Headwinds from a fresh Covid wave and the beginning of taper by the US have brought in some volatility and uncertainty in the stock markets in recent times. However, for investors with a high appetite for risk and a long-term perspective, there are some bottom-up opportunities. The stock of Sharda Motor Industries — a supplier of exhaust systems for trucks, cars and off-road vehicles — is one such. Opportunities in this segment for value-addition over the next few years from more stringent emission norms is a key driver for the stock. This apart, the company is also stepping on to the electric vehicle (EV) bandwagon.
At ₹882 levels, the stock now trades at about 20 times its trailing 12-month consolidated earnings. With this valuation being above its three- and five-year historical average, investors can make use of corrections due to market volatility to accumulate the stock, rather than buying at one go.Considering the small-cap nature of the stock(₹2,620 crore), it is best to hold only limited quantities.
Business and prospects
Sharda Motors derives over 80 per cent of revenues from supply of exhaust systems for vehicles, with the remaining coming from suspension systems, seat frames/covers and roofing. Exhaust system revenues are equally spread between cars and commercial vehicles (CVs), with one-tenth of the revenues from off-road vehicles. The company has a market share of about 30 per cent in exhaust systems in the domestic passenger car segment and caters to almost all major players (excluding Maruti Suzuki). In the CV /tractors space, it supplies to Tata Motors, Ashok Leyland, Escorts and TAFE. Sharda Motors has market share of about 15-20 per cent in the CV segment currently. To obtain capabilities to supply to heavier CVs domestically, the company entered into a joint venture (JV) with Eberspaecher Exhaust Technology in 2019. Eberspaecher is among the leading suppliers of exhaust and emission systems for CVs across the US and Europe. Sharda Motors now operates two plants under this JV.
Auto sales have been nothing to write home about, thanks to Covid-induced economic slowdown and dwindling of disposable incomes first, and then the shortage of semiconductors. In the near-term, these challenges could remain. But in the medium-term, an upturn in the auto cycle will benefit Sharda Motors. Being a powertrain linked product, the kicking in of more stringent emission norms across vehicle types is a tailwind for the company as upgrading to higher norms typically involves more content supplied per vehicle. For example, the next stage in BS VI norms – the BS VI RDE (Real Driving Emissions) is expected to be implemented in April 2023. The norms will require cars to achieve emission targets in real world conditions, as opposed to a laboratory environment (which is the case during the initial phase of introduction). For cars, the company expects content to go up by 10-15 per cent for petrol vehicles and about 25 per cent for diesel vehicles (including for small CVs), due the implementation of BS VI RDE norms.
Similarly, CEV IV (April 2021) & CEV V (April 2024) norms and TREM IV (April 2022) & TREM V (April 2024) emission standards for off-road diesel engines used in construction and agricultural equipments respectively is expected to favour the company too. Under both these standards, higher engine power segments (37 kW to 560 kW) are covered under stage IV. The opportunity for Sharda to boost content per vehicle will become much bigger once the norms are brought in for lower engine power vehicles in 2024.
The company is shielded from the EV onslaught to an extent as it supplies a good chunk of its exhaust systems to CVs as well as off-road vehicles, which are not so much the focus areas for EV adoption in the early stages. Secondly, it has recently set up a JV with Kinetic Green, which manufactures electric scooters and three-wheelers. Under the JV, Sharda will be supplying batteries and battery management systems to Kinetic. With an initial investment of ₹20-25 crore, production is expected to commence in Q3FY23.
For the half-year ended September 30, consolidated sales moved up by 93 per cent year-on-year to ₹1,059 crore. Consolidated profits (after adjusting for loss of ₹6.5 crore of associate ) stood at ₹66 crore. Profits were at ₹9.74 crore a year ago. Operating margins came in at 9.6 per cent, compared with 4.6 per cent in the April-September 2020 period. A low base due to Covid-induced lockdown has helped. Besides, management commentary indicates better product mix and cost saving initiatives in the first half of FY22.
The Eberspaecher JV has been a drag on the consolidated numbers, making losses considering the downturn in the CV cycle in the last 2-3 years. The JV posted revenues of ₹140 crore in FY21 and as per the management, the break-even revenue stands at ₹200 crore. A turn in the CV cycle as infrastructure spending and economic activity improves, is expected to boost revenues and profitability. Production at the second plant of the JV has also commenced this year. Order wins for some new models will be a tailwind, too.
The company is debt-free and has ₹286 crore of surplus cash as of September 30. In the foreseeable future, incremental capex is expected to be met from internal accruals, helping the company maintain its debt-free position. A delay in the implementation of emission norms will be a risk to watch out for.