Should you subscribe to Sona BLW Precision IPO?

Does a decent business at a lofty valuation make for a good investment? This is the dilemma that investors face in the IPO of Sona BLW Precision Forgings (brand name Sona Comstar). At the price band of ₹285-291, the offer is valued at a whopping 76-77 times the trailing 12-month earnings (consolidated). The defence : Peers are highly valued too! With the markets touching dizzying heights since the March 2020 low, a combination of price rise as well as depressed earnings – the latter, especially in the quarter ended June 2020- has seen valuations move up sharply. The shift in favour of cyclical stocks in the second leg of this rally has also favoured auto and auto component players. Motherson Sumi, a global auto parts supplier just like Sona BLW, trades at 74 times its trailing 12-month earnings. While Endurance Technologies trades at 40.5 times, Bosch is valued at 97 times. Bharat Forge and Varroc Engineering are loss-making at the consolidated level and hence trailing valuations are not meaningful.

The company is just looking to make hay when the sun shines (not the first one to do so), with the primary purpose of the IPO being shedding of stake by the private equity player (a Blackstone entity) to the extent of ₹5250 crore.

Capacity utilisation is at comfortable levels, leaving room for growth without capex in the near term. Hence, alongside the PE exit, an additional ₹300 crore is being raised for just debt repayment (₹241 crore). The current gearing though is not any cause for concern, standing at a comfortable 0.28. But the repayment may help keep some powder dry for debt-funded acquisitions in future, if the company chooses to follow the inorganic growth strategy. Quite a few global auto component suppliers in India have adopted this route. Sona BLW itself acquired Comstar Automotive in 2019. This purchase added electric drive motors and inverters to Sona BLW’s existing product line of differential gears and assemblies for electric vehicles (EVs). Comstar is a 100 per cent subsidiary and the approval for merger of this entity with Sona BLW is pending with the NCLT.

In today’s euphoric market conditions, it is better to be fearful when others are greedy, to borrow Warren Buffet’s words. Investors can skip subscribing to the offer. With long-term prospects sanguine, the stock can be owned at a later date by buying in the secondary market at a reasonable price.

Business prospects

In an industry which is highly fragmented and where single product, single customer, single vehicle segment companies are not uncommon, Sona Comstar has a well-diversified business (see accompanying charts).

With about 40 per cent of its revenues from hybrids (mostly micro hybrids) and EVs, the company is a play on the growing market for cleaner vehicles across the globe, thanks to tightening emission control norms everywhere. Differential gears, assemblies and starter motors (motors for conventional and micro-hybrid vehicles only) form bulk of the product mix as of today.

However, the share of starter motors to total revenues which is at 51 per cent now, is set to shrink in the near to medium term, as the company expects the mix to change in favour of EVs, which don’t require this product. Instead, the share of differential assemblies is expected to go up. A differential assembly plays an integral role in how a vehicle turns. When a vehicle goes around a corner, the wheel on the outside must travel faster than the wheel on the inside. Thus, the product is designed to drive a pair of wheels while allowing them to rotate at different speeds.

The expected change in product mix is value adding for the company as revenue realisations (and hence, profitability) for differential assemblies generally move up as the powertrain shifts from combustion to full hybrids and EVs. Today, differential assemblies bring the highest margin for the company and it supplies this component only to EVs.

Its customer base across the globe is a positive, although the company is not ready to reveal the identity of some key ones, due to critical nature of the components supplied. Disclosed ones include Daimler, Jaguar Land Rover, Carraro, Volvo Cars, Revolt, TAFE, Ashok Leyland, Mahindra Electric, Ampere and Maruti Suzuki. However, there is a bit of client concentration for the company, with top 3 customers bringing in 45 per cent of the revenues and top 5, 58 per cent.

A point worth noting here is that share of EVs in the revenue mix has jumped sharply from very low single-digits in the earlier fiscals to 14 per cent in 2020-21. Revenues from a North American EV manufacturer has also increased in a similar proportion during these years. As of FY21, this customer brings in 13.1 percentage points of the 14 per cent revenue the company receives from the EV segment. The remaining 1 percentage point comes from about 8 customers across US and Europe. The expected change in revenue mix in favour of EVs in the near to medium term could be driven by the order book from this one customer, rather than any rapid EV adoption across the globe.

Financials

Though it has the levers for growth, it is yet to show up in the earnings. Over the last three fiscals, revenues have grown at a CAGR of 4.76 per cent, to ₹1566 crore in 2020-21. This is based on proforma numbers, assuming Comstar’s numbers were consolidated since 2018-19. Proforma profits for the same period shows 0.47 per cent growth to ₹215 crore.

The proforma EBITDA margin stands at 27-29 per cent for this period and PAT margin at 13-18 per cent. Margins vary based on product, geography as well as models supplied to and the range is as wide as 15-50 per cent, according to the management. Given that it has substantial global exposure, the company follows a policy of hedging 75 per cent of its following 12 months’ forex exposure.

COMMENT NOW