EQUITY RESEARCH: ZF STEERING GEAR (INDIA) LTD.

Z F Steering Gear (India) Ltd is engaged in the enterprise of manufacturing and assembling of steering structures for vehicles, buses and tractors. The Company is mainly engaged in the production of automobile factor (steerage tools) and renewable energy (solar and wind energy). The Company's segments consist of Auto Component and Renewable Energy. The Company's product variety includes steering systems, vane pumps, pump pulleys, oil reservoirs, steering & pump mounting brackets, steering columns, intermediate shafts, universal joints, bevel gears containers and power steering oil dexron II. The Company's five mega-watt (MW) solar power challenge is positioned at Gujarat Solar Park. The Company operates approximately seven wind turbine machines, that are located in districts of Satara and Ahmednagar, which have an aggregated capacity of about 6.7 megawatts. The Company has plant at Vadu Budruk, close to Pune for manufacturing and assembling of steerage systems and add-ons.

ZF STEERING GEAR (INDIA) LTD.

ABOUT:

ZF Steering Gear (India) Ltd. (ZFI), a joint venture with ZF Friedrichshafen AG, was established in 1981. Later, ZF Lenkystene GmbH was purchased by Robert Bosch Automotive Steering GmbH, who changed the company's name to Robert Bosch Automotive Steering GmbH. In India, it is a pioneer in the production and distribution of mechanical steering systems with worms rollers and ball and nuts. Its factory is situated in the Shirur district, which is close to Pune and home to numerous OEMs including Force Motors, General Motors, Mercedes Benz, Mahindra Trucks & Bus Ltd, TATA Motors, etc. The plant can currently produce 2,00,000 units of mechanical steering gears (worm and roller) and 3,75,000 units of integral hydraulic power steering gears (ball and nut). In the March 2023 quarter, Robert Bosch Automotive Steering GmbH exited the business by selling its 25.8% ownership in ZFI to the Indian founders. Numerous CV manufacturers as well as heavy vehicles like dumpers and haulage trucks receive steering gears from the company. Based on customer needs, ZFI uses cutting-edge technology to design and manufacture various types of mechanical and power steering systems. It is actively expanding its product line to satisfy the rising demands of the automotive sector and is eager to diversify into the right product categories.

SHAREHOLDING PATTERN

Q1FY24 FINANCIAL

Topline growth in Q1 FY24 was respectable at 9.6% YoY. As CV volumes remained strong, net sales grew to Rs 121cr from Rs 110cr in the comparable quarter the previous year. Sales rose sequentially by 3.4% QoQ. EBITDA increased by 0.2%/16.0% YoY/QoQ to Rs 18cr as raw material inflation decreased QoQ, causing gross margins to increase by 360bps. EBITDA margin decreased by 140 bps year over year while increasing by 250 bps week over week to 15.2%. PAT increased by 139% year over year as MTM reporting of investments resulted in a profit of Rs. 7 crore versus a loss of Rs. 3 crore in Q1FY23. Tax expenses represented 32% of PBT, down from 42% in Q1FY23. PAT increased sequentially by 19% to Rs 12cr.

KEY TRIGGERS

CV sales growth to moderate in FY24

After a slow first five months of FY24, CV sales have begun to pick up speed. Domestic wholesale volumes for the Indian commercial vehicle (CV) market increased by 11.7% year over year and 14.7% sequentially in September 2023. The domestic CV sector reported a wholesale volume gain of 2.4% YoY for H1 FY24 (April-September).

ICRA anticipates that wholesale volumes in the CV industry will stay stable for the remainder of the year, helped by stable freight demand over the forthcoming holiday season, economic growth, and the government's emphasis on infrastructure spending in line with budgetary allocations. It anticipates that the sector would see volume growth in wholesale dispatches of 2-4% to 0.98-1 million in FY24. The expansion in FY2024 would come after a year of strong demand in FY2023, when industry volumes increased by more than 30% on the back of a solid foundation and a significant uptick in macroeconomic activity.

Backward integration to reduce manufacturing costs

As a step towards backward integration for the production of some of the crucial components needed for its final product, steering gears, ZFI created two wholly-owned subsidiaries in April 2022. The Wholly-Owned Subsidiaries (WOS) are known as:

1.     DriveSys Systems Private Limited

2.     NexSteer Systems Private Limited

At the Supa Partner Industrial Park, managed by the Maharashtra Industrial Development Corporation (MIDC), near Ahemdnagar, Maharashtra, both of these businesses have purchased and taken control of industrial land. Construction is currently taking place on the production sheds for the two enterprises, which are located at the aforementioned locations. Major equipment has been ordered by DriveSys for its commercial operations. These businesses are anticipated to start up by the end of the current fiscal year.

The company has so far subscribed to the equity share capital of DriveSys and NexSteer for a total of Rs. 8 crore and Rs. 8 lakh, respectively. The aforesaid projects will require a total capital investment of somewhere around Rs 100 crore. This would improve the company's cost management and raise the overall kit value.

Strong position in domestic steering systems industry for M&HCVs and tractors

Three key players—JTEKT India Limited (formerly Sona Koyo Steering Systems Limited), Rane TRW Steering Systems Private Limited, and ZFI—dominate the Indian steering gear market. ZFI and Rane Group are more prevalent in the CV and tractor categories than JTEKT is in the passenger vehicle (PV) segment. ZFI and Rane Group control 90% of the domestic M&HCV and tractor steering systems market, which is essentially a duopoly.

Margin expansion on increased capacity utilization

Higher demand for the company's products as a result of the CV cycle's increase has improved capacity utilization. Expanding operating margins would result from higher operating leverage. Since the company has significantly cut fixed and electricity (own windmill) expenses, the current demand revival will have a superior influence on profits and pay off in an upcycle.

Steering industry overview

The Automotive Steering Market, which was valued at USD 27 billion in 2022, is predicted to increase at a CAGR of more than 5.5% during the following five years to reach USD 38 billion. One of the primary drivers propelling the growth of the automobile steering industry is the long-term usage of steering-mounted electronics, which makes it more intuitive. Many of the dashboard-based activities that have been controlled by steering during the past 20 years are anticipated to be transferred to CV steering thanks to technology advancements. 80–85% of the market is made up of electric and hydraulic power systems. The remainder of the market is made up of manual steering applications utilized in tractors, 3W, and construction equipment, among other things. While electric power steering is frequently utilized in passenger cars, hydraulic power steering is frequently employed in UV and CV segments with powerful engines. ZF Commercial Vehicle, Rane Holdings, JTEKT Corporation, Mando Corporation, Knorr-Bremse, ZF Steering, Nexteer Automotive Group, Bosch Auto Parts, Thyssenkrupp Business Area Components Technology, and Denso are some of the major competitors in the market.

KEY CONCERNS

Vulnerable to cyclicality in demand from CV/Tractor OEMs

ZFI is subject to the cyclicality in them because CV/Tractor manufacturers are its main customers for their steering system. Due to the ongoing supply issues in semiconductors and the substantial increase in retail fuel prices, volumes may continue to be partially limited.

Elevated commodity and fuel prices

The cash flows of truck operators are being impacted by elevated commodity prices and rising fuel prices. In the event that truck operators are unable to pass on the additional cost, the recent sharp spike in gasoline and diesel prices could have an adverse effect on demand. Commodity price increases can compel ZFI to raise its selling prices or pass along the increased expenses.

Increasing vehicle prices

The cost of vehicles has gone up to keep up with rising commodities prices and regulatory requirements, particularly pollution standards. Prices would increase further more if pollution standards for tractors and CV were made much stricter.

Rising competition

Competition issues for ZFI may arise if current players increase their stakes or if new players enter the market.

Low return ratios

Due to its poor PAT margins, low level of leverage, and low sales-to-fixed-assets ratio, ZFI generated low return ratios from FY19 to FY22. We anticipate that return ratios will increase in the upcoming years due to increasing capacity utilization.

Litigation by ZF group

ZF Friedrichshafen AG (ZF AG) informed ZFI that its trademarks "ZF" and/or "ZF India" had been violated. In addition to other things, ZF AG is said to have asked for Rs 100 crore in damages from the company and given it the option to meet and talk about the situation. The ZFI authorized representatives did speak with ZF AG in an impartial manner. ZF AG immediately ended the negotiations and discussions, nevertheless. On June 30, 2023, ZFI filed business lawsuits with the Honorable District Court of Pune.

VALUATION:

ZF Steering Gear (India) Ltd. (ZFI) stands as a significant player in the automotive sector, particularly in the tractor and commercial vehicle (CV) steering systems market. ZFI, in collaboration with the Rane Group, maintains dominance over approximately 90% of the domestic market for Medium and Heavy Commercial Vehicles (M&HCV) and tractor steering systems. This market structure predominantly operates as a duopoly. The prevalence of power steering has steadily grown in M&HCVs and tractors due to its driver convenience and necessity. Furthermore, the cost of power steering has substantially decreased in relation to the overall vehicle cost, thus stimulating higher adoption by businesses. In the fiscal year 2023, the Indian CV cycle exhibited notable growth, and a further increase of 2 to 4 percent is projected for the fiscal year 2024. Augmenting capacity utilization rates would enhance operational efficiency and bolster the company's profit margins. ZFI has also taken proactive measures to ensure backward compatibility, including the establishment of two wholly-owned subsidiaries and the allocation of land. Improved control over input costs is expected to yield further margin enhancements. On October 3, 2022, we initiated coverage on the stock, recommending investors to "Buy within the Rs. 540–550 range and consider adding during declines in the Rs. 480–490 range." This recommendation was made with a base case fair value target of Rs. 611 and a bull case fair value target of Rs. 649 to be achieved over the subsequent 2-3 quarters. Both these objectives were successfully met within the stipulated time frame. Looking forward, we anticipate ZFI's revenue, EBITDA, and PAT to experience a compound annual growth rate (CAGR) of 12% from FY23 to FY25E, with a target price of Rs. 910.

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