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Riding On Superior Technology

Owing to the strength that it derives from its parent, Bosch Limited is a good long-term stock…

Bosch Limited is the Indian arm of Germany’s Bosch Group which is a leading global supplier of technology-based products and services. It manufactures and sells products such as diesel and gasoline fuel injection systems, auto electrical components, special purpose machines, packaging machines, electric power tools, and security systems. Bosch’s manufacturing facilities are located at Bangalore, Nashik, Naganathpura, Jaipur and Goa. Its service network spans 1,000 cities and towns wherein it employs over 4,000 authorised representatives.

Sources of moat
Dominant player in automotive segment. The company has a strong presence in the Indian automotive services sector, which contributes around 90 per cent of its total revenue. Bosch has a monopoly in production of diesel injection equipment for commercial vehicles (CV) and commands nearly 75 per cent market share in such equipment. It is India’s leading supplier of fuel injection pumps to original equipment manufacturers (OEMs), with the majority of its sales coming from the CV and tractor segments.
Strong parentage. Strong support from Bosch Group in terms of technology transfer and upgradation, introduction of new products, and sourcing of exports has enabled the Indian subsidiary to achieve and maintain dominance in both domestic and export markets.
Innovative products. Bosch has a track record of launching industry-shaping innovative products. It has leadership position in areas like anti-braking systems, traction control systems, and electronic stability programme.
The company introduced the Common Rail Injection System for diesel vehicles in 2006, which revolutionised the Indian car and sports utility vehicle (SUV) markets. The company recently launched the common rail system for multi and heavy commercial vehicles (M&HCVs) as well.
The popularity of diesel vehicles has been increasing in the Indian car market due to the high level of acceptance that the Common Rail System (CRS) has received. Diesel engines with CRS have proven to be quicker, more fuel efficient, better performing and cleaner. The CRS technology meets Bharat Stage III and IV emission norms and is also capable of meeting Euro V emission norms.
Opportunity in sale of spare parts. Given Bosch’s dominant position in various segments, customers usually prefer the same brand when they need to replace parts. Bosch’s spare parts business has grown at a compounded annual growth rate (CAGR) of 25 per cent between CY06 and CY09 owing to strong replacement demand. This growth was supported by increase in network strength, advertising and promotional campaigns targeting end customers, and by customer relationship building programmes. The company possesses among the largest distribution networks for spare parts in the country. Sales in the replacement market accounted for an estimated 20 per cent of CY2011 revenue.
Differentiated technology position. Bosch’s differentiated technology position produces high cash returns and relatively more stable margins throughout the business cycle that is difficult for its industry peers to match. Normally original equipment manufacturers (OEMs) squeeze vendors during downturns and force them to supply goods at lower prices. But because of Bosch’s technological superiority, OEMs are not able to squeeze it. This leads to stable margins in different parts of the business cycle.
High pricing power. The company’s high pricing power limits downside risks to margins, in a scenario of industry-wide cost pressures owing to rising prices of commodities, as is the case currently.
High entry barriers. The company enjoys high margins in the auto component segment due to high entry barriers in the form of technological knowhow. Better utilisation of new capacity and localisation of component supplies is expected to help the company sustain its margins.

What could cause moat to be breached
The segments in which Bosch operates are susceptible to technological upgradation and innovation. If any of its competitors is able to come out with more innovative products in these segments at cost-effective prices, they could take away Bosch’s leadership. But no such threat is apparent in the near future.
Peer comparison. Some of the other key players in the auto component industry include Amtek Auto, Exide Industries, Motherson Sumi Systems and Tube Investments. In terms of net sales, Bosch is ahead of all its peers. Moreover, it commands the highest net profit margin within the group. However, in terms of ratios such as return on capital employed (RoCE) and return on equity (RoE), it lags behind Exide Industries and Motherson Sumi Systems.

Growth drivers
Expanding vehicle market. Given its unique products, Bosch is expected to benefit richly from India’s expanding low-cost car segment. This segment has evolved to become one of the most important growth segments in the passenger car market. Bosch India (along with group companies) supplies front and rear drum brakes, starter motor, alternator and fuel injection system for the Nano. Increased demand for safe personal mobility and growing stress on overcrowded urban roads are the key drivers that will boost sales in the small-car segment.
Bosch is also likely to benefit from the growing demand for commercial vehicles and tractors.
Spending on infrastructure. Bosch’s non-automotive business is also slated to grow on account of the Indian government’s strong focus and high allocations to infrastructure-related projects, especially metro rail projects.
The rising gap between demand and supply of electricity will create additional demand for auxiliary power units powered by diesel as well as other sources of energy, such as solar. Bosch supplies components to all these segments as well.
Growing consumer confidence. Rising consumer confidence and fast-rising agricultural income are expected to lead to strong demand in the auto industry, particularly in segments such as passenger cars, utility vehicles, commercial vehicles and tractors.
Bosch enjoys stable margins throughout the business cycle on account of its technology leadership which gives it strong pricing power. Although the entire auto component industry is really under pressure arising from rising raw material prices, Bosch’s margins are expected to remain resilient.

Concerns
Labour unrest. The company witnessed labour unrest at two of its facilities (Naganathapura and Bangalore) in February 2010, which could only be settled after a month’s negotiation with the labour union. If such labour unrests occur in future, they could disrupt normal production schedules, thereby impacting earnings.
Inflation. Higher-than-expected inflation and interest rates could affect consumer confidence, which in turn would affect the demand for passenger cars, utility vehicles, and trucks over the medium term.
Input cost. If commodity prices rise by such a quantum that they cannot be passed on to customers, that would lead to compression of EBITDA margin.
Currency risk. The company’s operations are subject to risk arising from fluctuations in exchange rates. The US dollar and the euro are the two foreign currencies whose fluctuating rates would primarily affect Bosch’s profits.

Valuation
The stock is trading at a price-to-earnings (P/E) ratio of 22.85, which is slightly below its five-year median P/E of 23.24 times. On a five-year EPS CAGR of 20.64 per cent, the stock is trading at a price-earnings to growth (PEG) ratio of 1.1, which is slightly expensive. In terms of PEG, the stock seems expensively valued.
Owing to the strength that it derives from its parent, the Indian automobile market’s long-term potential, and introduction of more stringent emission norms in future, Bosch is a good long-term growth stock. Accumulate the stock whenever its price dips.