The Hindu Business Line : Subros: Buy

Investors who prefer a stock with moderate appreciation potential and minimal downside can consider investing in Subros. At the current market price of Rs 237, the stock discounts the annualised April-December 2006 earnings by 10 times.

Given the hectic growth rate in the passenger car industry and the fact that the company is a major supplier to two of the top three car manufacturers in the country, the revenue and earnings visibility is excellent. Subros' capacity expansion plans and its breaking ground with new major customers such as Mahindra & Mahindra spell confidence.

The only worry, which is also the biggest risk to our recommendation, is the likely pressure on margins that Subros could face following increasing input and interest costs and the inability to pass them on in a competitive market. Automobile companies, which are themselves facing competitive market pressures, demand and get a reduction in component prices from vendors at periodic intervals.

Subros has been taking steps to mitigate this risk by diversifying its raw material sourcing and initiating local sourcing of some of the components that it was hitherto importing. The benefits of this have begun to show in the company's financials.

The operating margin has been rising steadily in the last two quarters — it was at 12.25 per cent in the third quarter — after dipping to around 10 per cent in the first.

Good prospects

Subros makes automotive air-conditioning systems and is the only integrated manufacturer in India producing complete air-conditioning systems, including compressors.

It derives almost all of its business from just two customers — Maruti and Tata Motors — both of which are doing well in the passenger car market. It caters to 70 per cent and 60 per cent respectively of the requirements of the two vehicle manufacturers. Given the booming demand for passenger cars — 21 per cent increase in sales in the April-Jan 2007 period — and the fact that almost all of the cars sold are those with factory-fitted air-conditioners, the business prospects for automotive air-conditioning systems manufacturers such as Subros appear good.

While there are others such as Behr India, Delphi, Visteon and Denso Kirloskar competing with Subros, what augurs well for Subros is that it is an integrated producer with a strong R&D base and access to technology from Denso, Japan, which also holds 13 per cent equity in the company.

Its predominant position (43 per cent market share) is reinforced by recent developments such as its bagging an order to supply air-conditioning kits for the Maruti Swift; these were hitherto being imported. There are also possible deals to supply commercial vehicle (CV) cabin air-conditioning kits to Tata Motors, Ashok Leyland, Eicher Motors and Volvo.

The volumes are not likely to be significant as CVs with air-conditioned cabins are yet to catch on in the country but Subros will get a foothold in a new market with potential for future growth.

Strong financials

Subros has a conservative financial profile with low gearing despite the ongoing Rs 77-crore investment in capacity expansion. In the nine months ended December 31, 2006, the company's earnings (Rs 20.36 crore) and revenues (Rs 490.07 crore) grew by a third and a fourth respectively, compared to the same period year before.

The fourth quarter revenues and earnings will get a boost from the Swift supplies, which began in January. Besides, the January-March quarter is traditionally a peak period when vehicle manufacturers are on an overdrive and this should translate into additional demand for the company.

The rapidly growing passenger car industry, which itself is driven by the booming economy, augurs well for Subros' prospects in the long term.

Conservative investors willing to invest and hold over the medium-term horizon can invest in the Subros stock.

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