In Top Gear - ZF Steering Gears (India)

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We at DSIJ believe that the auto ancillary sector is certainly the flavour of this fiscal. And in this with a topline and bottomline growth of 30 per cent and 100 per cent respectively in FY10, 20 years’ dividend track record, FY10 dividend of Rs 8.5 per share resulting in a dividend yield of 2.9 per cent, capacity expansion, liquid investments of Rs 106 per share, low debt status, expanding margins and low valuations, there could have been no better pick than ZF Steering Gears (India) (ZFS). ZFS is a manufacturer of power and mechanical steering systems in India. About 85 per cent of its revenues come from power steering systems, while 15 per cent are derived from mechanical steering systems.

The power steering systems find applications in commercial and passenger vehicles, while the mechanical steering systems are used in tractors and some construction equipments. There are reasons why we believe that ZFS will do well. First and foremost, the auto sector has bounced back. It continues to deliver numbers and Q1FY11 was no different with 35 per cent and 33 per cent growth in commercial vehicles and passenger vehicles.

Thus with such strong numbers and demand in place, there is bound to be incremental demand for ZFS’ products as well. In fact ZFS is already expanding its capacities in the wake of this demand.

The company has increased its capacity of mechanical steering gears from 1,40,000 units to 1,80,000 units by March 2010 and this capacity is expected to be ramped up to 2,10,000 units, while power steering capacity is also in the process of being increased to touch 3,00,000 units from 2,20,000 units currently. ZFS has an enviable list of clients that includes Tata Motors, Ashok Leyland, Force Motors, Daimler, Eicher Motors, Swaraj Mazda, Volvo India, International Tractors (Sonalika), Mahindra & Mahindra, etc. ZFS continues to add new clients and has also introduced new products. Besides, with strong client list and its presence in Pune, one of the country’s major auto hubs, it strengthens its growth prospects further. But the icing on the cake comes with the huge cash and liquid investments in its books, worth Rs 96.48 crore or Rs 106.37 per share. This makes up almost 36 per cent of the total market cap of ZFS.

That apart, ZFS is also a low-debt company with its DE ratio at a mere 0.2x. Thus, with low interest outgo the margins would tend to remain healthy. Moroever, with ZFS commissioning 5 MW of windmills to add to its existing 1.7 MW capacity will help it cover 90 per cent of its power requirement in FY11 as compared to 30 per cent in FY10. [PAGE BREAK]

This will reduce its power cost and help expand margins further, which already have improved in FY10 by 374 bps and 433 bps on the operating and net levels.For FY10 ZFS’ topline increased by 30 per cent Rs 216 crore (Rs 166 crore), while profits increased by 100 per cent to Rs 28.66 crore (Rs 14.31 crore).

At these numbers ZFS is available at a PE of 9x and EV/EBDITA of 6x, which is low and up for grabs with a target price of Rs 410.