SHANTHI GEARS LIMITED : STOCK OF TOP GEAR !!!

Scrip Code: 522034 / SHANTIGEAR

CMP:  Rs. 72.10; Buy at current levels.

Short Term Target: Rs. 80.00; Medium to Long Term Target: Rs. 100.00; STOP LOSS – Rs. 66.30; Market Cap: Rs. 590.40 Cr; 52 Week High/Low: Rs. 75.90 / Rs. 47.55.

Total Shares: 8,17,15,853 shares; Promoters : 5,73,02,913 shares –70.12 %; Total Public holding : 2,44,12,940 shares –29.88 %; Book Value: Rs. 33.33; Face Value: Rs. 1.00; EPS: Rs. 2.04; Dividend: 60.00 %; P/E: 32.03 times; Ind. P/E: 20.85; EV/EBITDA: 9.65.

Total Debt: ZERO; Enterprise Value: Rs. 497.75 Cr.

SHANTHI GEARS LTD: Shanthi Gears Limited was founded in 1969 and was incorporated in 1972. It was earlier known as Shanthi Engineering and Trading Company. The company is headquartered in Coimbatore, India. Form, November 19, 2012, Shanthi Gears Limited operates as a subsidiary of Tube Investments of India Limited. The company came out with an IPO on May 1986 offering 5,32,000 equity shares of Rs. 10 each issued at par. Shanthi Gears Limited engages in designing, manufacturing, and supplying custom and standard gears and gearboxes in India and internationally. The company offers standard worm gear boxes; helical and bevel helical gear boxes; geared motors; cooling tower, extruder, and rolling mill gear boxes; and textile gears and gear assemblies. It also offers custom loose gears, including spur/helical gears, pinion shafts, internal gears, worm and wheel products, straight bevel gears, and spiral bevel gears; and special gearboxes for steel, power, cement, sugar, mining, paper, and marine sectors. The company has two divisions: Gears Division and Gear Box Division. Its Gear Division caters to the needs of textile and other industries as the supplier of the original equipment and Gear Box Division undertakes the design and manufacture of gear boxes for various industries. Shanthi Gears Ltd is locally compared with Elecon Engineering Ltd, Cummins India Ltd, L.G. Balakrishnan Ltd, Suzlon Energy Ltd, Kirloskar Brothers, Premier Ltd, Birla Machining and Tooling Ltd, Dynamatic Technology Ltd, AIA Engineering Ltd, HMT Ltd and globally compared with Caterpillar Inc of USA, Cummins Inc of USA, Eaton Corporation Plc of Ireland, Navistar International Corporation of USA, WABCO Holdings of Belgium, Howden Africa Holding Ltd of Africa, Industrial Holdings Bulgaria, China Automation Group of China, Trinity Precision Technology Company Ltd of Taiwan, Focus Dynamics Technologies Berhad of Malaysia and Woorim Machinery Company limited of South Korea, Fuji Hensokuki Co., Ltd of Japan.

Investment Rationale:

SHANTHI GEARS LTD was founded in 1962 and is a part of Rs. 22,314 Crores Murugappa Group, one of India's leading business conglomerates. The Group has 28 businesses including eight listed Companies. Shanthi Gears is leading organized player in the industrial gear segment in India. It manufactures wide range of critical components involved in power transmission like Gears, Gear boxes, Gear motors and Gear assemblies. The company is strongly positioned in the custom made gears and gear boxes with about 70‐75 % of revenues coming from customized products catering industries like steel, textiles, power, chemical, rubber, paper, mining, cement, sugar etc. It operates from five fully integrated manufacturing units and one foundry division located in Coimbatore. The Gear Industry is segmented into Automotive and Non‐Automotive (Industrial) gear industry. The Automotive gear segment consumes the largest size of the industry pie. The Industrial Gear industry usually includes manufacturing of Gears, Gear boxes, Gear Motors and Gear assemblies. The Gears and gear boxes are categorized as Standard (non‐customized) and Non‐standard (Customized) which are manufactured by organized, unorganized and international players. Industrial gear caters mainly to the needs of sectors like steel, cement, Textiles, Power, Sugar, Paper, Mining, etc. Notably, non‐standard segment includes custom built gears and loose gears as well. The Indian industrial gear market is mostly dominated by manufacturers of Standard (non‐customized) Gears and Gear boxes as manufacturing of non‐standard (customized) gears requires high end expensive technology, skills and facilities to deliver to the specific needs of different clients in a short span of time. According to FY13 Annual report of Shanthi Gears, the Standard gearboxes constitute about 35 % of the market and are growing approximately at over 10 % CAGR, while the non‐standard (customized) gear box constitute over 75 % and is growing below the Industry average. Shanthi Gears has fully integrated and the largest modern gear making facilities in India with infrastructure for fabrication and engineering, in‐house foundry and forging facilities and tool room for gear cutting. The facilities of the Shanthi Gears are up to the mark step-up when compared to its peers. These contains CAD work stations, state‐of‐the‐art manufacturing and quality control machines and equipment, in‐house pattern making, castings including bronze wheel rings, forgings, fabrication, heat treatment, etc. This along with a strong R&D, technology up gradation and skill up gradation of its manpower has enabled the Shanthi Gears to maintain its designing and manufacturing edge over its competitors. Shanthi Gears currently has five Units out of which one is vacant and others carry out operations such as Manufacture of components & gears for the textile industry these units account for 10 % of the sales; Engineering Unit which accounts for 90 % of the sales; CSR Unit; Foundry unit. The product range of the company is segmented into standard (non‐customized) and non‐standard (customized) gears and gear boxes. The standard (non‐customized) gears account for 35 % of the total revenue with an operating margin between the levels of 10 % ‐ 15 % and the rest is customized gears, which constitutes 75 % of the revenue with high operating margins between the levels of 30‐35%. Unlike other domestic gear manufacturers, Shanthi Gears focuses on the customized gears and ensures that its factory utilization is not more than 85 % to take advantage of urgent and emergency orders. Unlike most of its competitors, Shanthi Gears has been able to maintain operating margins at all times due to its product mix, and the relatively lower raw material costs incurred for custom built gearboxes. Shanthi Gears Ltd is a market leader in the customized gears space with operating margins in excess of 25‐30 %, as compared to 15‐17 % for Elecon Engineering which is the biggest player in the overall gears industry. Elecon engineering despite having a market share of 30 % is commanding lower operating margins due to lower presence of 20 % in customized products which usually yield higher margins and higher raw material imports. Shanthi Gears has Seven wind mills in one of its manufacturing unit with an Agreement with Tamil Nadu Electricity Board (TNEB). The seven wind mills have a total power generating capacity of 6.66 MW. The power generated through the wind mills is used for captive purpose and the surplus is sold to Tamil Nadu Electricity Board (TNEB). The company also has power linkages with total sanctioned power of 6500 kva and own diesel gensets with a capacity of 8500kva. The possession of captive wind mills and power linkages is likely to help company save on power cost and fuel costs. Currently, power and fuel cost comprises of 8 % of the total costs.

Outlook and Valuation:

Shanthi Gears is the unique gateway to a wide range of power transmission products which includes gears, gear boxes, geared motors and gear assemblies both standard and custom-made. With headquarters at Coimbatore, South India, we are in the business of designing, manufacturing and supplying various kinds of gears, gearboxes to almost all industries and applications for the past four decades. Nearly, two years back, Tube Investment of India Ltd a flagship company of Murugappa group acquired 3.6 Cr equity shares or 44.12 % stake in Shanthi Gears for Rs. 292 Cr at Rs. 81 per share. Tube Investment further acquires 2,12,46,122 equity shares or 26% of Shanthi gears via open offer price of Rs. 81, with this addition Tube Investment of India Ltd now holds 5,72,96,413 or 70.12 % of Shanthi Gears. Tube investments acquired Shanthi Gears mainly for reasons like : to take itself to a higher level of engineering; to synergize the transmission business with its chain business; to create an opportunity for both exports and supply for offset requirements which is expected to become huge in India; due to Shanthi Gear’s strong balance sheet, cash, surplus land, engineering skills; to foray into sectors like defense and aerospace; to reduce its reliance on auto sector which is facing various challenges; to get access to company’s large customer base. On the contrary, Shanthi Gears benefited from this acquisition like now shanthi gear has headroom for growth and trap the opportunities in engineering sector; it can now access to stronger hands i.e. Murugappa group. The Indian industrial gear market depends heavily on imports i.e. 40 % imports, especially for highend gears. The rupee depreciated to Rs. 68.8/US$ in H2FY14 and is now stable at the levels of Rs. 60‐61/US$. It is believed that rupee which has depreciated almost 15 % from the levels of Rs. 47‐48/US$ more than two years back, is not expected to reach those levels soon. So it is expected that with rupee depreciation making imports costlier, import substitution is likely to take place. Other companies are likely to prefer buying gears domestically from branded companies like Shanthi Gears. Also, on raw material front, other companies which import its high amount of raw materials are expected to pass on the costlier import’s price on their final products to customers, whereas Shanthi Gears which imports merely 2 % of its raw material is likely to pass on no/marginal price hike on its final products. This makes Shanthi gears again a customer’s preferred choice. Going forward, the outlook for Shanthi Gears looks positive with fully integrated modern facilities, high presence in customized gears (non‐standard gears), fewer dependence on imported raw materials, investments in wind mills and power linkages to aid margins. Also, with exposure across various industries, management’s effort to bring back old niche clients and introduction of new standard products to lead in diversity of clientele, Uptick in investment cycle to provide the company ample opportunities to grow and Tube Investments of India’s acquisition to create synergies between both companies, the company financial prospects look bright. Adding to the above triggers, the company has strong balance sheet, cash, surplus land, improving ROE. At the current market price of Rs. 72.10, the stock is trading at a PE of 29.91 x FY14E and 22.18 x FY15E respectively as against the Indusrty PE of 21x. The company can post Earnings per share (EPS) of Rs. 2.41 in FY14E and Rs. 3.25 in FY15E. One can buy SHANTHI GEARS LIMITED with a target price of Rs. 100.00 for Medium to Long term investment and for the SHORT TERM PLAYERS it should be Rs. 80.00.

KEY FINANCIALS	FY12	FY13	FY14E	FY15E
SALES (₹ Crs)	173.00	145.65	156.25	175.00
NET PROFIT (₹ Cr)	28.11	15.47	19.72	26.59
EPS (₹)	3.44	1.89	2.41	3.25
PE (x)	11.18	29.87	28.59	21.20
P/BV (x)	1.27	1.79	2.12	2.03
EV/EBITDA (x)	3.74	9.44	10.54	7.99
ROE (%)	11.34	6.01	7.42	9.56
ROCE (%)	19.33	11.81	11.63	12.61

I would buy SHANTHI GEARS LTD for Medium to Long term for target of Rs. 100.00 and for the shorter term the target would be Rs. 80.00. As I always say, I am a long term believer in markets & I do respect the markets and will keep a strict stop loss of ₹ 66.30 on every purchase. (Why Strict stop loss of 8 % ?) - Click Here

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