The Hindu Business Line : Subros: Buy

Increasing penetration of auto AC systems, order wins for new models and cost-control measures suggest good earnings prospects for the company over the medium term.

Parvatha Vardhini C

Investors with a moderate risk profile and a long-term perspective can consider taking exposure in the Subros stock at the current market price of Rs 56. At this price level, the stock trades at around eight times the estimated FY-08 earnings. Subros is the market leader in the domestic car air-conditioners market with Maruti Suzuki and Tata Motors as its major clients. Increasing penetration of auto AC systems, order wins for new models, capacity expansion and cost-control measures suggest good revenue and earnings prospects for the company over the medium term.

Financials

For the quarter ended September 2007, Subros reported a 5.3 per cent drop in net sales to Rs 157 crore on a year-on-year basis with a 4 per cent drop in volumes. Realisations too dropped by about 1 per cent. The fall was mainly due to lower offtake from Tata Motors. Although new order wins and the strong show by Maruti may boost volumes in the next few years, pricing pressures could continue due to aggressive strategies adopted by OEMs (Original Equipment Manufacturers). A better product mix in terms of supplies to higher end cars such as the SX4 will mitigate this to a certain extent by improving the company’s overall realisations.

On the operating front, backed by higher levels of localisation and greater efficiencies, the operating margin improved by 1.3 percentage points on a Y-o-Y basis to reach 12.3 per cent. Also, the commissioning of plants at Manesar and Pune, closer to the facilities of Maruti and Tata Motors, has helped save freight and packaging costs. However, a rise in interest and depreciation costs due to capacity expansion has resulted in a 17.6 per cent decline in net profits. Going forward, interest costs are expected to moderate as the company has swapped debt contracted at rates of about 11 per cent with commercial paper (pegged at 7.5 per cent).

Promising Prospects

The company has a concentrated client base, with almost 90 per cent of volumes coming from Maruti and Tata Motors. Mahindra and Mahindra has recently been added to the client list and the company has started supplying to the Logan this year and will begin supplies to the new Scorpio this month. Besides, it is also entering the commercial vehicles market by supplying cabin ACs for higher tonnage trucks to players such as Ashok Leyland, Eicher and Volvo. This helps in diversification and gives better margins, but volumes are unlikely to be significant and the company’s fortunes will still be tied to that of its major clients. This need not be a cause for concern as, in such businesses, a concentrated client mix is the norm globally. A very diversified clientele will make it difficult for the company to supply on a consistent basis.

Going forward, Subros will be well-positioned to benefit from a sustained improvement in the performance of Maruti Suzuki — the success of the Swift and the SX4 (both introduced in 2007), recent orders from Maruti for supply of compressors for its export (A Star) model, and the planned sedan version of the Swift, are pointers to this.

While the company’s performance has been tepid in the September quarter the prospect of increased offtake of ACs for the soon-to-be introduced Rs 1-lakh car from Tata Motors exists.

sEven if the basic model for this car is not offered with a factory-fitted AC, there is a high possibility of buyers opting for an AC variant, as the incremental cost of an AC (above the price of the basic model) may not be a significant deterrent to buyers. Should such a trend materialise, it could translate into additional revenues for Subros.

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