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Stock Insight: Clutch Set for a Long Drive

With over 500 different products in its portfolio & global expansion on the cards, Clutch Auto is fueled to ride the automobile industry's growth juggernaut

As India's growth story unfolds, the reflections are visible on the vrooming growth of the automobile industry.

Improvement in road infrastructure, regulation on load carrying limits, increasing tractor demand, growing disposable income of consumers, and popular financing schemes augur better times for the country's automobile industry. Add to this, the global opportunities that outsourcing is bringing to India.

If automobile industry in the country is on a roll, can auto ancillary industry be far behind! With clients like Tata Motors, Ashok Leyland, Maruti Udyog, Mahindra and Mahindra, Bajaj Auto, TAFE, Toyota, BEML and Escorts; Clutch Auto is on course to ride the auto part industry's growth juggernaut.

Being India's largest clutch manufacturer and exporter, the company holds nearly 60 per cent market share in the commercial vehicle segment and dominates the tractor space with a market share of 80 per cent , supplying to all manufacturers in India.

After taking a dip in 2002- 2003, production for commercial vehicles has been rising continuously and as a result demand for clutches has intensified too. This augurs well for a company like Clutch Auto.

With over 500 different size and types of clutches and 16 patented products in its stable, the company enjoys a competitive edge over other similar players in the domestic market. Its huge portfolio gives the company the much needed strength to expand exports.

CAL is moving towards becoming a niche player in high value-added heavy-duty segment as entry and growth rate in this segment is not restricted to existing equipment players.

In-house research and development and a thrust on innovative products at cheaper costs have widened CAL's product portfolio. CAL has also developed capabilities to make specialized ceramic clutches for Ashok Leyland and eco-friendly non-asbestos clutches for Tata Motors.

The company is taking initiatives to emerge as a niche player with a focus on the export market. Contribution from exports is expected to go up from 32 per cent in FY06 to 45 per cent in FY08, recording a compound annual growth rate of 78.8 per cent to Rs 153.6 crore.

At present, CAL's products are exported to over 40 countries. However, the company is bullish on the US, targeting its heavy-duty clutch market worth around $550 million with its patented products. The US truck market with class 7-8 trucks has grown at a CAGR of around 13.5 per cent in last four years. There are around 4.5 million trucks operating in the US and every year 200,000 new trucks are added, translating into a huge opportunity for CAL.

Eaton is the leading player in the US in both original equipment manufacturer and replacement clutch market with a market share of about 98 per cent .

CAL with its innovative cheaper patented products is planning to enter the replacement market to garner a market share of about 2-5 per cent in next 2-3 years in the United States. To this end, the company has recently acquired the clutch division of Pioneer Inc, which has an established distribution network in the US.

The acquisition is likely to strengthen CAL's foothold in the US.

Pioneer's warehouses, marketing network, sales force and most importantly, its client base of 500 companies in the replacement market will strengthen CAL's position in the US market in addition to bringing Pioneer's clients to its fold.

CAL has bagged a five-year contract worth $60 million (Rs 270 crore) from Fleet Pride, a leading heavy-duty class parts distributor in the US with a network of 165 delivery outlets. CAL has also filed six patents for class 7 & 8 trucks in the US and their registration will help the company expand its order book from Fleet Pride.

CAL's undue focus on domestic market, where the demand was sluggish, was hindering its business in the past few years.

The company was operating on an EBITDA (earnings before interest, taxes, depreciation, and amortisation) margins of around 16 per cent in past two years. With the increasing contribution from export revenues, the EBITDA margins are likely to improve from FY07 onwards as margins on exports are higher by about 4-6 per cent . The company is also rationalising its manpower, which will also push EBITDA margins up. The implementation of Kaizen is likely to further help the company to lower its operational costs, improve EBITDA margins from 16.3 per cent in FY06 to 22 per cent in FY08. CAL's higher finance costs were impacting its net profit. To come out of the problem, the company has issued convertible warrants on preferential basis. Moreover, it has managed to avail loans at cheaper interest rates.

For FY'06, CAL reported sales growth of 58 per cent to Rs 149.3 crore, supported by a more than 100 per cent rise in export revenues to Rs 48 crore. EBIDTA registered a 55 per cent growth in FY06. However, the rise in raw material costs brought EBITDA margins under pressure, which were down by 30 basis points to 16.3 per cent . With the rising export revenues and CAL's focus on high-value added products, net sales are likely to rise at a CAGR of 45.5 per cent to Rs 316 crore in FY08. Contribution from exports will increase from 32 per cent in FY06 to 45 per cent in FY08. With improving EBITDA margins, net profit will expand from Rs12.7 crore in FY06 to Rs 42 crore in FY08; a CAGR of 82.1 per cent.

With improving top and bottom lines, the EPS of diluted equity would rise phenomenally from Rs 9 in FY06 to Rs 25.7 in FY08.

With the growth in industrial economy and positive trend in automobile industry, demand for automotive clutches is expected to remain strong. This will translate into the robust earning growth, improving profitability ratios for CAL The stock is currently quoted at 9.5x FY07E and 4.9x FY08E earnings and is likely to nudge the level of Rs 257 in a year's time.

Threats
Fluctuations in the cost of inputs for manufacturing clutches, like steel, may affect the margins of the company. The unorganized sector too poses a threat to the company's products in the domestic market as well as to its revenue growth. The company's plan to expand in the US is likely to face a stiff challenge from Eaton, which has a market share of around 98 per cent in the country.

Source: Idirect