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Efficient, proxy play on cyclical recovery in CV segment

Automotive Axles (AAL), established in 1981, is co-promoted by the Kalyani Group (35.5% stake) and Meritor Inc. (US, 35.5% stake). AAL is the largest independent manufacturer of rear axle drive assemblies in India (primarily for CVs; MHCV). It is also a prominent brake manufacturer. Rear drive axles comprise ~60% of its topline with brakes share at ~20% and other parts comprising the rest. AAL counts all major CV OEMs as its clients with prominent being Ashok Leyland, M&M, Volvo, Daimler India, Tata Motors among others. It has four manufacturing locations pan India with capacity pegged at ~20,000 units/month for axles, ~120,000 units/month for brakes

Triggers

Infra push, scrappage policy to propel healthy CV growth

Commercial vehicle (CV) segment is a cyclical industry. Currently, we have seen it turn the corner of its usual two year down cycle. January-March 2021 volume prints by industry majors like Tata Motors, Ashok Leyland and Eicher Motors (VECV arm) reaffirm our thesis with healthy double digit sequential pick up in volumes. FY21 domestic sales volumes in the CV space were at ~5.7 lakh units, down 44% from the peak clocked in FY19 i.e. ~10 lakh units.

Within the CV space, M&HCV saw a sharper decline at ~60% over the twoyear period with industry volumes being pushed back by ~12 years while decline was limited to ~33% in the LCV space with segmental volumes being pushed back by ~4 years. Going forward, however, given the government’s push on infrastructure development amid growth oriented Union Budget 2021-22 and recently announced scrappage policy promoting sales of new fuel efficient vehicles for Indian roads, we feel the CV industry will bounce back sharply and grow in excess of 30-35% in the next two years, withstanding the minor hiccups due to Covid resurgence.

With AAL deriving 90%+ of its revenues from the CV segment, especially the M&HCV sub-segment, we expect it to be a natural beneficiary of the same. With this, coupled with its penchant to launch new products as well as break into new OEMs, AAL is well poised to clock ~37% sales CAGR in FY21E-23E.

Capital efficient business model, unlevered balance sheet

AAL, over the years, has demonstrated healthy capital efficiency with FY16- 20 average RoE, RoCE, RoIC at ~15%, 23%, 25%, respectively. In normal times, it clocks an asset turnover of ~3x, realises ~10-12% EBITDA margins and has working capital cycle of =20%. On the balance sheet front, AAL had gross debt of ~| 35 crore as of FY20, with cash & cash equivalents at ~| 74 crore, thereby making it a net debt free company.

Over the years, its leverage has been quite minimal. Also, with capex executed in the recent past, the unlevered nature of balance sheet is expected to persist, going forward. On the cash flow front, it has been a consistent cash generator i.e. positive CFO, with cumulative 10 years (FY11-20) CFO at ~| 800 crore while FCF in the aforesaid period is at ~| 350 crore. Healthy b/s and consistent cash generation bodes well and acts as a good margin of safety to our investment thesis.

Valuation & Outlook

With cyclical recovery envisaged in the CV space, we expect sales to grow at a CAGR of ~37% in FY21E-23E to ~| 1500 crore in FY23. PAT in the aforesaid period is expected to grow to ~| 95 crore in FY23E with capital efficiency reviving to ~20% levels (RoCE, RoIC). We are also enthused by the Vision 2025 statement at AAL, wherein the management’s intent is to grow profitably ahead of industry including exports. With favourable riskreward at hand, we ascribe BUY rating to the stock with a target price of | 1,260 i.e. 20 x P/E on FY23E numbers.

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