NEUTRAL

Automobiles
India OCTOBER 10, 2016
THEME
BSE-30: 28,061

Bearing fruit. We believe the Indian bearing industry is at an inflection point with
promising long-term growth prospects led by step change in technology, which is likely
to increase bearing content. Our positive view on the sector is underpinned by (1)
double-digit growth potential over the next 10 years, (2) relatively consolidated nature
of the industry, (3) reasonable pricing power and (4) strong cashflow generation and
return ratios. We initiate coverage with BUY rating on FAG Bearings (TP ₹5,000),
ADD rating on Timken India (TP ₹630) and REDUCE on SKF India (TP ₹1,400).

Strong long-term growth prospects; organized players well placed for market share gain

We expect the Indian bearing industry to grow at 13% CAGR over FY2016-25 period led by
(1) double-digit growth in automobile demand, (2) increase in bearing content with the adoption
of next generation bearings particularly in passenger vehicles and railways and (3) gradual
recovery in industrial segments led by pickup in economic growth. We believe that increase in
the use of more complex and technologically superior bearings augurs well for the top MNC
bearing manufacturers in India. We expect players such as SKF India, FAG Bearings and Timken
India to gain 100-200 bps market share over the next five years.

Increased use of third generation bearings to drive content increase in passenger vehicles

As per our understanding, bearing content per vehicle in the passenger vehicle industry is
₹3,000/vehicle (~0.6% of vehicle price), which is one third that of content per vehicle in
developed markets. In India, OEMs still use elementary bearing technology, which will likely
change with (1) the government’s focus on stringent emission and safety regulations and
(2) OEMs’ efforts to increase fuel efficiency and improve vehicle performance. As per our
checks, OEMs are already migrating to third-generation bearings due to increase in focus on
improving mileage and vehicle performance. Overall, we expect penetration of next generation
bearings to increase to 50% over the next five years from 18% currently.

Modernization of railways to drive adoption of next generation bearing technology

The government’s plans to upgrade railway infrastructure with dedicated freight corridors,
high-speed trains and metros in big cities would lead to significant demand for bearings from
the railways sector (17% CAGR over FY2016-25E). Higher load carrying capacity of wagons
and increase in train speed would drive demand for ‘Class K’ railway bearings as compared to
‘Class E’ bearings, which are used currently leading to increase in overall bearing content.
Similarly, increase in focus on high-speed passenger trains and metro rail will lead to higher
demand for Linke Hofmann Busch coaches; bearing content in these coaches is 2-3X that of
normal coaches.

Initiate coverage with BUY rating on FAG, ADD on Timken India and REDUCE on SKF India
Nishit Jalan
FAG Bearings is our top pick in the sector as we believe that the company is well placed to
capture the changing trends in the industry. Timken India has strong product positioning in
focused segments, which will drive further market share gains for the company. We expect the Hitesh Goel
company to deliver 25% EPS CAGR over the next four years and initiate coverage with ADD
rating. We are excited about SKF India’s technological prowess and growth prospects, but are
concerned about higher sourcing from unlisted parent entity, which drives our REDUCE rating
on the stock.

For Private Circulation Only. FOR IMPORTANT INFORMATION ABOUT KOTAK SECURITIES’ RATING SYSTEM AND OTHER DISCLOSURES, REFER TO THE END OF THIS MATERIAL.
Automobiles India

OVERVIEW: INDUSTRY AT INFLEXTION POINT; LONG-TERM GROWTH PROSPECTS STRONG

Bearing industry is a play on (1) improvement in demand for automobiles, (2) expansion and modernization
of the Indian railways and (3) gradual recovery in industrial segments led by the pickup in economic growth.
Technology-driven increase in content per vehicle, particularly in passenger vehicle and railways segments,
augurs well for organized players. Strong long-term growth prospects, relatively consolidated nature of the
industry, reasonable pricing power, strong cashflow generation and superior return ratios underpin our
positive view on the sector. We initiate coverage with BUY rating on FAG Bearings India (FAG IN, TP ₹5,000),
ADD rating on Timken India (TMKN IN, TP ₹630) and REDUCE rating on SKF India (SKF IN, TP ₹1,400).

Bearings: an integral component of automobile and industrial segments

Bearings are critical components in automobiles and most industrial applications as it
reduces friction between moving parts and thus enhances the life of an engine, transmission
and other components. The criticality of a bearing depends primarily upon the load and
rotational speed of the part where it is used. In the automobile segment, bearings account
for 0.5-1.5% of the vehicle price with wheel, engine, transmission and differential bearings
being key components in four-wheelers. Growth prospects of the bearing industry is strong
in India as India still uses elementary bearing technology as the focus of OEMs have been to
reduce costs. However, we believe that stricter emission norms, safety regulations and
modernization of railway infrastructure could lead to significant improvement in bearing
technology, which will likely result in increase in content per vehicle for bearings.

The automotive segment accounts for 52% of the overall bearing industry; 70% of the auto
segment’s revenues comes from supplies to OEMs while after-market accounts for the
remaining 30% of automotive revenues. Two-wheeler OEM is the largest automotive
segment, followed by passenger vehicle and commercial vehicle segments. Industrial
segment accounts for the remaining 48% of the bearing industry; railway is the largest sub-
segment accounting for 22% of industrial revenues. After-market accounts for 37% of the
industrial segment and other process industries (wind, power, cement and steel) account for
the remaining ~40%.

Exhibit 1: Bearings account for 0.5-1.5% of vehicle price; significant scope for increase in content particularly in passenger vehicles
Size of key bearing segments, content per vehicle, key players across segments (₹ bn, %)
FY2016 revenues As % of Average bearing content Major players
Segment (Rs bn) industry size Per vehicle (Rs) As % of vehicle price across segments Growth prospects & key drivers
Automotive segments
Segment growth will be largely driven by two-wheeler
Two-wheelers 13.3 14.0 700 1.0-1.5 SKF, FAG, NRB OEM industry volumes; limited scope for increase in
bearing content
Mid-teen growth prospects; OEM industry growth and
Trucks and tractors 10.4 10.9 3,000-22,000 0.5-1.5 Timken, FAG, SKF, NEI increase in content per vehicle due to stringent emisson
norms are key growth drivers
Strong long-term growth prospects driven by double-digit
FAG, SKF, NEI, NSK,
Passenger vehicles 10.3 10.9 3,000 0.5-1.0 growth in passenger vehicle industry volumes and shift
JTEKT
towards third generation bearings
Total automotive OEM 34.0 35.8
SKF, FAG, NEI, Timken, Steady 8-12% growth prospects; increase in product
Replacement market 15.0 15.8
Chinese imports complexity positive for bigger players over the long-term
Expect 14% revenue CAGR over FY2016-25E;
Total automotive segment 49.0 51.6
passenger vehicle segment is the key growth driver
Industrial segments
Strong long-term growth prospects led by government's
Railways 10.0 10.5 NEI, SKF, Timken, FAG focus on dedicated freight corridor, high speed
passenger trains and metros
Wind energy is an important segment accounting for 25-
SKF, FAG, Timken, NEI,
Other industrial segments 19.0 20.0 30% of segment revenues; success of 'Make in India'
Chinese imports
could lead to stronger-than-expected growth
SKF, FAG, Timken, NEI, Power, steel and cement are key segments; cheaper
Replacement market 17.0 17.9
Chinese imports imports from China is a key threat for organized players
Expect 12% revenue CAGR over FY2016-25E; railways
Total industrial segment 46.0 48.4
segment is the key growth driver
Overall bearing industry 95.0 100.0 Expect 13% revenue CAGR over FY2016-25E

Source: Kotak Institutional Equities estimates

KOTAK INSTITUTIONAL EQUITIES RESEARCH 3

India Automobiles

Strong growth drivers in place; organized players well positioned to gain share
We believe the Indian bearing industry’s revenues can grow at 13% CAGR in the next 10
years led by the following factors.

 Improvement in demand for automobiles: We expect domestic automotive industry’s

production to grow at a 10% volume CAGR over FY2016-25E period, which will be
driven by (1) double-digit growth in passenger and commercial vehicle segments and
(2) high single-digit growth in two-wheeler and tractor segments.

 Technology advancements leading to increase in content per vehicle: We believe

the implementation of stricter emission norms and safety regulations in the Indian
automobile sector will lead to increased demand for more complex and technologically
advanced bearings. In particular, bearing content per passenger vehicle in India could
increase significantly in the next 10 years (75% increase over FY2016-25E) due to higher
adoption of third-generation bearings. As per our understanding, the content per
passenger vehicle in India is one-third that of developed markets. Third-generation
bearings are priced 2X more than first generation bearings as they offer additional
functions – (1) two flanges; one for mounting brake on the wheel and the second to
integrate the vehicle suspension and (2) integrated speed sensors to provide the required
signal for ABS/ESP control (discussed in detail in subsequent sections).

 Expansion and modernization of railways: Government’s plans to upgrade railway

infrastructure with dedicated freight corridors, high-speed trains and metros in big cities
would lead to significant demand for bearings from the railways sector (17% CAGR over
FY2016-25E). Higher load carrying capacity of wagons and increase in train speed would
drive demand for ‘Çlass K’ railway bearings as compared to ‘Class E’ bearings used
currently leading to an increase in content per vehicle (Class K bearings are around 70%
more expensive than Class E bearings). Similarly, increased focus on higher-speed
passenger trains and metro rail will lead to higher demand for Linke Hofmann Busch
(LHB) coaches; the bearing content in these coaches is 2-3X more than in normal
passenger train coaches.

 Gradual recovery in capex cycle: Improvement in industrial capex will lead to increase
in demand for bearings from process industries such as cement, power and steel. We
note that demand from this segment has been flat in the last five years (since FY2011)
and therefore, improvement in economic growth and success of government’s ‘Make in
India’ could drive strong demand from this segment.

 Organized players to gain market share in the long term: Imports and the
unorganized industry form a large chunk of the bearing industry (30% of overall industry)
especially in aftermarket and select industrial segments. We believe the increase in the
use of more complex and technologically superior bearings augurs well for the top MNC
bearing manufactures in India. Overall, we expect players such as FAG Bearings, SKF India
and Timken India to gain market share and deliver around 15% revenue CAGR in the
next 10 years.

4 KOTAK INSTITUTIONAL EQUITIES RESEARCH

Automobiles India

Exhibit 2: We expect bearing industry to grow at 13% CAGR over FY2016-25E

Domestic bearing industry growth forecasts, March fiscal year-ends, 2014-25E (₹ bn)

(Rs bn) Automotive segment Industrial segment

350

300

250
131
200 117
103
150 91
78
67
100 58
51 159
46 47 140
43 47 124
50 94 108
71 82
49 55 62
40 44
-
2014 2015 2016 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025E

Source: FAG India annual report, Kotak Institutional Equities estimates

Exhibit 3: Domestic automotive industry likely to have higher safety standards and stringent emission
norms
Timeline of upcoming government regulations across automotive segments
Commercial vehicles
1. Comply with BS-IV emission standards versus BS-III emission norms currently
(a) Effective from April 1, 2017 for all models
2. Comply with BS-VI emission standards from April 1, 2020
Passenger vehicles
1. Implementation of BS-IV norms in remaining towns and cities from April 1, 2017
2. Mandatory crash test norms - frontal crash tests will be at 56 kmph, while the norm set for side crash tests is 50 kmph
(a) from October 1, 2017 for new models and
(b) from October 1, 2018 for all existing models
3. Comply with BS-VI emission standards from April 1, 2020
Two-wheelers
1. Comply with BS-IV emission standards versus BS-III emission norms currently
(a) from April 1, 2017 for new models and
(b) from April 1, 2018 for all existing models
2. Mandatory ABS for all vehicles with an engine capacity above 125cc and CBS for vehicles below 125cc engine
(a) from April 1, 2018 for new models and
(b) from April 1, 2019 for all existing models
3. Comply with BS-VI emission standards from April 1, 2020

Source: Ministry of Road Transport, Kotak Institutional Equities

KOTAK INSTITUTIONAL EQUITIES RESEARCH 5

India Automobiles

Exhibit 4: Top five players account for 65% of industry Exhibit 5: Share of top players to increase over the long term
Domestic revenue market share of bearing manufacturers, March Domestic market share of bearing manufacturers, March fiscal year-
fiscal year-end, 2016 (%) end, 2025E (%)

SKF, 22.8
Others, SKF, 24.3
29.6

Others,
48.0
JTEKT-
Koyo, 1.6 FAG, 14.8
ABC, 1.9
FAG, 17.9
NSK, 2.4

NRB, 5.3
Timken, NEI, 14.7 Timken,
6.9
9.9

Source: Companies, Kotak Institutional Equities Source: Companies, Kotak Institutional Equities

Exhibit 6: Organized players have gained market share over FY2008-16 period
Domestic market share of different bearing manufacturers, March fiscal year-ends, 2008-16 (₹ bn, %)

2008 2009 2010 2011 2012 2013 2014 2015 2016

Domestic revenues (Rs bn)
SKF 14.1 14.7 14.6 18.8 21.9 20.5 20.4 21.6 21.6
FAG 5.5 6.3 7.4 9.4 11.4 12.4 11.7 13.3 14.1
NEI 5.3 5.9 7.3 8.9 10.2 10.7 12.0 13.0 14.0
Timken 2.1 2.2 2.2 3.0 4.7 4.7 4.4 5.4 6.5
NRB 2.9 2.5 3.3 4.3 4.9 4.4 4.6 5.1 5.0
NSK — NA 0.3 0.6 1.2 2.3 2.1 2.2 2.3
ABC 1.7 1.3 1.6 2.0 1.8 1.5 1.4 1.6 1.8
JTEKT-Koyo — — — — NA 1.1 1.0 1.5 1.5
Others 22.3 24.0 23.3 32.9 28.9 25.0 25.3 26.8 28.1
Total bearing industry 54.0 57.0 60.0 80.0 85.0 82.5 83.0 90.5 95.0
Market share (%)
SKF 26.2 25.7 24.3 23.5 25.8 24.8 24.6 23.9 22.8
FAG 10.2 11.1 12.4 11.8 13.4 15.0 14.1 14.6 14.8
NEI 9.8 10.4 12.1 11.2 12.0 13.0 14.4 14.3 14.7
Timken 3.9 3.9 3.6 3.7 5.5 5.7 5.3 6.0 6.9
NRB 5.4 4.4 5.4 5.4 5.8 5.3 5.6 5.6 5.3
NSK — NA 0.6 0.7 1.5 2.8 2.5 2.4 2.4
ABC 3.1 2.3 2.7 2.5 2.1 1.8 1.7 1.8 1.9
JTEKT-Koyo — — — — NA 1.4 1.2 1.6 1.6
Others 41.4 42.1 38.9 41.2 34.0 30.3 30.5 29.7 29.6
Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0

Notes:
(a) For companies with calender year-ends (FAG), FY2016 represents CY2015 data.
(b) For unlisted organized players, actual data is available till FY2015; FY2016 revenues are our estimates.

Source: Companies, Ministry of Corporate Affairs, Kotak Institutional Equities

6 KOTAK INSTITUTIONAL EQUITIES RESEARCH

Automobiles India

Initiate coverage on bearings sector; FAG Bearings is our top pick

We initiate coverage with BUY rating on FAG Bearings India (FAG IN, TP ₹5,000), ADD
rating on Timken India (TMKN IN, TP ₹630) and REDUCE rating on SKF India (SKF IN, TP
₹1,400). We use DCF-based valuation methodology to arrive at target prices of these
companies as DCF will better capture the robust long-term growth potential of the industry,
in our view. We believe that Indian bearing industry is still at a nascent stage and industry
revenues can grow at 13% CAGR to ₹290 bn (~US$4.1 bn) by FY2025E. To put things in
perspective, the current size of bearing industry in China is >US$25 bn, which is expected to
increase to US$58 bn by CY2023, as per industry reports (refer to Exhibit 7 for details).

Our target price for FAG and Timken India implies PE multiple of 26X on September 2018E
EPS and 23X for SKF India. Valuation multiples for these companies are largely comparable
to the current trading multiples of tier 1 auto ancillaries as well as large companies in the
industrial segment which are plays on domestic capex cycle recovery (refer to Exhibit 10).
We note that growth trajectory and return ratios of bearing companies will likely mirror that
of Tier-1 auto ancillaries in the medium-term. Bearing companies along with top auto
ancillaries are major beneficiaries of increasing content per vehicle due to the government’s
focus on implementation of stringent emission norms and safety regulations. We would also
like to highlight that in the past five years, bearing companies have delivered superior
earnings growth as compared to large industrial segment companies and also have stronger
balance sheets and superior return ratios.

 We expect FAG, Timken and SKF India to deliver 18%, 20% and 16% EPS CAGR over
FY2016-25E respectively led by 14-16% revenue CAGR and improvement in profitability.
We note that revenue growth for the industry and these players will be particularly strong
over FY2020-22E period driven by (1) 22% CAGR in the railways segment due to
increased demand for high-speed wagons post commissioning of the Dedicated Freight
Corridors (DFC), (2) increase in content per vehicle in automotive segments due to
implementation of BS-VI emission standards and (3) ~20% CAGR in the passenger vehicle
segment led by increase in adoption of third generation bearings.

 Core post-tax RoEs/RoCEs (excluding cash) of bearing companies will improve to >25%
levels in the next 2-3 years from 17-20% levels currently.

 Bearing companies have net cash balance sheets and will generate strong free cashflow
in the long term. FCF-to-PAT ratio in the next 10 years will be around 40-45% for SKF
and Timken India and around 55% for FAG India.

Exhibit 7: Global bearing industry stood at US$74 bn in CY2013

Global bearing industry size, calendar year-ends, 2008-23 (US$ bn, %)

Bearing industry size (US$ bn) CAGR (%)

2008 2013 2018E 2023E 2008-13 2013-18E 2013-23E
North America 12.0 13.3 17.5 21.9 2.1 5.6 5.1
United States 9.7 10.1 13.5 16.7 0.8 6.0 5.2
Western Europe 15.5 13.8 17.0 20.5 (2.3) 4.3 4.0
Asia-Pacific 27.1 37.6 57.7 87.8 6.8 8.9 8.9
China 12.2 21.0 35.6 58.1 11.5 11.1 10.7
Japan 7.7 6.9 7.9 8.9 (2.2) 2.7 2.6
Others 7.2 9.7 14.2 20.8 6.1 7.9 7.9
Other regions 7.9 9.0 12.4 16.8 2.6 6.6 6.4
Total 62.5 73.7 104.6 147.0 3.4 7.3 7.1

Source: Freedonia World Bearings report, Kotak Institutional Equities

KOTAK INSTITUTIONAL EQUITIES RESEARCH 7

India Automobiles

Exhibit 8: Schaeffler Group is the global leader in automotive Exhibit 9: SKF is the global leader in industrial segment
bearings segment Global market share in industrial bearing segment, calendar year-end,
Global market share in automotive bearing segment, calendar year- 2014
end, 2014

Source: SKF Group presentation Source: SKF Group presentation

Exhibit 10: Domestic bearing companies: Strong growth prospects and return ratios justify premium valuations
Global and domestic peer comparison, March fiscal year-ends, 2016-19E

Price Market cap. EPS CAGR (%) P/E (X) EV/EBITDA (X) RoE (%)
(LC) (US$ mn) 2011-16 2016-19E 2016 2017E 2018E 2016 2017E 2018E 2016 2017E 2018E
Domestic bearing companies
SKF India 1,437 1,135 2.8 18.9 37.3 29.9 25.7 23.8 19.7 16.8 13.6 15.4 16.2
FAG Bearings India (a) 4,130 1,028 9.9 18.5 34.8 31.2 25.4 20.9 18.3 15.2 16.5 15.9 17.0
Timken India 580 590 11.0 24.1 42.0 35.7 27.4 23.8 20.7 16.0 19.5 19.3 21.1
NRB Bearnings 132 192 (4.7) NA 30.5 20.8 16.7 13.7 10.9 9.3 15.8 20.0 21.5
Global bearing companies
Schaeffler (a) 14 10,234 NA 11.7 11.0 9.0 8.4 6.7 5.5 5.0 92.6 56.5 42.7
SKF (a) 148 7,792 0.4 (0.7) 12.2 15.0 13.4 8.2 9.2 8.3 23.1 16.8 18.4
NSK Ltd 1,101 5,852 20.8 (6.5) 8.9 13.5 12.2 5.2 6.3 5.7 14.3 9.7 10.2
JTEKT 1,566 5,184 21.0 (3.0) 9.8 12.8 11.9 4.7 5.4 4.9 11.8 9.5 10.0
The Timken Company (a) 36 2,808 (38.5) 106.2 NA 18.3 17.2 7.6 8.3 7.6 NA 11.1 9.9
NTN Corporation 376 1,930 0.9 15.7 13.3 12.8 10.1 5.4 6.2 5.8 6.3 6.8 8.4
Median 0.9 5.5 11.0 13.2 12.1 6.0 6.2 5.7 14.3 10.4 10.1
Mean 0.9 20.6 11.0 13.6 12.2 6.3 6.8 6.2 29.6 18.4 16.6
Domestic Tier 1 Auto ancillaries
Bosch 23,136 10,881 7.7 24.4 58.3 47.3 36.3 37.5 31.9 24.2 15.9 16.8 19.0
Motherson Sumi Systems 329 6,918 16.6 21.1 34.1 28.0 22.6 13.5 11.7 9.6 33.8 32.8 32.8
Bharat Forge 957 3,335 17.5 19.1 35.0 37.9 27.6 17.4 18.6 14.5 18.5 15.8 19.1
Amara Raja Batteries 1,048 2,681 27.0 15.7 36.6 30.8 27.2 21.8 17.8 15.9 25.8 25.0 23.6
Exide Industries 193 2,460 0.0 1.1 26.4 24.8 22.8 16.3 14.8 13.7 14.7 14.3 14.2
Wabco India 6,117 1,738 9.9 24.7 56.7 38.7 33.6 38.1 25.0 21.2 21.3 25.2 23.3
Median 13.3 20.1 35.8 34.3 27.4 19.6 18.2 15.2 19.9 20.9 21.2
Mean 13.1 17.7 41.2 34.6 28.4 24.1 20.0 16.5 21.7 21.6 22.0
Domestic industrial segment - capex cycle plays
L&T 1,457 20,338 2.0 19.9 28.6 26.3 20.0 18.7 19.3 17.0 12.9 13.4 16.1
Siemens 1,243 6,631 (4.6) 30.1 68.0 46.8 38.4 38.3 29.1 23.8 11.1 13.8 15.8
BHEL 135 4,956 NA NA NA 59.2 27.1 NA 26.9 10.9 (2.7) 1.7 3.6
ABB 1,148 3,642 36.4 37.6 81.1 62.5 41.6 34.2 30.1 22.9 10.3 12.4 16.8
Cummins 910 3,780 3.2 10.9 34.4 32.0 27.9 32.7 29.8 25.6 24.2 23.7 24.6
Thermax 893 1,594 (6.3) 15.6 38.7 34.6 31.5 24.3 22.6 20.2 12.2 12.5 12.5
Carborundum Universal 293 828 (3.5) 30.2 38.5 28.2 21.6 19.0 15.0 12.0 12.6 15.7 18.3
Domestic industrial segment - capex cycle plays
Median (3.5) 30.1 38.7 40.7 29.7 32.7 28.0 21.5 11.6 13.1 16.3
Mean 5.0 24.9 52.1 43.9 31.4 29.7 25.6 19.2 11.3 13.3 15.3

Notes:
(a) For companies with calender year-ends, FY2016-19E represents CY2015-18E data.

Source: Companies, Kotak Institutional Equities estimates

8 KOTAK INSTITUTIONAL EQUITIES RESEARCH

Automobiles India

FAG Bearings: Top pick in the sector; well-diversified with superior return ratios

FAG Bearings India is the subsidiary of Germany-based Schaeffler Group (51% holding),
which is the world’s largest bearing manufacturer for the automobile sector and number
two player in the overall bearing industry. The company is the second-largest player in India
with ~15% market share, well-diversified across segments and is the market leader in the
passenger vehicle segment. It has a strong track record which is reflected in 500 bps market
share gain in the past 10 years. Further, FAG has the lowest share of revenues from the
trading segment among large players which augurs well for the company’s profitability and
return ratios. We expect the company to gain ~300 bps market share in the next 10 years
and deliver 15%/18% revenue/EPS CAGR over FY2016-25E. We initiate coverage with BUY
rating and DCF-based target price of ₹5,000/share.

Timken India: Play on strong growth in railways and commercial vehicle segments

Timken India is the subsidiary of US-based Timken Company (75% stake), which is one of
the top six global bearing players with primary focus on manufacturing tapered roller
bearings. In India, Timken is a niche player (7% overall market share) with heavy trucks and
railway freight segments (one of the top two players in both these segments) accounting for
more than 60% of its domestic revenues. Exports have grown at 30% CAGR in the past six
years (accounts for 35% of overall revenues) due to the parent’s focus on sourcing bearings
from low-cost countries. We expect the company to sustain strong growth momentum in its
focused segments and deliver 16%/20% revenue/EPS CAGR over FY2016-25E. We initiate
coverage with ADD rating and DCF-based target price of ₹630/share.

SKF India: Market leader with potential for further market share gains
SKF India is the subsidiary of Sweden-based SKF Group (~54% stake), which is the largest
bearing manufacturing company globally. The company is the market leader in India with
around 23% market share. SKF India has lost 300 bps in market share over FY2008-16 to
FAG, NEI and Timken India driven by scale-up of products in passenger vehicle and railway
segments by competitors. SKF has received orders for third-generation bearings in PVs and
has also developed new products for the railways segment. This, coupled with our view of
market share gain for organized players due to increasing product complexity, will lead to
150 bps market share gain for the company in the next 10 years.

While we are excited about the strong growth prospects of the bearing industry in India and
SKF’s technological prowess, we are a bit concerned about the structure of SKF India. SKF
India only books trading income for supplies to railways and most other industrial segments
(manufacturing is done by unlisted Indian subsidiary SKF Technologies of SKF Group and it
imports some bearings as well); thus only a part of profitability will flow through the listed
entity unless the company decides to increase in-house manufacturing of industrial bearings.
Due to the higher trading mix, SKF India’s RoE is inferior to that of FAG Bearings and Timken
India while all three companies have largely similar growth trajectories. Hence, we believe
SKF India will trade at a discount to both FAG and Timken India until SKF India’s return
profile catches up with its peers. We expect SKF to deliver 14%/16% revenue/EPS CAGR
over FY2016-25E and initiate with REDUCE rating and DCF-based target price of
₹1,400/share.

KOTAK INSTITUTIONAL EQUITIES RESEARCH 9

India Automobiles

Exhibit 11: SKF India has higher traded revenue mix and lower RoE as compared to other players
Comparison of FAG India, SKF India and Timken India across different parameters segments, March fiscal year-
ends, 2014-16

SKF FAG Timken

FY2016 market share in domestic bearing industry (%) 22.8 14.8 6.9
FY2016 revenue mix (%)
Passenger vehicles 6.5 10.1 —
Trucks and Tractors 6.2 7.5 18.0
Two-wheelers 17.3 9.0 —
Total automotive OEM 29.9 26.6 18.0
Auto replacement 14.2 10.5 6.6
Total automotive segment 44.1 37.1 24.6
Railways 8.5 7.0 19.0
Other industrial segments 39.9 38.5 20.7
Total industrial segment 48.4 45.5 39.7
Total domestic revenues 92.5 82.6 64.3
Exports 7.5 17.4 35.7
5-year CAGR (%)
Revenues 2.8 10.6 17.8
EBITDA 0.7 10.7 17.9
Net profit 2.8 9.9 12.5
Revenues from traded goods as % of total revenues - FY2016 44.5 29.7 34.1
Costs and profitability (%) - FY2016
Raw material cost to sales 62.5 57.2 60.1
Employee cost to sales 8.4 7.6 6.4
Other expenses to sales 17.0 17.4 18.1
EBITDA margin 12.0 17.7 15.3
EBIT margin 9.8 13.9 13.2
Key balance sheet ratios - Last 3-yr average
Working capital days 58 61 100
Inventory 45 45 66
Debtors 58 71 70
Creditors 45 54 37
Fixed asset turnover (X) 2.5 2.1 2.9
Net debt to equity (X) (0.4) (0.3) (0.1)
RoE (%) 14.1 14.7 17.2
RoCE (%) 16.7 16.5 18.0

FCF-to-PAT ratio (%) - Last 3-yr average 52 62 33

Source: Companies, Kotak Institutional Equities

10 KOTAK INSTITUTIONAL EQUITIES RESEARCH