Buy Varroc Engineering For 37% Gain: SMIFS

Varroc Engineering Ltd (Varroc) is world’s 6th largest external automotive lighting company and among the top five diversified Indian auto ancillary. It is on the cusp of strong double digit sales growth over the next 2-3 years supported by operationalization of its 6 manufacturing facilities in its international lighting business and introduction of BS-VI related products in Indian market.

It is expected to add ~29% incremental sales over FY20-22E. This is likely to lead robust operating and financial leverage resulting in 51.4% PAT CAGR over FY20-22E. At Rs447 the stock quotes at a PER of 9.8xFY22E and EV/EBITDA of 4.1x. We find valuations attractive. Initiate coverage with a BUY rating and target price of Rs615 (~14xFY22 PER).

 Varroc’s International lighting business (~62% of its sales) is set to grow at 15%+ CAGR over next 2-3 years on account of scaling up of its 6 newly constructed manufacturing facilities which are backed by assured business (~70% booked) and new orders wins.

The Company is in process of investing ~200mn euros in these plants which has a potential to generate incremental sales of ~ 525mn euros (60% additional sales) over the next 2-3 years. We anticipate healthy double digit sales CAGR over FY20-23E.

 In its domestic business (~38% of sales), Varroc has developed new BS -VI related products like catalytic converter and electronic fuel injection systems. Also it has recently received order for 720,000 AC generators from TVS of Rs0.45bn.

These products can add ~10% incremental sales to its existing revenue base. Varroc has also developed prototype for traction motor and controller for 2W EV’s which is currently under testing by its potential customers. We expect its domestic business to report ~11% Sales CAGR over FY20-22E.

 We expect Varroc to report EBITDA margins of 9.8% and 10.6% in FY21E and FY22E respectively (135bps expansion over FY20-22E) on account of strong operating leverage (~29% additional sales) and increased automation in its factories.

 We estimate Varroc’s PAT margins to expand from 2.3% to 4.1% over FY20-22E. The company is expected to report earnings CAGR of 51.4% over FY20-22E resulting in profits more than doubling over the same period.