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'Fasten’ your seatbelts

We initiate coverage on Sundram Fasteners Ltd (SFL) with a target price of Rs.1220 (~27% upside) and BUY. A leader in the fastener industry with a 40% market share, SFL is slated to grow faster than the last business cycle due to strong growth in domestic auto OEM sales, rising demand for heavy vehicles in North America, rampup of EV portfolio and planned addition of new products. A process that started sometime back and continuing momentum, SFL is also reducing auto cyclicality risk by diversifying into non-auto segments. Further, margin expansion due to price hikes, net debt/ equity < 0.2x and 20%+ return ratios will drive re-rating for SFL. Being part of an innately conservative auto-focused group, proven long-term value delivery through impressive growth over years amid cycles, SFL merits its seemingly high valuations.

* SFL to grow faster than last business cycle – SFL’s towering 40% fastener market share and long-standing customer relations (~75% wallet share of major OEMs) should propel growth faster than the last business cycle due to the turnaround of the auto cycle, driven by high government spending, private capex and increased disposable income. CV sales have not yet crossed pre-Covid levels unlike PV sales, leaving under-exploited opportunities. More growth should come from exports where freight and replacement demand are driving sales of heavy vehicles. Penetration in new geographies, expansion of non-auto business, addition of new products like powertrain components, etc. should contribute further to revenues.

* Diversification to de-risk business; long way to go for EVs – SFL’s strategy to increase exposure to non-auto segment e.g. windmills, industrials, etc. from 35% to 50% in the long term is the right step to de-risk business from steep auto downcycles. The Rs3.5bn capex for manufacturing windmill tower bolts at Puducherry has the potential to more than double revenues from FY22 levels, supported by strong demand from Europe. Expansion of capacity as per PLI scheme) to develop Advanced Automotive components has the potential to ramp up revenues to Rs5bn annually. EV penetration in India is a low of 4% and SFL has ample scope to develop and sell new components like pinions, dual gears, electrical fuel pumps, along with rising export demand from long-standing customers like General Motors.

* Margin expansion and industry leading return ratios strengthens conviction - We expect ~200bps margin expansion due to price hikes starting Q4FY23, gradual increase in high-margin exports (especially for EV) and incentives from the PLI scheme. Its strong cash flow generation will ensure that capex of ~Rs1000cr over the next three years will be met from internal accruals thereby maintaining net debt/ equity 20% ROE/ROCE post margin expansion. Industry leading financials and strong earnings growth trajectory can drive outperformance for SFL.

* Valuation & Risks - We expect the company to post Revenue/ EBITDA/ PAT CAGR of 14.5/19.3%/21.2% over FY22-25E. We value SFL at avg. of 32x Dec’24 PE Ratio and 20x Dec’24 EV/EBITDA to arrive at a TP of Rs1220/share and initiate with BUY. The premium multiple is assigned due to best in industry financials, strong earnings growth visibility, scarcity premium and history of impeccable capital allocation. SFL’s 10-yr track record of 6% revenue CAGR, 10% EBITDA CAGR and 32% share price CAGR is particularly noteworthy. Risks – automotive downcycle, failure to receive price hikes and slow adoption of EVs.

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