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The Heart of Tractors

Founded by Punjab Tractors & Kirloskar Oil, Swaraj Engines is a rare example of a supplier-customer joint venture

Swaraj Engines Ltd. (SEL) was set up to manufacture engines for fitment into Swaraj tractors for Punjab Tractors Ltd. (PTL), which has since been merged with Mahindra & Mahindra, which bought 63.3 per cent stake in PTL in July 2007 and retained Swaraj brand. Subsequently, SEL has also become supplier of hi-tech engine components to SML Isuzu Ltd., the erstwhile Swaraj Mazda Ltd. Since start of commercial operations in 1989-90, SEL has supplied around 4,04,000 engines (upto FY11) for fitment into Swaraj tractors. SEL’s engine business currently constitutes around 94 per cent of the company’s product revenue. The remainder represents value of hi-tech engine components being supplied to SML Isuzu for assembly of commercial vehicle engines.

Huge space to tract
Despite a low penetration level of tractors in many states, India is one of the largest markets in the world in terms of sales volume. Riding on the strength of increased need for mechanization due to shortage of farm labour, supported by government initiatives, domestic tractor sales for FY11 reached 4,82,200 tractors – a growth of 20 per cent over last fiscal. Additionally, 62,900 tractors were exported too.
The domestic tractor market is traditionally divided into three segments: the low horsepower 20-30 HP, 30-40 HP and above 40 HP. Most of the major players cater to all the three segments. However, their relative strengths and market positions differ from segment to segment. M&M, which designs, develops, manufactures and markets tractors for Indian and overseas markets, is the largest manufacturer of tractors in India and has sustained its market leadership for more than 28 years now. Other big players are Tractors and Farm Equipment Limited (TAFE) and International Tractors (Sonalika Group).

Strengths SEL on a standalone basis had a market share of 9 per cent when it got taken over by M&M. Today it enjoys a market share of around 12 per cent. The parent M&M Group on a consolidated basis enjoys 42 per cent market share in the farm equipment sector.
* It has high margins compared to other auto ancillary businesses. SEL in FY11 registered an operating profit margin of 17.3 per cent (5 year average: 18 per cent), profit after tax margin of 11 per cent (5 year average: 10 per cent) and return on equity of 32 per cent (5 year average: 26 per cent). SEL has a proven ability to consistently earn high margins.
* The company does not have any debt on its books. In addition, it has a cash of Rs 77 crores as on September 2011 which works out to be Rs 62 per share. Taking into account the current year’s profits, it would be over Rs 100 per share as against the current share price of Rs 395. This can be attributed to its strong internal accruals and a negative working capital.

Growth Drivers
By manufacturing 47,413 engines against the capacity of 42,000, SEL registered a capacity utilization of 113 per cent in FY11. To meet the increased demand, SEL embarked an ambitious expansion programme in FY11 to increase its total installed capacity to 75,000 engines per annum. It is expected to have closed FY12 with an installed capacity of 60,000 engines which would grow to 75,000 engines by FY13. The entire capital expenditure of Rs 94 crore on the expansion would be met from internal resources.
Currently, the entire Swaraj engines’ production goes to Swaraj tractors and the remaining gap is plugged by M&M’s own engines or by sourcing from Kirloskar Oil Engines. Post capacity expansion, Swaraj engines would not only be able to fulfill demand of Swaraj Tractors but could also be used for group-company’s offerings like M&M’s tractors, Powerol’s genset and construction equipment business. The fact that Swaraj Engines is one of the lowest cost producers in the industry, this seems likely.

Concerns
* On the back of various favourable factors like good monsoon, tractors sales have been rising handsomely for past three years. If that were to change, any moderation or slowdown in tractor sales would have a direct impact on the sales of auto ancillaries.
* ICRA in its latest report (February 2012) on ‘Indian Tractor Industry’ has maintained its view that long term growth rate is likely to stay at 8-9 per cent. However, over the short- to medium-term, the tractor industry is likely to face dual challenges of moderation in growth rates on one hand and large capacity additions on the other.

Financials
In the five-year period ended March 31, 2011, SEL clocked a compounded annual growth rate of 22 per cent in the revenues and 26 per cent in earnings per share. Its balance sheet has no debt and a high cash level of Rs 77 crores as on September 2011. In the trailing 12-months (TTM), it registered a topline of Rs 424 crore with net profit of Rs 51 crore. It has a negative working capital implying there is no amount blocked in the day to day operations. As on March 2011 sundry debtors stood at Rs 8 crore whereas current liabilities were Rs 41 crore.

Valuations
At the current price of Rs 400, it is ruling at a price-earnings multiple of 9.4, which is at a discount of 28 per cent to its five year median PE of 13. Price to book value is at 2.7. It has been a consistent and high dividend payer (see table) with an average dividend payout ratio of 28 per cent in the previous three years. Current dividend yield stands at 3.25 per cent. A 26 per cent growth in earnings per share in the previous five years translates into an attractive peg of 0.37.BUY.