Shanthi Gears Ltd.

Initiating Coverage
Shanthi Gears Ltd.

April 28, 2022

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 Shanthi Gears Ltd.

Industry LTP Recommendation Base Case Fair Value Bull Case Fair Value Time Horizon

Industrial Equipments Rs 204 Buy in Rs 203-207 band & add more on dips to Rs 180-184 band Rs 224 Rs 238 2 quarters

Our Take:
HDFC Scrip Code SHAGEAEQNR
Shanthi Gears Ltd. (SGL) is an Industrial Gearing Solutions company supplying gears and gearboxes to different industries. It has an in-house
BSE Code 522034
R&D and designing capabilities developing better products which has helped its clients to improve productivity and save on costs. It is now
NSE Code SHANTIGEAR
focussing on developing products for export market and looking to increase its exports. Strong growth in end user industries like Steel,
Bloomberg SG IN
CMP Apr 27, 2022 203.9 Cement, Power, Paper, etc. is likely to increase demand for gears. Further, the company is part of the Murugappa group and exploring the
Equity Capital (Rs cr) 7.7 possibilities of jointly marketing products with Tube Investments (TI) and CG Power (CG). This could lead to strong topline growth and lower
Face Value (Rs) 1 costs resulting in margin expansion going forward.
Equity Share O/S (cr) 7.7
Market Cap (Rs cr) 1565 Valuation & Recommendation:
Book Value (Rs) 30.9 The management has targeted sales to double between FY21-FY24E and profit to triple in the same period. We expect SGL’s
Avg. 52 Wk Volumes 208,800 Revenue/EBITDA/PAT to grow at 25/39/39% CAGR over FY21-FY24E, led by increased demand from end user industries. We believe investors
52 Week High (Rs) 219.9 can buy the stock in Rs 203-207 band and add on dips to Rs 180-184 band (25.5x FY24E EPS) for a base case fair value of Rs 224 (31.5x FY24E
52 Week Low (Rs) 130.9 EPS) and bull case fair value of Rs 238 (33.5x FY24E EPS) over the next 2 quarters.

Share holding Pattern % (Mar 2022) Financial Summary

Promoters 70.5 Particulars (Rs cr) Q3FY22 Q3FY21 YoY (%) Q2FY22 QoQ (%) FY21 FY22E FY23E FY24E
Institutions 3.8 Operating Income 95 65 46.1 72 32.0 216 319 370 416
Non Institutions 25.7 EBITDA 17 11 64.8 12 46.9 27 56 64 72
Total 100.0 APAT 14 8 78.8 8 74.3 20 41 48 55
Diluted EPS (Rs) 1.8 1.0 78.8 1.0 74.3 2.6 5.4 6.3 7.1
RoE (%) 8.7 16.5 17.3 17.7
P/E (x) 77.5 37.8 32.5 28.7
EV/EBITDA (x) 57.8 27.6 23.9 21.0
(Source: Company, HDFC sec)
* Refer at the end for explanation on Risk Ratings

Fundamental Research Analyst

Atul Karwa
[email protected]

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 Shanthi Gears Ltd.
Q3FY22 Result Review
SGL reported strong growth for Q3FY22 with highest ever revenue of Rs 95cr, growth of 46% YoY. Focus on cost optimisation led to 65%
increase in EBITDA to Rs 17cr. EBITDA margin expanded ~210bps to 18.3%. Lower tax rate led to 79% increase in PAT and PAT margin
expanded ~260bps to 14.5%. During the quarter, the company registered an order booking of Rs 93cr and outstanding order book as on 31st
December 2021 stood at Rs 272cr. The Board declared an interim dividend of Rs 2.5/- per share for the financial year 2021-22.

Key Triggers
Superior product development capabilities
SGL has an in-house R&D and design facilities and has been developing better products which has helped its clients to improve productivity
and save on costs. It is also focusing on developing products for the export market. In FY21, it developed 14 parts for a new application
called, Airport Fire Rescue system, which were exported to US and now it has got regular business. Similarly, for a German customer it
developed 4 parts for High speed application gear and now getting regular business. Even for marine applications the company is getting
strong orders. Export revenue grew 27% YoY in FY21 and the company expects faster growth in exports.

In Q1FY22, SGL executed the prestigious order from one of the surface mining company, the height of this Gear Box is almost 15 feet. Also,
it developed new products for the Agra- Kanpur project, the rotary head gearbox for the pilling rig machine. Also, it has received first order
for the 750 KW wind mill gear boxes. And the maiden order received for the Main battle tank. It also secured a screw compressor gear, from
a major global OEM.

Strong growth in end user industries

With the increasing trend of population and income levels in India, industries like FMCG, Steel, Cement, Power, Infrastructure and Mining
are in the process of renovating and expanding their manufacturing facilities to meet the rising demand. The estimated market size of
industrial gearboxes in India is Rs 2,000cr and is expected to reach to Rs 2,600cr in next four years. Also, India is focusing on renewable
sources to generate energy and to achieve 40% of its energy from non-fossil sources by 2030 which brings the opportunity for the Wind mill
segment.

Industry Growth Drivers

Steel Boosted by higher spends on infrastructure and gradual revival of the automotive sector, India’s steel demand growth will
be the highest in 2022 at 7.5% among top consuming nations, including China and the US, according to the World Steel
Association (WSA).
Cement Cement Production in India is expected to touch 550 Million tonnes in 2025 from the current level of 327 Million tonnes.
Heavy expansions with entry of foreign players is expected due to steady demand and healthy profit margins. As India has

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a high quantity and quality of limestone deposits throughout the country, the Cement Industry promises huge potential
for growth.
Power Steady increase in peak demand for electricity in the country is expected at 6% CAGR for the next 4 years. Installed
renewable energy is 155 GW (Mar’22) which meets 38-40% of the total demand. The country is aiming for even more
ambitious target of 57% of the total electricity capacity from renewable sources by 2027.
Printing & Paper The Indian paper industry is estimated to be about 20 metric tonnes per annum (MTPA) and expected to average an annual
growth rate of 8-9 percent over the next five years, led by robust growth in packaging grades.
Mining and Minerals Mining plays an important role in Indian Industry, which significantly contributes to the Indian economy. The Government
has declared Mining as “essential service” and allowed the production and transportation of minerals during the country-
wide lock down. Several initiatives such “Mining and Mineral Policy” reforms are also taken to ramp up production and
maximize capacity utilization.

Healthy order book providing revenue visibility

The company had a healthy order book position, aided by higher capital and infrastructure expenditure undertaken in the end-user industries
such as engineering, steel industries, among others and increase in replacement orders from its end customers. As of Q3FY22, SGL’s order
book position stood at Rs 272cr (FY21: Rs 125cr). Generally, 80% of the order book gets executed within 12 months. The healthy order book
provides revenue visibility for the next few months.

Order Inflow and Order Backlog (Rs cr)

(Source: Company, HDFC sec)

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 Shanthi Gears Ltd.

Synergies with TI and CG could drive healthy topline growth

SGL is exploring the possibilities of jointly marketing products with Tube Investments (TI) and CG Power (CG). TI has more knowledge on
Metallurgy and heat treatment process which SGL uses, while CG makes motors which can be combined with SGL gears. We believe the
companies are likely to combine their knowledge and launch newer and better products. This would enable strong topline growth and the
synergies would lead to lower opex.

Strong parentage by virtue of being a subsidiary of Tube Investments of India Limited (TIIL)
TIIL, the flagship company of the Murugappa Group, acquired 70.12% stake in SGL in 2012. Ever since, the company has benefitted from the
strong management support and the operational synergies derived by being a subsidiary of TIIL. On April 9, 2019, SGL has undertaken a share
buyback of fifty lakh equity shares at a cost of Rs. 140 per share, post which TIIL’s stake has increased to 70.47% from 70.12% as on March
31, 2019.

Healthy financials
SGL is a debt-free company with modest capex requirement in the near term. The fund-based working capital utilisation has been nil over the
last eight years. Further it had ~Rs 45cr of cash and equivalents at the end of Q2FY22 indicating a strong liquidity position. We believe the
company is in a strong position to grow its profitability driven by growth in end-user industries. Further, it enjoys strong financial flexibility
and lender comfort, by virtue of being a subsidiary of Tube Investments of India Limited and being part of the well-established Murugappa
Group.

Growth in services business can help provide revenue visibility

Service business is currently 13% of the sales and SGL wants to take it to 20% with respect to the sales. Post Covid, its service personnel are
going on physical visits and trying to build capabilities and increase revenues from this source. The vast number of existing installations
provides a readymade source of repair/servicing in future years.

Risks & Concerns

Moderate scale of operations
The company has a moderate scale of operations with revenue of Rs 215cr in FY21. Higher scale enhances resilience to volatility in demand
and enables better cost absorption.

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Close linkage to capex cycle exposes revenues to cyclicality in end-user industries
SGL’s revenues are exposed to the cyclicality in the domestic capex cycle and any economic slowdown could impact its revenues as witnessed
in the past. However considerable share of revenues from the replacement market and presence across multiple segments with no segment
contributing to more than 25% of the revenues in FY2021, mitigates the risk to an extent.

Margins susceptible to fluctuations in raw material prices

The company’s margins are susceptible to fluctuations in raw material prices due to a lag of two to three months in manufacturing lead time.
Its major raw materials include steel and steel components, the prices of which have increased substantially over the past few months and
are close to multi-year high currently.

Bargaining power with OEMs

Due to its limited scale, the company may face delays in passing on the increase in costs to its customers. Consequently, its margins could get
impacted.

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 Shanthi Gears Ltd.
Company Background:
SGL is an Industrial Gearing Solutions company that designs and manufactures Gears, Gearboxes, Geared Motors and Gear Assemblies.
Commencing business as a gear manufacturer for the textile industry in 1969, the company has diversified over the years into manufacturing
standard (off-the-shelf) and customised (non-standard) gears. It has manufacturing facilities (including a foundry) located in and around
Coimbatore, Tamil Nadu.

SGL’s product portfolio encompasses a range of customised gear boxes, loose gears, worm gear boxes and helical gear boxes used across
various industries. It can manufacture gears from few mm dia to 3,200 mm dia with focus on industries such as Steel, Power, Cement, Mining,
Sugar, Off-Highway, Defense and Railways. SGL is the only gear company in India having AS 9100C certification (Aero Standards) with fully
integrated operations and strong in-house R&D and design capabilities. The Company has a strong marketing network with 15 Offices across
India with a strength of 50 sales / service engineers and a strong distribution setup

In July 2012, Murugappa Group’s Tube Investment of India announced the acquisition of the promoter’s entire 44.12% stake in SGL for a sum
of Rs 292cr. Subsequently, via tendering of an open offer, and a buyback in 2019, TIIL shareholding has increased to 70.47%.

Product portfolio

(Source: Company)

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 Shanthi Gears Ltd.
Financials
Income Statement Balance Sheet
(Rs cr) FY20 FY21 FY22E FY23E FY24E (Rs cr) FY20 FY21 FY22E FY23E FY24E
Net Revenues 242 216 319 370 416 SOURCE OF FUNDS
Growth (%) 0.3 -11.0 48.0 16.0 12.5 Share Capital 8 8 8 8 8
Operating Expenses 208 189 263 306 344 Reserves 221 229 255 284 316
EBITDA 35 27 56 64 72 Shareholders' Funds 229 237 263 292 324
Growth (%) -16.3 -22.9 109.5 14.7 12.5 Total Debt 0 0 0 0 0
EBITDA Margin (%) 14.3 12.4 17.5 17.3 17.3 Net Deferred Taxes -4 -2 -2 -2 -2
Depreciation 8 9 10 11 12 Other Non-curr. Liab. 1 2 3 4 4
Other Income 7 8 10 11 13 Total Sources of Funds 226 237 264 294 326
EBIT 33 26 55 64 73 APPLICATION OF FUNDS
Interest expenses 0 0 0 0 0 Net Block & Goodwill 53 67 66 66 68
PBT 33 26 55 64 73 CWIP 6 0 0 1 0
Tax 8 6 14 16 18 Investments 87 54 52 67 82
PAT 25 20 41 48 55 Other Non-Curr. Assets 10 8 11 13 15
Share of Asso./Minority Int. 0 0 0 0 0 Total Non Current Assets 155 129 130 147 166
Adj. PAT 25 20 41 48 55 Inventories 61 78 89 101 116
Growth (%) -24.5 -19.9 105.0 16.3 13.4 Debtors 38 47 65 73 81
EPS 3.3 2.6 5.4 6.3 7.1 Cash & Equivalents 2 3 6 3 3
Other Current Assets 23 66 60 59 55
Total Current Assets 124 194 219 237 256
Creditors 30 55 48 51 55
Other Current Liab & Provisions 23 31 37 39 41
Total Current Liabilities 53 86 85 90 96
Net Current Assets 71 108 135 147 160
Total Application of Funds 226 237 264 294 326

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Cash Flow Statement Key Ratios
(Rs cr) FY20 FY21 FY22E FY23E FY24E Particulars FY20 FY21 FY22E FY23E FY24E
Reported PBT 25 20 55 64 73 Profitability Ratios (%)
Non-operating & EO items 4 4 -2 -1 -1 EBITDA Margin 14.3 12.4 17.5 17.3 17.3
Interest Expenses -1 -2 0 0 0 EBIT Margin 13.5 12.1 17.2 17.3 17.5
Depreciation 8 9 10 11 12 APAT Margin 10.4 9.4 13.0 13.0 13.1
Working Capital Change 26 7 -23 -14 -13 RoE 9.5 8.7 16.5 17.3 17.7
Tax Paid -8 -5 -14 -16 -18 RoCE 12.3 11.2 22.0 23.1 23.6
OPERATING CASH FLOW ( a ) 56 33 26 44 52 Solvency Ratio (x)
Capex -17 -15 -10 -12 -14 Net Debt/EBITDA -0.1 -0.1 -0.1 -0.1 0.0
Free Cash Flow 38 18 16 32 38 Net D/E 0.0 0.0 0.0 0.0 0.0
Investments 38 -9 2 -15 -15 PER SHARE DATA (Rs)
Non-operating income 3 4 0 0 0 EPS 3.3 2.6 5.4 6.3 7.1
INVESTING CASH FLOW ( b ) 24 -20 -8 -27 -29 CEPS 4.4 3.8 6.7 7.8 8.7
Debt Issuance / (Repaid) 0 0 0 0 0 BV 29.8 30.9 34.3 38.1 42.2
Interest Expenses 0 0 0 0 0 Dividend 2.0 1.5 2.0 2.5 3.0
FCFE 80 12 18 17 23 Turnover Ratios (days)
Share Capital Issuance 0 0 0 0 0 Debtor days 71 72 64 68 68
Dividend -23 -12 -15 -19 -23 Inventory days 99 118 96 94 95
Others -75 0 0 0 0 Creditors days 46 72 59 49 46
FINANCING CASH FLOW ( c ) -23 -12 -15 -19 -23 VALUATION (x)
NET CASH FLOW (a+b+c) 57 1 3 -2 0 P/E 62.1 77.5 37.8 32.5 28.7
P/BV 6.8 6.6 5.9 5.4 4.8
Price chart EV/EBITDA 43.7 57.8 27.6 23.9 21.0
EV / Revenues 6.2 7.2 4.8 4.1 3.6
Dividend Yield (%) 1.0 0.7 1.0 1.2 1.5
Dividend Payout (%) 60.9 57.0 37.1 39.9 42.2
(Source: Company, HDFC sec)

(Source: Company, HDFC sec)

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HDFC Sec Retail Research Rating description

Green Rating stocks
This rating is given to stocks that represent large and established business having track record of decades and good reputation in the industry. They are industry leaders or have significant market share. They have multiple streams of cash flows and/or strong balance sheet to withstand downturn in
economic cycle. These stocks offer moderate returns and at the same time are unlikely to suffer severe drawdown in their stock prices. These stocks can be kept as a part of long term portfolio holding, if so desired. This stocks offer low risk and lower reward and are suitable for beginners. They offer
stability to the portfolio.

Yellow Rating stocks

This rating is given to stocks that have strong balance sheet and are from relatively stable industries which are likely to remain relevant for long time and unlikely to be affected much by economic or technological disruptions. These stocks have emerged stronger over time but are yet to reach the level
of green rating stocks. They offer medium risk, medium return opportunities. Some of these have the potential to attain green rating over time.

Red Rating stocks

This rating is given to emerging companies which are riskier than their established peers. Their share price tends to be volatile though they offer high growth potential. They are susceptible to severe downturn in their industry or in overall economy. Management of these companies need to prove their
mettle in handling cyclicality of their business. If they are successful in navigating challenges, the market rewards their shareholders with handsome gains; otherwise their stock prices can take a severe beating. Overall these stocks offer high risk high return opportunities.

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