Strong order book, improving cash flows positive for Motherson Sumi

Further margin gains could be a key trigger for the stock

The stock of India’s largest auto component maker shed 7 per cent on Thursday after brokerages downgraded it on higher valuations. A strong March quarter performance had seen the Motherson Sumi scrip jump about 13 per cent on Wednesday but the rally fizzled out.

Despite the stock volatility, the fundamentals have seen an improvement with gains including a robust order book, potential for margin gains, improvement in cash flows and debt reduction. Given its products in multiple segments and key supplier status, the company could be a prime beneficiary as demand recovery takes hold.

The company’s order book of 15.6 billion euros and a book-to-bill ratio of 3.2 translates to revenue visibility over the medium term. About a fourth of new order additions of 4.5 billion euros in the second half of FY21 are related to electric vehicles and revenues from these projects are expected to start in the next two years. While a strong order book, a diversified presence across trucks, buses and cars, an engine agnostic product base are positive, the company could face some pressure given the shortage of semiconductors and containers.

The key takeaway in the quarter has been the strong margin profile at its international operations housed under SMRPBV. Though the business was impacted by lower number of working days and decreased production by auto makers, margins were stable at 9.9 per cent as compared to 10.1 per cent in the December quarter; they were up 270 basis points as compared to the year ago quarter.

While rising copper prices are a worry, the company has a pass through clause. However, longer pass through contracts and higher copper content in the truck business could lead to near term pressures as was the case with its subsidiary PKC which saw profitability pressures despite a 21 per cent rise in revenues.

Analysts at JM Financial say that SMRPBV reported strong margins for the second consecutive quarter driven by sustained improvements in performance of greenfield facilities owing to continued focus on cost reduction and efficiency enhancements. This coupled with no major greenfield facility in the near term is expected to translate into an improvement in cash flows and falling debt levels. Consolidated net debt is down from Rs 7,992 crore at the end of FY19 to Rs 4,820 crore in FY21. Most analysts expect the return on equity (current 10 per cent) and net profit growth to jump 3-4 times over the next four years.

While the street is positive about the execution capabilities, healthy order book, improving margins and growth expectations from a cyclical upturn, some brokerages have downgraded it citing valuations concerns. Despite a beat on estimates, Edelweiss has downgraded the stock given the sharp rally in the stock price. While management continues to execute well, the brokerage believes the Street’s extremely high expectations (reflected in valuations) leave little room for disappointment.

At the current price, the stock is trading at 21 times its FY23 estimates as against its historical average of 20 times. Further corrections could be used as an opportunity by investors to buy the stock.