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M&M acquires further stake, to be sole promoter entity

About stock: Swaraj Engines (SEL) is involved in manufacturing diesel engines (20- 85 hp) for M&M’s Swaraj brand of tractors. Installed capacity - 1.5 lakh units (FY22).

* Steady ~10% compounding of revenues, EBITDA, PAT over past five years

* Net cash positive b/s; consistent cash flow generation; highly capital efficient player with history of >30% return ratios & high dividend payouts

Key Highlights:

* M&M has informed exchanges about acquisition of 21,14,349 equity shares constituting 17.41% of the paid up equity share capital of the company (SEL) from Kirloskar Industries for | 296 crore i.e. | 1,400 per share

* Post this acquisition, M&M’s stake in Swaraj Engines will increase to 52.13% vs. 34.72% earlier with SEL now being classified as a subsidiary of M&M. With this acquisition M&M now becomes the sole promoter at SEL

* Structurally, in terms of decision making, we do not foresee any change as the top management at SEL were all M&M veterans with automotive division head always on SEL board. We expect SEL’s growth to largely mirror the tractor growth at Swaraj brand of tractors at M&M, as was the case in past

What should investors do: The stock has largely been flat in a five-year period from ~| 2000 in September 2017, underperforming the broader Nifty Auto index.

* We maintain HOLD rating tracking muted growth prospects in tractor space on high base of FY21 and await structural positives before turning positive

Target Price and Valuation: Upgrading our estimates, we now value SEL at | 2,075 i.e. 18x P/E on FY24E EPS of ~| 115/share (earlier target price | 1,680).

Key triggers for future price performance:

* Play on farm mechanisation courtesy ~33% volume share of M&M’s tractor sales via Swaraj brand. Beneficiary of positive monsoons

* Superlative return ratios (RoCE: ~50%, RoIC: ~100%) along with positive CFO, FCF generation & high dividend yield (~5%)

Alternate Stock Idea: In our auto- ancillary coverage, we like Apollo Tyres.

* Walking the talk on b/s deleveraging, sweating of assets & capital efficiency

* BUY with target price of |335

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