Good business fundamentals and efforts to make value additions to the product mix favour Precision Camshafts, an export focused auto component manufacturer with an 8 per cent global market share in camshafts.

But given that the market capitalisation of the stock will be around ₹1,700 crore and that the size of business is much smaller than other component makers with substantial overseas operations, its valuation of 19 times the expected 2016-17 earnings is a bit on the high side. Considering the current volatility in the stock markets and the fact that small-caps may be more vulnerable to corrections, investors can keep away from the offer.

Holds promise

Precision Camshafts derives about three-fourths of its revenues from export of camshafts (castings and machined), predominantly for passenger cars.

While Ford and General Motors are its key clients, each bringing in 25-35 per cent of the revenues, the UK, Germany, Spain and the US are some of its key markets. The company makes over 150 varieties of camshafts.

The more complex castings and machined camshafts fetch higher realisations and superior operating margins. Over the last four fiscals, machined camshafts have contributed about 30-35 per cent to revenues.

Average realisations have improved steadily from ₹375 per camshaft in fiscal 2011 to ₹504 in fiscal 2015. Since fiscal 2012, net sales (₹516 crore in 2014-15) has grown at a compounded annual rate of 19.9 per cent and net profits (₹62.3 crore in 2014-15), by a CAGR of 45.3 per cent.

Currently manufacturing the chilled cast iron variety of camshafts, the company is expanding into the ductile iron variety and assembled camshafts. This is expected to help bring Japanese auto makers such as Toyota and Suzuki which use this variety, on board.

It is towards setting up a machine shop for ductile iron camshafts that the company is raising about ₹240 crore from this IPO, apart from an offer for sale for about ₹170 crore from promoters.

While ductile iron camshaft castings per se are not a higher margin business, machining operations on these are expected to help better realisations and margins.

The trend of increase in outsourcing of machining operations for these components by auto manufacturers is expected to aid on this front.

Weak areas

Favourable foreign exchange movements, availability of certain export incentives from the government and production of some value-added camshaft varieties have helped operating margins soar to 24-26 per cent in fiscal 2015 and in the first six months of this year. Earlier margins have been at around 10-13 per cent.

The sustainability of over 20 per cent margins in the next two-three years is a question.

Over the long term, it may expand based on acquisition of higher machining business.

Secondly, three key promoters/management personnel have taken home a remuneration and commission of about ₹19 crore and ₹13 crore respectively in 2014-15. This seems high, compared to the net profit of ₹62 crore for this period.

Finally, while there are no direct peers, despite its smaller size, the valuation is on par with bigger and more mature Indian companies that are focused in the overseas markets, such as Bharat Forge and Motherson Sumi.

As per Bloomberg estimates, other foreign companies that have a presence in camshafts such as Musashi Seimitsu, ThyssenKrupp and Linamar trade at 7.5-9.5 times FY17 earnings.

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