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Exports to remain a structural growth driver

Wabco India’s (WIL) Q1FY22 operating earnings were in-line with consensus estimates as EBITDA margin came in at 8.6% (down 316bps QoQ). Operating leverage was a major drag on margins led by employee costs (up 414bps QoQ). We like WIL’s underlying business due to i) dominant market share (>85%) in domestic M&HCV industry, ii) turnaround of CV cycle as domestic industry is likely to remain on growth path well into FY24E,

iii) strong technology leadership and support (from parent ZF Group) and iv) diversification into new product / content introduction (e.g. ESC, air disc brakes, ADAS) for both domestic and export markets. The stock remains one of the best M&HCV proxy plays; however, valuations remain elevated (~36x PE/1.2% FCF yield FY23E). Maintain ADD.

Key highlights of the concall:

* WIL to invest in new plant to scale up exports business as current capacity utilisation peaks. The company has applied for lease of ~50-acre land parcel in Oragadam, Tamil Nadu, ~EUR15mn capex for new plant will be spent over the next two years. Existing Mahindra world city plant will manage FY22 export demand.

* Domestic plant at Ambattur would be incrementally augmented for engineering purposes, moving production closer to customer and R&D footprint in Ambattur will be increased.

* Revenue distribution for Q1-OEM: Rs1.63bn (up 425% YoY), aftermarket: Rs0.61bn (up 90% YoY) and exports: Rs2.2bn (up 305% YoY).

* ZF is consolidating CV business globally and Wabco India will come under ZF CVS (commercial vehicle sales) division. However, most parts of the sale related to MHCVs would be handled by WIL. The decision of handling of contracts between WIL and unlisted entity will depend on customer and go to market strategy.

* India is expected to be a sourcing hub for ZF as it would 1) manufacture in India for ZF requirement; 2) new product development where India can be low cost hub; and 3) global centre for digital innovation and IT.

* Capex for next 10 years for WIL would be ~Rs18bn (WIL currently spends Rs1bn per year). Incremental capex would focus first on exports, digitisation, modernisation in existing facilities.

* ZF to be a multi-division organization in India with 9 divisions (e.g. a) transmission for OHT customers, b) components of windmills, c) CV, d) PV, e) aftermarket.

* CV division (including domestic OEM, aftermarket, exports) for ZF in India is expected to reach EUR1bn annual revenues in next 10 years.

Valuation methodology

We like Wabco’s business model (dominant market share, improving content/vehicle, multi-year potential M&HCV upcycle, low leverage, strong RoCEs). New capex plans indicate confidence of parent (ZF) in capabilities of Wabco India. We raise earnings for FY22E / FY23E by 2.1% / 3% on the back of better export growth potential.

Though we like the business, we would seek lower valuations to turn further constructive. We maintain our target multiple at 40x FY23E EPS of Rs196. We maintain our ADD rating on the stock with a revised target price of Rs7,860 (earlier: Rs7,629).

Upside risk: Faster adoption rates of new products such as AMT/ESC amongst large M&HCV OEMs.

Downside risk: Slower than expected M&HCV recovery and lack of well incentivised scrappage policy.

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