings from the agricultural space have also been buoyant. Thanks to strong demand for goods carriage, freight rates have been on the rise this year. Fleet owners have also been able to pass on increases in fuel and other costs without impacting demand.

According to data from the Indian Foundation of Transport Research and Training (IFTRT), truck rentals on trunk routes have increased anywhere between ₹13,300 and ₹22,900 since January this year. The rise in rentals have outpaced the increase in fuel costs by ₹3,600-₹8,600 during this period for these routes.

Continued infrastructure spends along with the record output in agriculture production expected this year, are expected to keep demand for freight carriage ticking. The steady shift in consumer preference for higher tonnage multi-axle trucks also bodes well for the company. From about 40-43 per cent in 2015-16 and 2016-17, the share of higher tonnage trucks (those exceeding 25 tonnes) in the total heavy truck sales has moved up sharply to over 50 per cent in 2017-18.

The new axle norms put out by the government, permitting higher loads for new and existing vehicles, are not expected to dampen demand for new vehicles sharply. To economise on running costs, especially when fuel prices inch up, overloading in the haulage and tipper segment is already rampant in several pockets in the country. Besides, given that permissible load limits in other countries have been higher than ours, trailer trucks used to carrying export-import containers have been transporting more than permissible loads already.

Besides, with the Supreme Court ruling that only BS VI vehicles should be sold from April 2020, pre-buying of cheaper BS IV vehicles will keep up the momentum in CV sales from the second half of next fiscal. This apart, a scrappage scheme for commercial vehicles, that is over 20 years old, is in the works. Its implementation will also aid new vehicle sales in the near to medium term. Automotive Axles will gain from all these tailwinds.

Value additions

Apart from manufacturing axles, the company also produces gears, axle housings and assemblies and drum and air disc brake assemblies. Axle assemblies, being a step up in the value chain, bring higher realisations. The company is now the largest maker of rear drive axle assemblies in the country. It has diversified into the manufacture of components for air actuated S-CAM brakes too.

To further increase its value proposition, the company has expanded its product portfolio to include off-highway axles and suspension systems. It is looking to introduce integrated system combining suspension, axles and brakes. With the auto component industry being highly fragmented, an improvement in its product portfolio would help enhance the bargaining power and bring higher margins.

Strong financials

In line with the pick-up in CV sales, the company has recorded strong growth both in the year ended March 2018 as well as in the first quarter of this year. For the three months ended June 2018, net sales moved up by 62 per cent over the June 2017 quarter to ₹474 crore. Net profits more than doubled to ₹29 crore as against ₹13 crore in the same period last year. Operating margins expanded by almost two percentage points to 11.8 per cent for the June 2018 quarter.

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