Value Investing Contest Winning Entry #3: Munjal Auto

This report was prepared by Sudhanshu Jain, as part of the Safal Niveshak Value Investing Contest. None of the facts herein have been validated by Safal Niveshak. Also, please DO NOT treat this report as a “recommendation” from either the author or Safal Niveshak. Do your own homework.

Business Description and History
Munjal Auto Industries Limited (Munjal) operates as an auto component manufacturing company in India. The company provides exhaust systems, steel wheel rims, and spoke wheel rims for two-three wheelers; and fuel tank assemblies, seat structure systems, and side step assemblies for four-wheelers.

It also offers assemblies, including BIW parts, pillars, cross bars, control arms, tie end bars, accelerators, and brake and clutch pedal assemblies; and sheet metal components comprising mild steel parts, stainless steel parts, welded components, tri-nickel chrome plated components, liquid painted oven baked parts, heat resistant painted parts, tubular components, and roll formed parts.

The company was incorporated in 1985 and is based in Gurgaon, India. The company is a subsidiary of Thakurdevi Investments Pvt. Ltd. It is part of the Munjal group of companies. Its manufacturing plants are located in Gujarat, Haryana and Uttarakhand.

Peers/Competitors
Lumax Auto Technologies Ltd., Sharda Motor Industries Ltd., Wabco India Ltd., Amtek Auto Ltd., Shivam Autotech Ltd., Rane (Madras) Ltd., Bharat Gears Ltd., Majestic Auto Ltd., Automotive Axies Ltd., and Autoline Industries Ltd.

Major Customers
Tata Johnson Controls Automotive Ltd., Schneider Electric India Pvt. Ltd; General Motors India Pvt. Ltd., Piaggio Vehicles Pvt. Ltd., Tata Motors, Autofit Pvt. Ltd., and Hero Motors Corp. Ltd.

Investment Thesis/Rationale

• Cheap on multiples and valuation (at a price of Rs 40.8 on report date of 3rd March 2014);
• Wide product range;
• Strong financials and healthy balance sheet;
• Presence of tax-free zone enables lower taxes compared to peers;
• Relationships with major vehicle manufacturers especially with Hero Motors (Munjal is a part of Hero Group of companies) provides good cash flows;
• Economic moat as it has an ability to maintain competitive advantages over its competitors in order to protect its long-term profits and market share from competing firms in exhaust systems market; and
• Market leading presence, strong free cash flows, increased liquidity, and growth initiatives are the major strengths of the company over peers.

Operational Analysis

• Stable Exhaust Systems Manufacturing Business: Munjal is one of the largest manufacturers of exhaust systems in the world. The company manufactures close to 22,000 exhaust systems per day. Besides, the company produces more than 10,000 spoke rims for the two-wheelers and steel wheel rims daily.
• Wide Product Range: Munjal has been working on broadening its product portfolio. In last three years, Munjal started manufacturing fuel tanks for cars and chassis components like impact beams. In addition, within the category of mufflers as a product, the company is looking at the opportunities of higher capacity motorcycles for export markets, according to the 2013 Annual Report. It is looking forward to developing strong R&D capabilities, which will enable it to implement innovative technology and deliver advanced products and services, and provide it with an edge over its peers.
• New Plant and Capacity Addition of Fully Operational Fuel Tanks Business: Munjal’s plant at Waghodia to make fuel tanks for Tata Motors’ Nano car turned fully operational during 2011-2012. The capacity of this plant is 150,000 fuel tank units per annum. During the last 5 years, Munjal has invested over INR 700 million for these expansions.

Financial Analysis

• Strong Free Cash Flow and Operating Cash Flow Generating Business: The company has consistently generated operating cash flows each year, which increased from INR 120 million in 2010 to INR 442 million in 2013. Further, Munjal’s free cash flow in 2012 and 2013 were INR 240 million, and INR 307 million, respectively. These strong cash flows are helped by the effective cost management (COGS as percent of sales decreased from 86% in 2009 to 76% in 2013) and a lower tax rate.
• Presence of Tax-free Zone Enables Lower Taxes: Approximately 50% of Munjal’s revenue comes from tax-free Haridwar plant, which also contributes more than 75% to profits. This plant has excise benefit until FY19 and income tax benefit until FY14. Approximately 70% of Haridwar profits post FY14 will be taxed.
• Consistent Increase in Top Line and Bottom Line: Munjal’s revenue increased from INR 2,171 million in 2008 to INR 7,173 million in 2013 and INR 7,853 million in the trailing 12-months (TTM) period. Similarly, EPS increased from INR 2.0 in 2008 to INR 7.9 in 2013 and INR 9.18 in TTM.
• Good Dividend Yield and Pay-out: Munjal’s dividend pay-out increased from 15% in 2008 to 25% in 2013. In 2013, the company paid a total dividend of INR 2/share which implies a dividend yield of approximately 4.9%. The company has consistently paid dividends in last 6 years.
• Decreasing Leverage: The company had a debt to equity ratio of of 0.67 in 2011, which decreased to 0.30 in 2013.
• Increasing liquidity: The company had approximately INR 677 million in cash and short-term investments in 2013, representing an increase of approximately 30% over INR 502 million in 2012. Its current ratio increased from 1.3x in 2011 and 2012 to 1.5x in 2013. Similarly, the working capital increased from INR 18 million in 2011 to INR 552 million in 2013. The increasing liquidity position along with working capital provides the company with adequate capital to expand both geographically and operationally and to meet its short term obligations.
• Good Inventory Management: In 2013, the company had 14 days in inventory which was lower than the comparable companies (Lumax Auto: 16 days, Automotive Axies: 41 days and Autoline Industries: 92 days). However, the inventory days of 14 days in 2013 were slightly higher than the inventory days of 12 days in 2012.
• Strong Return on Equity and Return on Invested Capital: The company’s ROE has been consistently increasing each year. Munjal’s ROE of 18.7% in 2008 increased to 28.3% in 2013. Similarly, ROIC increased from 14.0% in 2008 to 21.0% in 2013.
• Magic Formula Stock Analysis: For a stable business, the higher the earnings yield, cheaper the stock. The Magic Formula requires an earnings yield greater than 10%. With an Enterprise Value of INR 2189 million and EBIT of INR 491 million, the implied earning yield of the company was 22%. In addition, Greenblatt recommends using a return on invested capital greater than 25%. The company’s ROIC was 21% in 2013, slightly less than the recommended ROIC by Magic Formula.
• Click here to download Munjal’s historical financial performance analysis.

Management Quality Analysis

• Experienced Management: Management’s ability to grow the business at a consistent rate while maximizing shareholder value is perhaps the most impressive feature of the business. Mr. Sudhir Munjal, who has more than 33 years of experience in automotive industry, serves as the Managing Director of the Company since 1993.

Risks

• Customer concentration risk (Hero Motors contributes maximum to the revenue).
• Volatility in the price of raw materials — nickel, paints, steel, etc.
• Intense competition from organised and unorganised players in the auto ancillary sector.
• Performance dependent on the fortunes of the auto industry.

Valuation

• Cheap on Valuation/Market Multiples: The stock (at a price of Rs 40.8 as on the report date) is trading at a TTM EV/Revenue and TTM EV/EBITDA multiples of 0.3x and 3.7x, respectively. These multiples looks cheap compared to the industry average EV/Revenue and EV/EBITDA multiples of 1.2x and 6.0x, respectively. Further, the P/E, EV/FCF and P/FCF multiples of 4.6x, 7.4x, and 6.9x, respectively, appears to be low compared to peers. Given Munjal’s higher profitability and growth expectation, an EV/Revenue multiple of 0.5x, EV/EBITDA multiple of 6.0x and a P/E multiple of 7.0x are not unreasonable for this type of business, which would result in target intrinsic value range of INR 60-65/share.
• Reverse DCF/Implied Growth Rate and Margin of Safety: Utilizing a reverse DCF (assuming a discount rate of 15.0% and a terminal growth rate of 0.0%), the current market price of INR 40.80/share implies a discrete period growth rate of -6.0% for the next 5 years, which appears very conservative. The company recorded a revenue growth of 5% in 2013 over 2012 and a three-year average annual growth of approximately 35.0%. However, after 2014 the profitability of the Company may decrease due to the termination of tax benefits at Haridwar plant. Therefore, given the facts and circumstances, a growth rate of 3.0% for the consolidated company in the 5-year discrete period and 1.0% in perpetuity is not unreasonable, which would result in a target intrinsic value of approximately INR 70/share and implies a margin of safety of 70.0% over the current market price.
• What-If/Scenario Analysis: DCF valuation of the company under the different scenarios of terminal growth rate (0.0%-3.0%) and discount rate (10.0%-20.0%) shows that the stock is undervalued and there is a good margin of safety.

Conclusion
Based on the current market multiples, Munjal’s stock appear to be undervalued (at a price of Rs 40.8 as on the report date).

Munjal’s short-term and long-term growth prospects are bullish due to historical revenue growth and strong earnings estimates. The company is supported by strong management along with strong financials and healthy balance sheet. It has low debt, current ratio of 1.5x and a dividend yield of 4.9%. Further, the company has a strong ROE and ROIC of 28.0% and 21.0%, respectively.

I like the business due to the strong cash flows, high dividend pay-out, healthy balance sheet, competitive advantage over peers and low valuation multiples.

Disclosure: I, Sudhanshu Jain, am not invested in the stock. However, a few of my family members are invested.