bearings sector 140221 edelweiss initiating coverage fag bearing,skf india,nrb bearings,timken india...

Edelweiss Securities LimitedShradha Sheth+91 22 6620 [email protected]

Manoj Bahety, CFA+91 22 6623 3362 [email protected]

Reconditioning, Product & Service Packages,

Failure Analysis, Calculation & O

ptimization,

Condition Monitoring, Mechatronics,

rT aining, Installation Consulting

Mounting Services

Production Process Know-How,

Application Knowledge

s e r i e sG r o w t h W i t h o u tM a i n t e n a n c e

BANYAN

We are delighted to initiate Bearing sector under our mid-cap series, Banyan. Banyan signifies Growth Without

Maintenance and under the series we endeavour to present stocks not widely covered owing to low management access /

liquidity, but which possess robust long-term fundamentals and structural drivers. Considering the low management access

and long-term structural drivers, we will not release regular maintenance updates on the said stocks.

Our selection framework is differentiated in this series and not clouded by valuations alone. Some of the important

attributes of stocks under the series are:

1. Good corporate governance history

2. Healthy balance sheet with robust cash flows

3. May have low liquidity

4. Low or no management access

5. Not widely covered

6. Low institutional holding

Our latest initiation under the Banyan Series are SKF and FAG. The companies, by virtue of their dominance ~45% market

share in ball bearings segment for SKF and ~45% market share in the roller bearings segment for FAG, make them domestic

market leaders. A strong product portfolio with technology expertise make players like SKF and FAG preferred suppliers to

original equipment manufacturers (OEMs) right from the product development stage. The sector is highly diversified with

auto sector contributing 48% and industrial segment at 52% of overall sales. We perceive huge growth opportunity in

automotive segment as India becomes one of the major manufacturing hubs for global OEMs. Also, the healthy industrial

segment will reap benefits as imports get substituted with localised sales. Hence, with expected uptick in auto and

eventually industrial sectors, we expect SKF and FAG to register 26% and 31% CAGR in earnings over CY13-15E,

respectively. Companies have strong financial metrics: (1) high return ratios (average core RoCE of ~40%, core RoE of

~28%); and are (2) cash rich with net cash per shareSKF and FAG at INR105/share (17% of market cap) as on CY12 and

INR195/share (12% of market cap) as on CY13, respectively. We initiate coverage with BUY recommendations on SKF and

FAG with target prices of INR795 and INR2,022, implying upsides of 26% and 30%, respectively.

As always, we await your valuable feedback.

Regards

Nischal Maheshwari

Co-Head Institutional Equities & Head Research

Bearings

1 Edelweiss Securities Limited

Executive Summary

Executive summary We initiate coverage on Indias bearing industry with a

positive view. We expect an uptick in cyclical driversauto

and eventually industrial sectorover the medium term,

while the structural drivers are expected to look up over the

longer term with increasing localisation of industrial bearings,

which are currently imported (32-43% of sales). High level of

technology-based differentiation achieved by players in their

respective focus areas ensures strong positioning and low competitive

intensity. A strong product portfolio with technology expertise make players

like SKF and FAG preferred suppliers to original equipment manufacturers

(OEMs) right from the product development stage. Highly diversified profile

with auto sector contributing 48% and industrial segment at 52% of overall

sales. We perceive huge growth opportunity in automotive segment as India

becomes one of the major manufacturing hubs for global OEMs. Also, the

healthy industrial segment will reap benefits as imports get substituted with

localised sales. Hence, with expected uptick in auto and eventually industrial

sectors, we expect SKF and FAG to register 26% and 31% CAGR in earnings

over CY13-15E, respectively. We initiate coverage with BUY

recommendations on SKF and FAG with target prices of INR795 and INR2,022,

implying upsides of 26% and 30%, respectively.

Secular drivers: The Indian bearings industry is driven largely by the industrial sector (52%

contribution) and automobiles (48% contribution). SKF and FAG majorly import industrial

bearings from their parents. This is in the form of traded bearings, with SKF earning 43%

revenue and FAG 32% from this segment. Massive capital outlay is expected to drive

increasing localization, in turn propelling huge structural opportunity for the industry. This

will be predominantly led by declining lead times and immense cost benefits. We expect the

companies to pass on benefits of growing localisation, which could lead to market share

gains. Additionally, global auto majors making India a manufacturing hub offers

unprecedented growth opportunity.

Cyclical drivers: The automobile sector is a major driver for the bearings industry with

revenue contribution of ~48%. The uptrend in two-wheelers (2W) is eventually expected to

extend to passenger vehicles (PVs) and commercial vehicles (CVs) in the last leg. With

expected recovery in automobiles, SKF (derives ~58% OEM revenue from 2W segment) will

be a strong beneficiary. FAG will be a strong beneficiary of the uptick in PV and CV

segments, deriving ~44% and ~30% of its automotive OEM revenues from these segments,

respectively. The bearing companies have a diversified revenue mix with almost half (~52%)

coming from the industrial sector. With expected revival in IIP, the industrial bearings

segment is expected to post robust growth also led by improvement in key segments such

as railways, power and mining sectors.

Competitive advantage: SKF, FAG, Timken and NRB have carved a niche with dominant

positioning anchored by their strong product portfolios along with technology expertise. As

a result, these players have been able to partner with OEMs right from the product

(Click here for

video clip)

Bearings

2

Edelweiss Securities Limited

development stage. In India, SKF commands a formidable ~45% market share in ball

bearings segment and FAG commands a strong ~45% market share in the roller bearings

segment. Strong global parentage provides huge expertise and global processes to these

companies which new companies find difficult to replicate. Thus, their dominant position in

niche areas provides them high growth opportunity in their respective segments.

Comparison: SKF is the market leader with an overall ~28% revenue share driven by its

global parentage. FAG stands at No.2 with an overall revenue share of 17%. SKF has a

diversified business model (~45% of revenue from automotive segment, 49% from industrial

segment, 6% from exports). Also, overall SKF derives 47% revenue from the aftermarket,

which makes its revenue profile less cyclical. FAG derives 35% revenue from the automotive

segment, 51% from industrial segment and 14% from exports. Overall, it derives 30%

revenue from aftermarket.

Strong financial metrics: The industry has strong financial metrics: (1) high return ratios

(average core RoCE of ~40%, core RoE of ~28%); and (2) strong cash rich companies with net

cash per shareSKF and FAG at INR105/share (17% of market cap) as on CY12 and

INR195/share (12% of market cap) as on CY13, respectively. With robust cash flow

generation, we expect cash per share to be augmented by 1.88x over CY12-15E to

INR197/share in CY15E (31% of current market cap) for SKF and by 1.7x over CY13-15E to

INR339/share in CY15E (22% of current market cap) for FAG.

Strong investment case with long-term horizon: SKF and FAG will be strong beneficiaries of

the uptick in the 2W and 4W segments. This, in conjunction with a strong industrial

portfolio, will derive huge benefits of growing localisation. SKF and FAG are trading at 12.0x

and 12.3x CY15E EPS respectively, which is at a discount of up to ~15-19% to SKFs mean

historical valuations of 15x. We initiate coverage with BUY recommendations on SKF and

FAG valuing at 15x and 16x CY15E earnings, to arrive at the target prices of INR795 and

INR2,022, implying upside of 26% and 30%, respectively.

Bearings


Contents

Executive summary .................................................................................................................. 1

Contents ................................................................................................................................... 3

At a glance ................................................................................................................................ 4

India bearing industry: Overview ............................................................................................. 5

Evolution of domestic bearings industry.................................................................................. 8

Industry revenues and market share of players ...................................................................... 9

Industry drivers ...................................................................................................................... 14

Steady long-term financials.................................................................................................... 18

Global bearings industry ........................................................................................................ 26

Companies (Initiating Coverage)

FAG Bearings .......................................................................................................................... 29

SKF India ................................................................................................................................. 53

Companies (Unrated)

NRB Bearings .......................................................................................................................... 77

Timken India .......................................................................................................................... 81

Bearings

4


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Bearings


Indian bearing industry: Overview

The Indian bearings market accounts for less than 4% of the worlds bearing market. Major

organised players include international manufacturers like SKF, FAG and Timken, along with

several local manufacturers such as NEI, NRB, ABC and TATA.

Fig. 1: Domestic industry size (By Source) INR85bn

Bearings

6


Chart 2: User segments

Source: Industry, Edelweiss research

Around 48% of industry sales are to the automobile sector. Bearing companies also have a

diversified profile with substantial industrial business, which is majorly imported. Companies

distribute bearings across a variety of industrial applications27% of industrial sales are to

general engineering, 20% to heavy industries and balance to electrical equipment and

others.

Chart 3: Type of bearings: Revenue equally divided between ball and roller bearings

Source: Source: Industry, Edelweiss research

The bearings industry is majorly divided between ball bearings (48% of demand) and roller

bearings segments (52% of demand). Within roller bearings, tapered constitute half and

balance is catered by spherical, cylindrical and needle bearings.

Automotive

48%Industry

52%

Ball

bearings

48%

Roller

bearings

52%

Tapered

42%

Cylindrical

29%

Spherical

17%

Needle

9%

Thrust

3%

Automobile

48%

General

Engineering

27%

Heavy Ind.

(incl

Railways)

20%

Electrical

equip. &

others

5%

Bearings


Table 1: Competitive landscape

Source: Source: Industry, Edelweiss research

Low competitive intensity: While there is no technology barrier per se, there is a level of

technology-based differentiation achieved by players like SKF and FAG making them

preferred suppliers to OEMs. SKFs and FAGs century-long experience in bearing

manufacturing gives them the ability to engage with OEMs from product development stage

and add much more value than a commoditised component supplier. The top-three are

dominant players in different types of bearings and do not compete head on or on pricing.

Low customer concentration: No single customer constitutes more than 10% of SKFs, FAGs

or NRBs revenues.

Industrials catered by imports: Companies have a diversified mix with bearings for

industrial applications catered to by imports from parent.

Variable cost structure: SKF, FAG and Timken procure their raw materials semi-finished for

traded goods, in turn saving in capital investment and cushioning cyclical downturns. This

will change with increasing manufacturing from FAGs stable.

Type of bearingsDeep grove

ball bearing

Spherical Roller

bearings

Cylindrical roller

bearings

Needle roller

bearings

Tapered roller

bearings

Thrust roller

bearings

Industry size (INR 95 bn) 46 8 14 4 21 1

Application Wide use in two-

wheelers,

four-wheelers,

three-wheelers

(Used in wheel, axles)

Car suspension,

drive shaft,

heavy machinery

Machine tools,

transmission,wheel-

set bearings for

railway

applications

Niche application in

engine, gearbox.

With less load and

thrust.

Wide application

in commercial

vehicles

Transmission,

Alternators,

axles, Wheels,

Compressors, Pumps,

Gearboxes, Fans,

Electrical goods

Suspension,

Gear boxes

Casters

Heavy stationary

Industrial

conveyor

systems

Industrial fans

Cement & Coal

pulverize

Pumps Compressor

Gear boxes

Centrifuges

Mining Equipments

Transmission

Transmissions

Transfer cases

Engine and valve

trains

Steering and braking

systems

Axle supports

Outbound engines

Power tool copiers

Vehicle front

wheels

Differential and

pinion

configuration

Conveyor rolls

Machine tool

spindles

Trailer Wheels

Classifiers

Extruders

Oil well swivels

Pumps

Pulp refiners

Machine tools

Market share SKF - 45% FAG - 45% FAG - 45% NRB - 70% Timken - (40-45%)

Other players FAG

National

Engineers

Timken

SKF

National

Engineering

National

Engineering

SKF

NRB

INA Bearings

SKF

SKF

FAG

National Engineers

ABC Bearings

SKF

FAG

Timken

Bearings

8


Evolution of domestic bearings industry

Chart 4: Revenue growth healthy through cycles

Source: Industry, Company, Edelweiss research

Table 2: Domestic manufacturing outpacing industry

Source: Company, Edelweiss research

Import substitution and plateauing unorganised market

Increasing preference for quality products has resulted in the unorganised replacement

market shrinking in size over the years. The trend during CY09-12 highlights that the

organised market posted 18% CAGR versus the unorganised markets -17%. Increasing

preference for longevity of product life cycle, lower maintenance and better R&D efforts to

develop new products have led to growth of organised players. Bearings are majorly

imported for the range of products currently being manufactured in India. Going ahead

though, imports will steadily fall as new production facilities are commissioned by organised

players in India. Hence, we expect the organised players to post strong market share gains,

particularly as they pass on the cost benefits when they start manufacturing.

0

14,000

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56,000

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FY

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FY

20

10

FY

20

11

FY

20

12

FY

20

13

(IN

R m

n)

SKF FAG NRB Timken NEI ABC

8% CAGR

20% CAGR

13% CAGR

Growth% CY09 CY10 CY11 CY12 CAGR (CY09-12)

Overall Bearings 5.3 33.3 6.3 - 12.3

Imports 15.5 33.3 6.3 (0.7) 12.1

Organised 4.0 42.3 16.2 - 18.3

Unorganised (18.9) - (46.4) 6.7 (17.0)

Healthy revenue growth through

the cycles barring last two years

Bearings


Industry revenues (CY12/FY13) and revenue market share of players

Chart 5: The top-5 players in organised bearing market account 79% of revenues

Source: Industry, Company, Edelweiss research

Note: Numbers of NEI, a CK Birla group company, are as of FY12.

Revenue contribution of top bearings company wise

SKF is a strong player in the ball bearings segment, whereas FAG is leader in roller bearings

and NRB leads in the more compact needle roller bearing segment. Break up for Timken

India is not available, though it is known that it is a major player in tapered roller bearings.

Chart 6: SKF IndiaMajor revenue contributors


0

5,000

10,000

15,000

20,000

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KF

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Deep grove ball

bearings

35%

Tapered roller

bearings

18%

Othes

47%

Each player specialising in a

particular area ensures low

competitive intensity

SKF - A strong player in ball

bearings

SKF India

30%

FAG

Bearings

17%

NEI ltd

13%

NRB

Bearings

7%

Timken

India

8%

ABC

Bearings

2%

Bearings

10


Chart 7: FAG BearingsMajor revenue contributors


Chart 8: NRB BearingsMajor revenue contributors


Both FAG and SKF will be beneficiaries of the uptick in automotive and industrial segments

in India with substantial contribution from the above-mentioned segments. SKF on account

of having better distribution network will be a stronger beneficiary of replacement growth

in the industrial segment, as higher proportion of sales is from industrial replacements. NRB,

being a pure auto play, will majorly benefit from the cyclical upturn in the auto OEM

segment. NRB and FAG stand to gain from strong exports due to upsurge in the industry.

Cylindrical roller

bearings

35%

Spherical roller

bearings

25%

Othes

40%

Needle roller

bearings

58%Cylindrical roller

bearings

16%

Othes

26%

FAG - A strong player in roller

bearings

NRB - A strong player in niche

needle roller bearings

Bearings


Revenue mix

Fig.2: SKF India


Fig. 3: FAG Bearings

Fig. 4: NRB Bearings


Note: NRBs industrial division has been demerged into a different company (NBIL) since October

2012. However, NBIL contributed a mere 6% to NRBs revenue at INR347mn.

Revenue

(C 12- INR22bn)Y

Auto - 45% Industries - 49% Exports - 6%

OEM - 70% Replacement - 30% OEM - 33% Replacement - 67%

Revenue

(C 12- INR14bn)Y

Auto - 35% Industries - 51% Exports - 14%

OEM - 66% Replacement - 33% OEM - 65% Replacement - 35%

Revenue

(F 13- INR5.9bn)Y

Auto - 80% Exports - 22%

OEM - 82% Replacement - 18%

Bearings

12


Stable aftermarket (INR30bn segment)

Bearings have a service life of more than four years, post which they come up for

replacement. Nearly 35% of the industry contribution is from aftermarket making it an

INR30bn segment in terms of size. Bearing companies replacement market exposure helps

them mitigate the cyclicality risk of OEM downturns and provides a favourable pricing

environment.

Chart 9: Aftermarket segment a major contributor

SKF revenue mix: ~40% from aftermarket FAG revenue mix: ~30% from aftermarket


SKF and FAG derive ~47% and ~30% of their revenues from the aftermarket segment,

respectively. We expect the automotive aftermarket segment to remain stable. Going ahead,

both SKF and FAG are set clock 20% plus CAGR over CY13-15, led by the replacement cycle.

Distribution network

SKF has ~20,000 retailers and ~300 distributers across the automotive and industrial market.

FAG has 200 distributors whereas Timken has 87 distributors.

Competitive edge

Competitive intensity among organised players is low given that each player is dominant in

one of the product segments. SKF, FAG, Timken and NRB have etched strong position in

industry owing to strong product portfolio in their respective segments along with

technology prowess. As a result, these players have been able to partner with the OEMs

right from the product development stage. Going forward we expect the current positioning

to remain the same based on the following factors:

Increased investments by each continue to protect their turfs.

Also, strong parentage provides the technological edge in their respective segments.

Continual innovation will lead to market share gains. New products contribute 10% plus

of revenues for these players.

Thus, their dominant position in the niche areas has reduced the competitive pressures and

provided sustained growth opportunity for each player.

OEM

47%

Replaceme

nt

47%

Exports

6%

35% of overall revenues from

aftermarket reduces cyclicality

OEM

56%Replaceme

nt

30%

Exports

14%

Bearings


Table 3: Competitive advantage


Table 4: Technology collaboration of bearing players


Critical success factor for scoring SKF FAG

Distribution reach (nos.) High (300) Moderate (200)

OEM reach Moderate (47%) High (56%)

Replacement share (% of overall sales) High (47%) Moderate (30%)

Auto (% of overall sales) High (45%) Moderate (35%)

Industrial (% of overall sales) High (49%) High (41%)

Traded sales (% of overall sales) High (43%) Moderate (32%)

Exports (% of overall sales) Low (6%) Moderate (14%)

Imports (% of overall sales) High (26%) Moderate (21%)

SKF India SKF AB

FAG bearings Schaeffler Technologies AG

Timken India The Timken Company

NEI Ltd NTN Japan

NRB Bearings NADELLA GmbH

ABC Bearings NSK Japan

Bearings

14


Industry drivers

Automotive bearing drivers

Automobile sector is a major driver for the domestic bearings industry with a high ~48%

contribution.

Chart 10: Correlation between bearing and automotive industry revenues

There is a strong correlation between the automobile and bearings industry growth.

Chart 11: 2W industry uptick SKF a major beneficiary with 58% of auto OEM sales


The 2W industry is estimated to register 9% volume CAGR over FY14-16, led by better rural

demand, good monsoons and pipeline of product launches by major OEM players like Bajaj

Auto and Honda Motorcycle and Scooter India. Additionally, more than 15 product launches

are expected across OEMs over the next 12-18 months. We expect SKF, which is a market

leader in 2W bearings (derives ~58% of auto bearings revenues) to be a strong beneficiary of

the burgeoning 2W segment.

(10.0)

0.0

10.0

20.0

30.0

40.0

FY

00

FY

01

FY

02

FY

03

FY

04

FY

05

FY

06

FY

07

FY

08

FY

09

FY

10

FY

11

FY

12

FY

13

(%)

Bearing industry growth (%) Auto growth

(18.8)

(9.4)

0.0

9.4

18.8

28.2

0

4

8

12

16

20

FY

02

FY

03

FY

04

FY

05

FY

06

FY

07

FY

08

FY

09

FY

10

FY

11

FY

12

FY

13

FY

14

E

FY

15

E

FY

16

E

(%)

(mn

)

2W % YoY

With ~58% of its OEM revenues

from 2W sales, SKF will be a

major beneficiary led by 10%

growth expected for industry in

FY16E

Strong correlation between

automotive and bearing industry

revenues with ~48% contribution

Bearings


Chart 12: PV to bottom out soon FAG, major beneficiary with 44% of auto OEM sales


PVs may witness back-ended growth in FY15, aided by robust growth in petrol vehicles,

improving rural demand and new product launches. Petrol vehicle sales are set to improve

due to the reducing gap between petrol and diesel prices. Over the next 18 months, ~16-17

new product launches are expected across the OEMs. We estimate PVs to register 9%

volume CAGR over FY14-16E, though more back ended with 12% growth expected in FY16E.

Chart 13: MHCV strong rebound in FY16E FAG, to benefit with ~30% auto OEM sales


Post the uptick in 2W and PV segment, going by the historic trend the last leg of demand

uptick is expected in the CV industry. The CV industry is expected to uptick in 2HCY14 and

grow by 11% in FY15 and 23% in FY16 post a 19-20% dip in FY14E.

Despite the current lackluster environment, the OEMs are incurring large capex towards

R&D and product development.

(8.0)

0.0

8.0

16.0

24.0

32.0

0.0

0.7

1.4

2.1

2.8

3.5

FY

02

FY

03

FY

04

FY

05

FY

06

FY

07

FY

08

FY

09

FY

10

FY

11

FY

12

FY

13

FY

14

E

FY

15

E

FY

16

E

(%)

(mn

)

PVs % YoY

(40.0)

(20.0)

0.0

20.0

40.0

60.0

0

80

160

240

320

400

FY

02

FY

03

FY

04

FY

05

FY

06

FY

07

FY

08

FY

09

FY

10

FY

11

FY

12

FY

13

FY

14

E

FY

15

E

FY

16

E

(%)

(mn

)

MHCVs % YoY

With ~44% of its OEM revenues

from PV sales, FAG will be a

major beneficiary led by 12%

growth expected in PV volumes

in FY16E

Bearings

16


Table 5: Capex plans of automobile companies


We expect FAG to be a major beneficiary with uptick in 4W OEM industry and SKF a major

beneficiary led by uptick in 2W OEM industry growth over next 2-3 years.

Overall, post a sluggish CY13 we expect the auto bearings segment of the companies to post

12% growth in CY14 and 19% in CY15 in the OEM segment.

Industrial bearing drivers

Bearing companies have a diversified revenue mix with half the revenues (~52%) coming

from the manufacturing sector (excluding automobiles).

Chart 14: Correlation between bearings and IIP, CGFC and core manufacturing growth


As can be seen there is a strong correlation between IIP, manufacturing GDP growth, gross

capital formation in the country and bearings industry growth.

Infrastructure expansion coupled with industrial growth will have a favourable impact on

the Indian bearings market.

Railways

The Indian Railways has earmarked an investment of INR5192bn (FY13-17) in the 12th

five

year plan. This is as compared to INR2012bn in the 11th

five year plan. This should positively

impact the bearings industry. In railways sector bearings are used in wheel axles, drive units,

traction motors, etc.

Capex (INR mn) FY12 FY13 FY14E FY15E

Ashok Leyland 6,753 7,659 2,500 2,500

Mahindra & Mahindra 14,195 12,362 11,000 11,000

Maruti 21,798 23,968 25,000 24,000

Tata Motors 30,802 29,000 25,000 25,000

Hero Motors 6,835 4,001 8,000 8,000

Bajaj Auto 3,000 3,000 3,000 3,000

(10.0)

0.0

10.0

20.0

30.0

40.0

FY

00

FY

01

FY

02

FY

03

FY

04

FY

05

FY

06

FY

07

FY

08

FY

09

FY

10

FY

11

FY

12

FY

13

(%)

Bearing industry growth (%) IIP

Demand to revive with improving

macros

Strong correlation between

industrial uptick and bearing

industry revenues with ~52%

contribution

Bearings


Power

The Twelfth five-year plan targets an investment of INR15,017bn which envisages an

incremental capacity of 88,537MW. This is as compared to the 53,922MW addition in the

11th

plan which had an investment outlay of INR7,285bn. Investment in the renewal energy

segment is projected at a strong INR3,186bn as compared to INR892bn in the previous plan.

In power sector bearings are used in Pulverizers, bowl mills, pumps and material handling.

Mining

The mining industry may witness resurgence with 25-30 mines in Karnataka re-commencing

operations over the next one year. These mines have already secured their Reclamation and

Rehabilitation Plan and are awaiting other statutory approvals. Usage of bearings in Mines:

Shovels, draglines, haul trucks, loaders, crushing, screening and material handling.

While there could be some delays in fresh investments (as measured by GFCF),

manufacturing growth could recover post more clarity in the government policies after the

general elections. With uptick in GDP and IIP from 2HCY14, we expect the industrial bearings

segment to record 16% growth in CY14 and 25% growth in CY15 post de-growth of ~10% in

CY13.

Customs duty savings

As can be seen manufacturing of ball or roller bearings in India helps in 2.5% cost savings. As

a result with increasing localization by players we expect companies to have cost savings.

Table 6: Customs duty structure

Source: Industry

Ball/roller bearings (%) Pig iron (%)

Customs Basic Duty 7.5 Customs Basic Duty 5.0

Addl Duty CVD 12.0 Addl Duty CVD 12.0

Spl Addl Duty(Spl.CVD) 4.0 Spl Addl Duty(Spl.CVD) 4.0

Excise Cess 0.0 Excise Cess 0.0

Customs Cess 3.0 Customs Cess 3.0

Bearings

18


Steady long-term financials

Revenue growth: SKF and FAG on secular uptrend

SKFs revenues posted healthy double-digits with 19% CAGR over the longer tenure (ten-

year term - CY02-12) in line with FAGs 19% CAGR. However, FAG has overtaken SKF in the

last five years, led by strong market share penetration. Going forward, with cyclical uptick in

industry, we expect growth to accelerate for both players.

Table 7: Sales CAGR over the years


Table 8: EBITDA CAGR over the years


Table 9: PAT CAGR over the years


Bearings industry has grown profitably over long term cycles. As can be seen, SKF and FAG

have registered 18% plus CAGR over ten years in sales and PAT as well as in past three years.

CY12

(INR mn)

1 year

growth (%)

3 year

CAGR (%)

5 year

CAGR (%)

8 year

CAGR (%)

10 year

CAGR (%)

SKF India 22,276 (8.5) 12.0 7.0 18.0 19.0

FAG Bearings 14,467 10.6 22.0 18.0 21.0 19.0

Timken India 6,885 (17.0) 30.0 15.0 12.0 16.0

NRB Bearings 5,916 6.0 19.0 12.0 13.0 14.0

CY12/FY13

(INR mn)

1 year

growth (%)

3 year

CAGR (%)

5 year

CAGR (%)

8 year

CAGR (%)

10 year

CAGR (%)

SKF India 2,584 (13.0) 13.6 - 14.0 16.0

FAG Bearings 2,209 (13.0) 29.0 11.0 20.0 17.0

Timken India 733 (31.0) 21.2 5.2 3.8 13.0

NRB Bearings 1,008 (12.0) 21.3 7.1 9.1 11.8

CY12/FY13

(INR mn)

1 year

growth (%)

3 year

CAGR (%)

5 year

CAGR (%)

8 year

CAGR (%)

10 year

CAGR (%)

SKF India 1,900.8 (8.8) 22.0 3.0 16.0 25.0

FAG Bearings 1,591.8 (9.5) 29.0 15.0 23.0 23.0

Timken India 442.4 (45.0) 11.0 3.0 4.0 14.0

NRB Bearings 480.4 (5.6) 30.0 7.0 7.0 14.0

FAG has consistently

outperformed peers across time

periods

Bearings


Gross margins/ EBITDA margins

Chart 15: Gross margins Chart 16: EBITDA margins


SKFs and FAGs overall gross margins at 35-37%. This is despite higher contribution of

traded goods to overall sales. On manufactured basis, both generate ~50% gross margins.

SKF has traded goods contribution of 43%, FAG 32% and Timken 25% of overall gross sales.

NRB and NEI have majority manufactured goods. Also, FAG has averaged ~17% EBITDA

margin and SKF at ~12% in last 5 years despite having trading sales led by its product profile

and operational efficiency.

Return ratios

RoE of FAG and SKF looks suppressed owing to huge cash in balance sheet. Core average

RoE of FAG and SKF at 28-29% is higher than NRBs RoE of 18%.

Chart 17: RoE profile of bearings players


25.0

32.0

39.0

46.0

53.0

60.0

CY08 CY09 CY10 CY11 CY12

(%)

SKF India FAG Bearings

Timken India NRB Bearings

11.0

16.6

22.2

27.8

33.4

39.0

CY10 CY11 CY12

(%)

SKF India FAG Bearings NRB Bearings Timken India

Average gross margins of FAG

and SKF at ~36% despite having

high traded sales

Average core RoE of FAG and SKF

at ~29-31%

7.0

11.8

16.6

21.4

26.2

31.0

CY06 CY07 CY08 CY09 CY10 CY11 CY12

(%)

SKF India FAG Bearings

Timken India NRB Bearings

Bearings

20


Table 10: SKF cash flow


Strong growth in operating cash flow and reduction in quantum of capex to lead to

improvement in free cash flow yield from CY14E.

Table 11: FAG cash flow


Higher growth along with better working capital management is expected to result in higher

operating cash flow and strong free cash yield over the next two years.

Table 12: NRB cash flow


Better working capital management will primarily drive NRBs operating cash flow in turn

leading to higher yield. While the company is financially leveraged, improvement in

operating cash flows will result in free cash flow.

Table 13: Timken cash flow


(mn) CY10 CY11 CY12 CY13E CY14E CY15E

Operating cash flow 1,159 1,509 1,989 1,543 2,336 2,881

Capex (922) (817) (807) (600) (500) (500)

Free cash flow 238 693 1,182 943 1,836 2,381

OCF yield (%) 3.5 4.5 5.9 4.6 7.0 8.6

FCF yield (%) 0.7 2.1 3.5 2.8 5.5 7.1

(mn) CY10 CY11 CY12 CY13E CY14E CY15E

Operating cash flow 1,320 826 1,371 2,050 3,023 3,454

Capex (194) (1,471) (1,407) (640) (1,100) (900)

Free cash flow 1,126 (645) (37) 1,410 1,923 2,554

OCF yield (%) 5.1 3.2 5.3 7.9 11.7 13.3

FCF yield (%) 4.3 (2.5) (0.1) 5.4 7.4 9.9

(mn) FY10 FY11 FY12 FY13

Operating Cash Flow 759 406 546 344

Capex (116) (358) (1,134) (936)

Free Cash Flow 643 48 (588) (592)

OCF yield (%) 43.5 11.6 15.6 9.9

FCF yield (%) 36.9 1.4 (16.9) (17.0)

(mn) CY10 CY11 FY12 FY13

Operating Cash Flow 584 384 341 131

Capex (81) (37) (443) (302)

Free Cash Flow 503 347 (102) (170)

OCF yield (%) 5.3 3.5 3.1 1.2

FCF yield (%) 4.6 3.1 (0.9) (1.5)

Bearings


Working capital

SKF followed by FAG is best in terms of net cash conversion cycle at an average of 42 and 49

days, respectively. NRB has high credit period due to higher auto OEM sales vis--vis SKF and

FAG. This is also due to NRB being a pure auto player. Industrial bearings are typically cash

and carry on account of being sold through a distribution network.

Chart 18: Average receivable days


Chart 19: Average inventory days


20

40

60

80

100

120


(No

of

da

ys)

CY10 CY11 CY12

20

65

110

155

200

245


(No

of

da

ys)

CY10 CY11 CY12

SKF and FAG have demonstrated

strong working capital

management with average cash

conversion cycle at ~42-49 days

With a variable cost structure,

both SKF and FAG have lower

working capital cycle

Bearings

22


Chart 20: Average payable days


Chart 21: Net cash conversion days


Asset turn

High FAT ratio and variable cost resulting in superior returns

On lower asset base, SKF, FAG and Timken have higher fixed asset turnover ratio (average of

2.4x). In fact, even the average core fixed asset turnover ratio (excluding traded revenues)

for FAG and SKF at an average 1.6x is higher than NRB at 1.1x. As a result, SKF and FAG have

strong return ratios (28% plus core RoEs and core RoCE of over 40%). With higher variable

cost structure, both SKF and FAG have lower working capital cycle of an average 42-49 days

as compared to ~190 days for NRB.

20

44

68

92

116

140


(No

of

da

ys)

CY10 CY11 CY12

20

60

100

140

180

220


(No

of

da

ys)

CY10 CY11 CY12

Also, industrial sales contribution

which is cash and carry, leads to

better credit period

With lower asset base, SKF and

FAG have higher fixed asset

turnover ratio; even core fixed

asset turnover ratio (excluding

traded revenues) is higher than

NRB

Bearings


Chart 22: Strong core fixed asset turn for FAG, SKF, Timken


Capex

Capacity expansion is currently on-stream, with the companies preparing for next leg of

demand upswing.

Chart 23: Capital outlay


SKF incurred significant capex of INR2.5bn in the past three years at an average run-rate of

INR850mn per year, which is expected to taper off to INR1.6bn over CY13-15 or at an

average run-rate of INR500-600mn per year. Currently, the company has capacity utilisation

of ~65%, which it intends to increase going ahead.

FAG invested INR3.5bn in the past two years and proposes to further invest INR3.3bn over

the next few years. We have assumed INR2bn over next few years. We expect the company

to log strong growth on massive capacity expansion and on basis of operating at full capacity

in CY11.

0.0 0.5 1.0 1.5 2.0 2.5

CY10

CY11

CY12

(x)

Timken India NRB Bearings FAG Bearings SKF India

0

320

640

960

1,280

1,600

CY10 CY11 CY12 CY13E CY14E CY15E

(IN

R m

n)

SKF FAG

Strong growth on massive

expansion and utilisation; SKF

incurred INR2.5bn over CY10-12;

we have assumed further

INR1.6bn over CY13-15E; FAG

incurred INR3.5bn over CY11-13;

we have assumed further INR2bn

over CY14-15E

Bearings

24


Exports

Exports contribution to revenues of the different companies is as follows: 6% of SKF, 14% of

FAG, 22% of NRB and 26% of Timkens revenues, as on CY12/FY13. The parent companies

source goods from their Indian subsidiaries (SKF India, FAG and Timken) to avail advantages

of low-cost operations. Exports have grown the fastest for NRB at 28% CAGR over CY07-12.

Over the mentioned period, SKFs registered exports at -2% CAGR, FAG at 18% CAGR and

Timken at 10% CAGR.

Chart 24: Export sales Chart 25: Exports as a % of sales


Imports

SKF, FAG and Timken import a sizeable portion of raw materials and finished goods. The

three Indian players primarily import industrial bearings from their parent company, which

complements their domestic production. Imports contribute 33-35% of both SKFs and

FAGs revenues, and 21% of Timkens revenues. As a result, their business model is asset

light and the cost structure is substantially variable, which helps during a downturn.

While SKF India manufactures industrial bearings on a small scale (6-7% of its industrial

sales), in CY10, subsidiary SKF Technologies started domestic manufacturing, for which SKF

will be a distributor. We believe increasing local manufacturing will help reduce the lead

time and costs. FAG manufactures industrial bearings to the extent of 18-19% of industrial

sales and started production of large size bearings at its Savli plant towards CY12 end. With

manufacturing operations in industrial segment expanding for both FAG and SKF (through

SKF Technologies) we expect imports to gradually decline over time.

216

679

1,143

1,606

2,070

2,533

CY07 CY08 CY09 CY10 CY11 CY12

(IN

R m

n)

SKF FAG NRB Timken

Exports a major contributor for

Timken and NRB at 26% and 22%

of revenues respectively; 14% of

FAGs sales and 6% of SKFs sales

0.0

10.0

20.0

30.0

40.0

50.0


(%)

SKF FAG NRB Timken

Bearings


Chart 26: Imports


Chart 27: Imports as a % of sales


0

2,000

4,000

6,000

8,000

10,000


(IN

R m

n)

SKF FAG NRB Timken

0.0

10.0

20.0

30.0

40.0

50.0


(%)

SKF FAG NRB Timken

Increasing localisation to result in

declining imports over time

Bearings

26


Global bearings industry: USD51bn in size

The global bearings market is estimated at over USD51bn in 2012, growing at 1-2% in local

currency. Asia is the largest bearings region with almost 50% of the total, having grown from

less than 30% ten years ago. Europe and Americas now account for less than 25% of the

world market. Chinas share of the worlds bearing market was slightly down to ~25%.

Japans share of the world bearing market has increased slightly, but the domestic Japanese

bearings demand still accounts for less than 15% of the world total. Other Asian markets

with sizeable bearing production and growth in recent years include India, Thailand,

Indonesia, Malaysia and the Republic of Korea. As per a market research report, the global

automotive bearings market is expected to post CAGR of 7.42% over 2014-18.

SKF is the global market leader in ball bearings with an estimated market share of ~20%,

followed by the Schaeffler Groups brands INA/FAG at ~18%, Timken (US) at ~12% and the

Japanese NSK and NTN at ~10% and ~7%, respectively. The top 3 Chinese producers hold 3%

of the global market, despite being in the largest region in terms of demand, which

highlights fragmentation levels of the Chinese bearings market.

The Asian bearings industry has

grown from 30% ten years ago to

~50% now; Europe and America

now account for less than 25% of

the world market

Bearings


Definitions

Bearing is a machine element used to support load and reduce friction in moving parts. The

bearings industry is classified into: a) bimetal bearings; and b) antifriction bearings (includes

ball bearings and roller bearings). The rolling element acts as a differentiator in a bearing.

Roller bearings are named after the rollers shape, such as cylindrical roller bearings, needle

roller bearings, tapered roller bearings, spherical roller bearings and thrust roller bearings.

The choice of bearing primarily depends on revolutions per minute (RPM) and load.

Deep groove ball bearings are versatile, self-retaining bearings with solid outer rings, inner

rings and ball and cage assemblies. These products are of simple design, durable in

operation and easy to maintain; they are available in single and double row designs and in

open and sealed variants. These are generally less customised and available off the shelf.

Due to their low frictional torque, they are suitable for high speed RPM and medium load

requirements.

Cylindrical roller bearings are very rigid, can support high radial loads, and due to the cage,

are suitable for higher speeds than the full complement designs. Bearings with suffix E have

a larger roller set and are thus designed for extremely high load carrying capacity. The

bearings can be taken apart and can therefore be fitted and dismantled more easily. Both

bearing rings can therefore have an interference fit.

Spherical roller bearings are double row, self-retaining units comprising solid outer rings

with a concave raceway, solid inner rings and barrel rollers with cages.

Needle roller bearings come with cylindrical rollers that are small in diameter. Needle roller

bearings are used in medium RPM, high-load requirements compared to ball bearings,

which are used in high RPM, medium-load requirements.

Tapered roller bearings comprise solid inner and outer rings with tapered raceways and

tapered rollers with cages. The bearings are not self-retaining. As a result, the inner ring

together with the rollers and cage can be fitted separately from the outer ring. Tapered

roller bearings can support axial loads from one direction as well as high radial loads.

Bearings

28


THIS PAGE IS INTENTIONALLY LEFT BLANK

Edelweiss Research is also available on www.edelresearch.com,

Bloomberg EDEL , Thomson First Call, Reuters and Factset.


FAG Bearings (FAG) is Indias second largest bearing company, with an

overall and roller bearings market share of ~17% and 45%, respectively.

In the past five years, the company has outpaced industry with 18% sales

CAGR, 15% operating margin, average core RoCE of 48% and 23% RoE.

High exposure to passenger vehicles (~45% of auto OEM sales) will drive

FAGs revenues. Considering significant ramp up in manufacturing

capacity (2.1x in gross block over CY10-15), the company is well placed to

capitalise on structural opportunity of India becoming one of the major

manufacturing hubs of global OEMs as well as localisation of industrial

sales. Parents (Schaeffler Group) sharpening focus on India and higher

localisation will be catalysts of strong sales growth and margin

expansion. Hence, we initiate coverage with BUY.

Huge capital outlay to drive growth and margin

With gross block expected to catapult 2.1x over CY10-15E, we have assumed 21% CAGR

in manufacturing sales over CY13-15. Also, FAG is localising industrial production of large

size bearings. With increasing capacity utilisation and gradual lowering of trading sales

(by 400bps over CY12-15E to 27.8% of sales), we expect gross and operating margins to

catapult 67bps and 203bps to 37.9% and 14.9%, respectively, over CY13-15E.

Mission India: Double share in parents turnover; exports hub

Indian operations currently contribute less than 4% to the group's annual turnover;

with expansion in portfolio and capacity (augmenting gross block by 2.1x over CY10-

15E) and the R&D set up, the parent aims to increase India contribution to ~8-10%.

This is in line with its strategy of not only tapping the growing domestic market, but

also using India as a significant hub for exports to the US, Europe and Asia.

Outlook and valuations: Robust bearing; initiate with BUY

We estimate FAGs earnings to surge 31% and 32% in CY14 and CY15, respectively,

post (-24%) in CY13. This growth will be led by robust rise in manufacturing sales post

capacity addition in auto as well as industrial division. The stock is trading at 16.3x and

12.3x CY14E and CY15E P/E, respectively, closer to mid band of its historical valuation.

We initiate coverage with BUY and target price of INR2,022, valuing the company at

16x CY15E earnings, implying 30% upside from current level.

INITIATING COVERAGE

FAG BEARINGS Growth uninterrupted

EDELWEISS RATINGS

Absolute Rating BUY

Investment Characteristics Growth

MARKET DATA (R: FAGB.BO, B: FAG IN)

CMP : INR 1,600

Target Price : INR 2,022

52-week range (INR) : 1,679/1,100

Share in issue (mn) : 16.6

M cap (INR bn/USD mn) : 27 / 427

Avg. Daily Vol. BSE/NSE (000) : 5.2

SHARE HOLDING PATTERN (%)

Current Q1FY14 Q4FY13

Promoters *

51.3 51.3 51.3

MF's, FI's & BKs 18.6 16.6 16.6

FII's 15.0 15.9 16.0

Others 15.2 16.2 16.1

* Promoters pledged shares

(% of share in issue)

: NIL

PRICE PERFORMANCE (%)

Sensex Stock Stock over

Sensex

1 month (2.8) (4.5) (1.7)

3 months (1.9) 13.7 15.6

12 months 4.9 182.5 177.5

Shradha Sheth

+91 22 6623 3308

[email protected]

Manoj Bahety, CFA

+91 22 6623 3362

[email protected]

India Equity Research| Bearings

February 19, 2014

(Click on image

to view video)

Financials

Year to December CY12 CY13 CY14E CY15E

Net revenues (INR mn) 14,467 14,300 16,764 20,343

EBITDA (INR mn) 2,204 1,836 2,319 3,024

Core profit (INR mn) 1,592 1,218 1,591 2,100

Diluted shares (mn) 17 17 17 17

EPS (INR) 95.8 73.3 95.8 126.3

P/E (x) 16.3 21.3 16.3 12.3

EV/EBITDA (x) 10.2 11.7 8.8 6.3

ROAE (%) 19.8 13.1 15.0 17.1

Bearings

30


Investment Rationale

Market leader in less competitive roller bearings

FAG is part of the Schaeffler Group, the second largest player in bearings and worlds

leading manufacturer of roller bearings and linear products. In India, the company

commands an overall market share of ~17% with leadership in the roller (spherical and

cylindrical) bearings segments with ~45% share. In the spherical roller bearing segment, it is

the market leader with around 56% share. The company also has substantial market shares

of around 35% and 19% in the cylindrical roller bearings and ball bearings segments,

respectively. Roller bearings face little less counterfeiting than deep groove ball bearings.

This enables FAG enjoy superior margin in roller bearings in the aftermarket compared to

other products.

Strong consistent performance outpacing industry historically

Historically, FAG has grown consistently and outpaced peers on growth and margin front,

owing to its extensive exposure to the high-growth PV industry. Over the past five years, the

company posted strong 18% CAGR in sales and 15% CAGR in PAT.

Table 1: Performance through the cycles

Source: Company

Note: For 3 years, 5 years, 8 years and 10 years we have taken CY12 base to make it comparable

since SKF has yet not declared results

Strong automotive relationships, high exposure to passenger vehicles

to drive growth

FAG derives 35% revenue from automotive segment, of which 66% is OEM. By virtue of the

companys high exposure to four-wheelers in the OEM segment (~44% and 30% in PVs and

CVs, respectively) we expect its auto (OEM) bearings segment revenue to post 15% CAGR.

Our optimism is underpinned by the pent up demand, improving rural demand riding a good

monsoon and new product launches (16-17 product offerings scheduled by OEMs over the

next 18 months).

Also, FAG globally derives 69% of its overall revenue from the automotive segment. Ergo,

the company is the preferred bearing systems supplier to worlds leading manufacturers of

cars and trucks like GM, Ford, Volkswagen, Volvo and Daimler Chrysler, to name a few.

Almost all these players are looking to enhance their presence in India. This gives FAG a

competitive edge over peers in the supply of bearings to these OEMs in India.

1 year 3 year 5 year 8 year 10 year

growth CAGR (%) CAGR (%) CAGR (%) CAGR (%)

Sales 14,300 (1) 22 18 21 19

EBITDA 1,836 (17) 35 11 20 17

PAT 1,218 (23) 34 15 23 23

CY13 (INR mn)

Strong product positioning in

roller bearings with 45% market

share and overall 15% market

share

India, a strong focus area for

parent, with vision to take its

contribution to global turnover

to 8-10% from ~3% currently

FAG Bearings

31


Chart 1: Uptick in Passenger vehicles industry on pent up demand from FY15E


Table 2: New product launches over next 1-2 years


(8.0)

0.0

8.0

16.0

24.0

32.0

0.0

0.7

1.4

2.1

2.8

3.5

FY

02

FY

03

FY

04

FY

05

FY

06

FY

07

FY

08

FY

09

FY

10

FY

11

FY

12

FY

13

FY

14

E

FY

15

E

FY

16

E

(%)

(mn

)

PVs % YoY

Company Brand Segment Timeline Remarks

Nissan Datsun Go Compact Q1FY15 On Micra platform; Compete with Alto, Eon etc

Datsun Go Plus MPV FY15 Compete with Ertiga

Datsun Go Sedan Sedan FY15 On Go platform

Micra Compact FY16 Refresh; based on modular CMF-A platform

Renault Lodgy MPV FY16 Compete with Ertiga/Innova

Hyundai Xcent Compact Sedan Q1FY15 Compete with Dzire

GC Compact SUV FY16 i20 Platform; Sub 4m

Honda Mobilio MPV Q3FY15 based on Brio platform; Compete with Ertiga

new Jazz Premium Compact Q3FY15 Known as Fit in Japan;

Honda Vezel Compact SUV FY16 mini CRV looking; Petrol/Diesel engines from City/Amaze

Maruti Celerio Compact Feb-14 First with AMT Technology

Ciaz Premium Sedan FY15 end New SX4; Compete with City/Verna

SX4 S-Cross Crossover FY15 SX4 Crossover; Compete with XUV, Duster

Y9T LCV FY16 First LCV with 800cc diesel engine

YBA Compact SUV FY16 Sub 4m; Built for India; Rivals Ecosport

Tata Motors Bolt Compact Q2FY15 Based on Vista platform; to replace Vista

Zest Sedan Q2FY15 Based on Manza platform; to replace Manza

Nexxon Compact SUV

M&M S-101 Compact SUV FY16 Sub 4m; Price 4L; Monocoque construction

Ford Figo sedan Compact Sedan FY15 Compete with Dzire

New Fiesta Sedan FY15 Fiesta refresh

VW Taigun Compact SUV FY17 Compete with Ecosport

Fiat Avventura Compact SUV H2FY15 Compete with Ecosport

GM Adra Compact SUV FY17

Toyota Etios Cross Crossover Q1FY15

Expected uptick in its key OEM

segment 4W (PV+CV) accounts

for ~75% of its overall auto OEM

sales - we expect automotive sales

to log 19% CAGR over CY13-15E

Bearings

32


Table 3: Capex plans of players (INR m)


Huge capex for automotive, as well localisation of industrial bearings to

drive growth

Led by ~135% capacity utilisation in CY10 in the manufacturing segment, FAG undertook

huge capex of INR3.5bn in the past three years to gear for growth. As a result, the company

enhanced capacity towards advanced generation three-wheel bearing cell and

technologically superior X-life cylindrical and spherical roller bearing production at its

existing plant at Vadodara. Also, in October 2012, it commissioned a new plant at Savli (near

Vadodara) for manufacturing low friction ball bearings and large-size bearings. Savli plant

has a capacity of 36mn ball bearings units per year and 12,000 pieces per year of large scale

bearings. Currently, FAG primarily imports industrial bearings (traded) from the parent

company. It derives 51% revenue from industrial bearings, of which while ~32% is from

trading, 19% is out of manufacturing. In line with its long-term strategy to invest in

qualitative growth, FAG has started further localising industrial production of large-size

bearings.

We expect a significant benefit with increase in India-made industrial bearings post the

planned expansion as it will reduce lead time and cut costs by way of lower manufacturing

costs and substitution of advalorem import duties.

We anticipate the massive capacity expansion of INR3.5bn (85% expansion on CY10 gross

block) to significantly boost growth. Further, capex of INR2bn (28% expansion on CY13 gross

block) is estimated over CY14-15. As a result, overall gross block will catapult 2.1x over

CY10-15E. We have assumed incremental manufacturing sales of INR5.7bn over CY11-15E,

on this overall capex of INR5.5bn over CY11-15E, a fixed asset turn of 1x. The company has

historically generated average core fixed asset turn of 1.8x. We have assumed 21% CAGR in

manufacturing sales over CY13-15E versus 15% CAGR in past five years.

Capex FY12 FY13 FY14E FY15E

Ashok Leyland 6,753 7,659 2,500 2,500

Mahindra & Mahindra 14,195 12,362 11,000 11,000

Maruti 21,798 23,968 25,000 24,000

Tata Motors 30,802 29,000 25,000 25,000

Capital outlay of INR3.5bn in past

three years; further capex of

INR3.3bn planned over next few

years; we have assumed INR 2bn

over next two years

Fag has generated fixed asset

turnover of 1.8X historically

Strong automotive relationships

with ~44% of OEM revenues

from passenger vehicles and

~30% from commercial vehicles

33


FAG Bearings

Chart 2: More than doubling of gross block over CY10-15E


The Savli plant is expected to reduce dependence on trading sales over time. Contribution of

trading sales is expected to dip from 31.8% in CY12 to 27.6% in CY15E and stimulate

profitability.

Chart 3: Increasing manufacturing sales trajectory


1.0

1.4

1.8

2.2

2.6

3.0

3,200

4,400

5,600

6,800

8,000

9,200

CY09 CY10 CY11 CY12 CY13 CY14E CY15E

(X)

(IN

R m

n)

Gross block Asset turn

(15.0)

(3.6)

7.8

19.2

30.6

42.0

1,330

2,510

3,690

4,870

6,050

7,230

CY07 CY08 CY09 CY10 CY11 CY12 CY13E CY14E CY15E

(%)

(IN

R m

n)

Traded bearings % Growth % of sales

Significant capex outlay (gross

block doubling over CY10-15) is

in line with parents vision to

double Indias contribution

Third generation

wheel bearing

plant commissioned

at Vadodara in 2011

Strong capex and automotive and

industrial uptick to lead to 21%

CAGR in manufacturing sales over

CY13-15E

Miscellaneous

34


Chart 4: Trading sales to gradually moderate


Lower traded sales, higher capacity utilisation to boost margin

FAGs overall gross margin stood at ~37% in CY12. Its manufacturing margin stood at ~49%

and traded margin at ~15% in CY12. In the latter, the company fetches only distribution

margin, which suppresses overall margin. Traded goods, which contribute 32% to overall

sales, are mostly imported from parent group company (Schaeffler Tech. AG, Germany). The

company has generated an overall average EBITDA margin of 17% in the past five years.

With increasing capacity utilisation and lower traded sales (import substitution) we expect

improvement in gross margin and operating margin by 67bps and 203bps to 37.9% and

14.9%, respectively, over CY13-15E. Ergo, we expect 28% CAGR in operating profit over

CY13-15E.

Chart 5: Superior EBITDA margins, set to further improve


(15.0)

(3.6)

7.8

19.2

30.6

42.0

1,330

2,510

3,690

4,870

6,050

7,230

CY07 CY08 CY09 CY10 CY11 CY12 CY13E CY14E CY15E

(%)

(IN

R m

n)

Traded bearings % Growth % of sales

10.0

13.0

16.0

19.0

22.0

25.0

29.0

33.0

37.0

41.0

45.0

49.0

CY08 CY09 CY10 CY11 CY12 CY13 CY14E CY15E

(%)

(%)

Gross margin (%) EBITDA margin (%)

Increasing manufacturing

capacity to reduce trading sales

contribution by 400bps over

CY12-15E to 27.8%

Increasing manufacturing sales

and operating leverage to lead to

gross and operating margins

surging 67bps and 203bps over

CY13-15E to 37.9% and 14.9%,

respectively

35


FAG Bearings

Parent envisions higher contribution from India; make it exports hub

India to account for ~8-10% of global market turnover over next few years

Schaefflers India vision is to reach EUR1bn in sales in 2020, implying 15% plus CAGR over

the next eight years (from sales of ~EUR0.3bn in CY12 for the group).

India to be exports hub to US, Europe, Asia: The Indian operation currently contributes less

than 4% to the group's annual turnover. However, with the expanding portfolio, capacity

and the R&D set up, the companys share will more than double. India will contribute more

than 8-10% to the groups global turnover as the company intends to tap not only the

growing domestic market, but also use India as a significant hub for exports to the US,

Europe and Asia.

Strengthening R&D to retain innovation edge: Banking on a strong global R&D network, the

parent intends to considerably strengthen innovation capabilities in Asia Pacific, to cater to

the regions customers. India, which is the centre of R&D excellence for the group's

motorcycle and tractor business, is expected to play a larger R&D role in other areas of

automotive and engineering businesses going ahead. FAG will invest close to INR500mn on

R&D for the group, and will be doubling the number of engineers to 400 in the next couple

of years. Globally, the Groups target is to maintain pole position in patent applications by

innovating continuously and maintaining R&D expense at 5% of annual sales. In CY12,

Schaefflers R&D expenses surged 19.8 % to EUR593mn (CY11: EUR495mn) or 5.3% of

revenue (CY11: 4.6 %).

Augmenting investments: Schaefflers target is to further expand the local production

network. In the groups global scheme of things, Asia Pacific is one of the key regions where it

envisages robust growth and sales over the long term. Hence, the group has chalked out plans

to invest around EUR300mn in Asia, of which EUR154mn will be invested in India over the next

few years. We assume half of this capex has already been met. The Schaeffler Group opened

new plants in India, Thailand and China, consistently implementing its in the region, for the

region strategy. FAG currently operates 13 production sites (out of total 70) in the Asia Pacific

region and more than half of the production is planned in the high growth Asia region.

Table 4: Planned greenfield sites and plant extensions for 2012-2014: Customer

proximity In the region, for the region strategy


Particulars

Savli, India

Pune, India

Hosur, India

Irapuato, Mexico

Kysuce, Slovakia

Skalica, Slovakia

Szombathely, Hungary

Brasov, Romania

Nanjing, China

Yinchuan, China

Taicang 5, China

Taicang 6, China

Suzhou, China

BienHoa City, Vietnam

Schaefflers India vision: EUR1bn

in sales in 2020 from ~EUR0.3bn

in CY12; more than 15% CAGR

Plans afoot to make India

significant hub for exports to US,

Europe and Asia

Miscellaneous

36


Focusing capital expenditure on growth regions such as India, China, and Russia is part of

the Schaeffler Groups strategy to protect its competitive edge and leading position in the

market. This will help the company to continue surpassing the market growth.

New product pipeline to spur growth

FAG was successful in adding over 100 new products to its portfolio in 2012. The company

will invest close to INR500mn on R&D for the group in India, and will double the number of

engineers to 400 over the next couple of years.

FAG Double-Row Angular Contact Bearings X-life

Double row angular contact ball bearings of X-life quality offer a longer operating life,

especially in use under axial load conditions.

They are therefore particularly suitable for use in pumps and agricultural machinery, for

applications in conveying equipment and packaging equipment, elevators and compressors.

FAG Spherical Roller Bearings E1 X-life

FAG E1 spherical roller bearings are used in all kinds of applications where heavy loads have

to be accommodated or where shaft deflections or misalignments of bearing seats must be

compensated for. They operate reliably in the harshest environmental conditions, for

example in gearboxes, paper machines, construction machinery and vibrating machinery.

FAG Cylindrical Roller Bearings X-life

With improved surface quality, the load ratings of X-life cylindrical roller bearings have been

increased even further in engineering applications. The dynamic load rating is 18 % higher

than in the older style used cylindrical roller bearings. The basic rating life has increased by

up to 70 %.

Strategic Roadmap 2016

Launched

Represents a shared vision of

Schaeffler Asia Pacific region.

Regional goals and strategic

direction to realise a strong

competitive position for Schaeffler

in this region articulated.

In 2012, FAG was presented with

an award for Excellence in Design

and Development by Maruti Suzuki

India

37


FAG Bearings

Valuation

FAG, the second largest bearing player in India, is structurally well positioned with strong

demand drivers for auto and industrial bearings. Strong gross block addition (doubling over

CY10-15E), demand uptick and localisation of industrial traded sales will be catalysts to the

company posting 31% and 32% earnings in CY14E and CY15E, respectively, post -24%

inCY13. A diversified portfolio, leadership in the differentiated cylindrical and spherical

bearings, a formidable service network and strong parentage equip it with significant

competitive advantage. We believe localisation of industrial sales will lead to narrowing of

the discount to the market leader, SKF, rendering improved visibility to gross margin

expansion.

Given the weak macro environment, we believe FAG maintaining its cash flow is

commendable and this could improve in the near future despite the huge capex. We expect

free cash flow over the next two years to be INR4.4bn (versus INR3.4bn in past six years).

As a result, we expect the companys net cash to stand augmented by 1.7x to

INR339/share in CY15E (22% of current market cap). Further, the companys EBITDA margin

is likely to expand led by new value-added products, gross margin expansion and operating

leverage. The company has a strong earnings growth trajectory, debt-free balance sheet and

robust cash flows with healthy average RoE and core RoCE of ~22% and 44%, respectively.

At current market price, FAG is trading at P/E of 16.3x CY14 and 12.3x CY15 earnings

estimates. It is trading slightly above mid-end of its historic valuation; on a relative basis,

SKF is trading at 12x CY15E below mid band of its valuation. FAG is expected to deliver net

profit CAGR of 31% over CY13-15E. We believe the stock is a re-rating candidate given its

consistent track record, direct beneficiary of localisation of industrial sales, strong returns

profile and earnings growth trajectory. Hence, we initiate coverage on the stock with BUY

recommendation and target price of INR2,022 based on 16x CY15E EPS, at higher band of its

valuation.

Table 5: Peer comparison

Source: Bloomberg, Edelweiss research

Note: *NRB and Global players estimates are as per bloomberg

Companies Currency Mcap

(INR bn) CY13/FY14E CY14/FY15E CY15/FY16E CY13/FY14E CY14/FY15E CY15/FY16E CY13/FY14E CY14/FY15E CY15/FY16E

Domestic Players

SKF INR 33.5 (7.8) 22.7 29.9 19.1 15.6 12.0 14.3 15.7 17.9

FAG INR 25.9 (23.5) 30.6 31.9 21.3 16.3 12.3 12.8 13.8 14.9

NRB* INR 4.8 (17.9) 37.5 20.0 9.0 6.5 5.5 21.9 17.9 22.0

Global Players*

Timken USD 361 (33.7) 19.4 22.0 19.3 16.2 13.3 14.1 21.4 27.7

SKF AB SEK 689 (24.4) 47.8 17.8 20.6 13.9 11.8 4.4 24.8 25.9

NSK JPY 37829 112.4 35.5 12.8 18.2 13.4 11.9 10.9 12.1 11.9

ROE (%)P/E (x)Core EPS Growth (%)

Stock to trade at a premium to its

historic valuation at 16x CY15E

with strong capacity uptick in

manufacturing sales, earnings

CAGR of 31%, direct beneficiary

of rising localisation; strong focus

area of the parent

Miscellaneous

38


Chart 6: One year forward P/E

Source: Bloomberg, Edelweiss research

0

500

1,000

1,500

2,000

2,500

Ap

r-0

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Se

p-0

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Ma

r-0

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(IN

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15x

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39


FAG Bearings

Key Risks

Delay in recovery in key segments

Slowdown in four-wheeler sales momentum can impact our sales growth projections since

four wheelers and commercial vehicles together contribute ~75% to FAGs auto OEM

revenues.

Forex fluctuation

FAG buys traded goods from group company (Schaeffler Tech AG, Germany). As a result, INR

depreciation against EUR may negatively impact margin on these EUR-denominated

imports. Imports constitute 33% of net sales. This also includes currency headwinds on

~34% of raw material costs (~11% of net sales) which are imported. Netting exports, which

are 14% of sales, the companys overall net imports constitute 19% of net sales. However,

the impact of forex fluctuation is limited as FAG follows a policy of hedging exposure over 4

quarters.

Royalty rate increase

Currently, royalty, trademark and service fees as a percentage of overall sales stand at 2%.

Any increase in the same could pose a risk.

Delay in ramping up Savli facility

Any execution delay in ramping up the Savli plant could impact growth as well as our

earnings estimates.

Japanese competition

International players like NSK, Nachi and Koyo are setting up base in India. This will heighten

competition in the auto bearings industry over the long term.

Miscellaneous

40


Company Description

Fig. 1: Evolution of FAG Bearings India

Source: Company

About FAG Bearings India

FAG is part of the Schaeffler Group of Germany, a leading global supplier in bearings with

revenues of EUR11bn (as of CY12). FAG, Germany, holds 51% stake in the company. In India,

FAG is the second largest player with market share of ~17% and ~45% in overall bearings

industry and roller bearings segment, respectively. The companys business spans across

rolling bearings and services systems. Within bearings, the company caters to automobile

OEM bearings, automobile aftermarket bearings, industrial OEM bearings, industrial after

market bearings and exports. Strong technological prowess and rich product portfolio

enable the company to partner with OEMs right from the product development stage. It has

a technology licence agreement with parent and pays royalty and technical fees of ~2% of

revenues.

While the company manufactures automotive bearings and part of industrial bearings

(~35%), balance 65% of industrial bearings are imported. As a result traded (industrial)

goods constitute 32% of overall revenue, which are majorly imported from overseas

Schaeffler Group companies. The company also exports 14% of its sales to the Schaeffler

Group.

FAG has plants at Vadodara with capacity of 51 mn, production of 78mn units and operating

at 154% utilization as on CY11. In terms of reach, the company has a pan-India presence

with ~200 distributors. The Savli plant, which was set up in CY12, increased companys ball

bearings capacity by 36mn units to 86.9 mn.

In India, FAGs exposure to the auto segment is 35%. 14% of sales are catered to by exports.

Within the auto segment, the company has high exposure to PV and CV segments (catering

to ~44% and ~30% of auto OEM bearings revenues respectively). Within automotive

revenue, ~66% is catered to OEMs and ~34% comes from replacement. Balance 51% of

overall revenues comes from industrial sales. Within industrial, ~65% is catered to OEMs

and 35% comes from replacement.

FAGs joint venture company, FAG Roller Bearings, manufactures taper roller bearings at its

Chakan unit near Pune.

2012

Savli plant commiss-

ioned atVadodara

which caters to ball

bearings and large

size industrial bearings

1964

Production

commenced at

Vadodara Plant

1975

Expansion:

Railway bearing

plant was

commissioned

1992

Brand name

changed from

NORMA to FAG

1999

Commissioned

India's first Wheel

Bearing Plant at

Vadodara Limited from

Norma HoffmanPlant

2003

Validation Centre

set up

at Vadodara

2010

Commenced

advanced X-life

bearing

production at

Vadodara

1962

Precision

Bearings India

Limited was

incorporated

1969

FAG Germany

acquired shares

from Norma

Hoffman

1986

Name of the

Company changed to

FAG Bearings India

LimitedNorma

HoffmanPlant

1997

Commissioned

export oriented

unit for cylindrical

roller bearings

2001

FAG

became a

part of Schaeffler

Group

2007

Introduced

E1 Spherical

Roller Bearings

2011

Commissioned

3rd Generation

Wheel Bearing

Plant at

Vadodara

FAG is No.2 player in Indian

bearings market with ~17%

market share

41


FAG Bearings

The company has identified India as one of its major growth markets. FAG, a listed entity in

India, currently has two production sites and one R&D center employing over 1,580. The

companys plants are situated at Maneja (Baroda) and Savli (Baroda). Parent also has

unlisted companies INA India (majorly catering to needle roller bearings) and Luk India

(~22% market share in clutches). These companies posted sales of INR5bn and INR2.7bn,

respectively, in Dec 2012 and Dec 2010 respectively. INAs plant is located at Talegaon

(Pune) and Luks plant is located at Hosur (Tamil Nadu).

Chart 7: Business mix as on CY12


Chart 6: Segment wise applications


Auto OEMs -

4W,CV

17%

Auto OEMs -

2W

6%

Auto

aftermarket

12%

Industrial

OEMs

33%

Industrial

aftermarket

18%

Exports

14%

Segment Product

Automotive Ball bearings

Tapered roller bearings

Barrel roller bearings

Automotive Aftermarket Deep grove ball bearings

Seals

Industrial Spherical and cylindrical roller bearings

Angular contact ball bearings

Axial Spherical roller bearings

Self aligning bearing

Industrial aftermarket Replacement part with service solutions

Manufactured

67%

Traded

32%

Others

1%

Miscellaneous

42


Chart 8: Sales break up trend


bearings sector 140221 edelweiss initiating coverage fag bearing,skf india,nrb bearings,timken india...

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healthy industrial segment

market cap

banyan series

market share

low liquidity

ball bearings segment

roller bearings segment

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