motherson sumi, $18 billion and 20.90%

Motherson Sumi Systems Ltd is primarily in the business of manufacture of components to automotive original equipment manufacturers. It is owned by Samvardhana Motherson International Ltd (36.93%) and Sumitomo Wiring Systems Ltd, Japan (25.29%); Sehgal family owns 3.39%. 

The company operates through 93 subsidiaries, 11 joint ventures and 2 associates in 25 countries. It has manufacturing plants in India, Sri Lanka, Thailand, UAE, Australia, UK, Germany, Hungary, Portugal, Spain, France, Slovakia, China, South Korea, USA, Brazil, Mexico, Czech Republic, Japan, South Africa and Ireland. 

Samvardhana Motherson Automotive Systems Group BV, The Netherlands (SMRP BV) is a joint venture between the company (51%) and Samvardhana Motherson International Ltd (49%). SMRP BV operates through its subsidiaries, Samvardhana Motherson Reflectec (SMR, 98.50%) and Samvardhana Motherson Peguform (SMP, 100%).

Motherson Sumi had revenues of Rs.345 b in 2015, of which 85% was from outside of India. Its latest annual report for the year ended 31 March 2016 is not yet out. Revenues increased by 38.85% annually for the last 5 years and by 46% for the last 10 years. 

It earned operating profits of Rs.18.35 b and net profits of Rs.8.62 b in 2015. Growth in operating profits was phenomenal at 93.85% per annum in the last 5 years and 33% in the last 10 years. Net profits grew at 28.86% and 26.23% annually during the respective periods. 

Earnings per share in 2015 was Rs.9.78 which grew at 27.70% (last 5 years) and 24.89% (last 10 years). During the last 10 years, the company issued 35.21 m shares by way of conversion of foreign currency bonds and 4.42 m shares through merger with Sumi Motherson Innovative Engineering Ltd. Apart from these issues, all increase in earnings have accrued to the original shareholders. 

The company approved 4 bonus issues during the last 10-year period, because of which the number of shares of increased to 881.92 m. In June 2015, there was another bonus issue and consequently, the number of shares outstanding as of now stands at 1322.88 m. 

Let's get all this hullabaloo out of the way and come to the point. As of now, the market price of the stock is Rs.308.85 and has an implied PE of 47.37. Note that EPS of Rs.6.52 is recalculated based on 2015 earnings but adjusted for bonus shares issued subsequently. 

Targets
Management has set some bold targets for the next 5 years, especially after considering the fact that their previous 5-year targets were easily met.

Revenues

How much do the investors stand to gain if the company is able to achieve these targets? Revenues would be Rs.1206 b in 2020 assuming a constant rupee-dollar exchange rate of Rs.67.

Margins

Both operating profit and net profit margins have been falling over the years. Average operating profit margin during the last 5 and 10 years is lower than 5%. In 2015, they were 5.31% and 2.49%.

If we consider operating margin of 5.50% and net margin of 2.50% as sustainable, operating profit would be Rs.66.33 b and net earnings would be Rs.30.15 b in 2020.

Capital efficiency

The next target for management is to achieve a return on capital of 40% in 2020. This is a quite adventurous if we consider the company's past heroics on this front.

It is not clear whether it is a pretax or after-tax return on capital. I do not like to measure return on capital before tax. However, if we do it for Motherson Sumi, the capital requirement in terms of reinvestment to achieve those target revenues appears to be overly courageous as we can see soon. So I will stick to the before tax target. 

Operating capital in 2015 was Rs.75.12 b without considering the effect of lease debt. Operating capital required to achieve 40% return on capital considering operating profits before tax would be Rs.165.82 b in 2020. 

Reinvestment required as measured by sales-to-capital in the past has been improving.

In 2015, revenues of Rs.4.60 were generated from a rupee of capital. With Rs.165.82 b capital required to achieve Rs.1206 b revenues in 2020, it increases to 7.27. This is already efficient enough. If we consider after-tax return on capital, the sales-to-capital increases to 11.19. This is what I called courageous. As I noted, I will stick to the before tax target. 

Reinvestment

Reinvestment of Rs.90.71 b would be required in the next 5 years to achieve the targeted revenues. Considering the fact that Motherson Sumi has not much diluted its per-share earnings in the past, we would expect to see the same trend to continue. I also assume that all reinvestment would be funded by new debt. 

Earnings per share and market pricing

Keeping the number of shares outstanding constant at 1322.88 m, earnings per share in 2020 would be Rs.22.79. 

I check PE multiples only as a matter of interest, but not necessarily for investment valuation purposes. I prefer to consider it in combination with DCF analysis. Since this analysis is to see where management is able to take its shareholders, I will use PE for coming up with a market price.

There is a range of PE at which the stock has been priced by the market in the past. The average high-PE in the last 5 years was 35.66 and the average low-PE was 19.35. Increase of EPS at 28.44% annually in the next 5 years is a big deal, and market could price the stock at higher multiples. 

I have excluded all cash flows remaining after payment of dividends for the purpose of this analysis, and have assumed that this cash would lead to higher PE multiple.  

If we consider a PE of 35, the market price would be Rs.797.69 in 2020. That is an expected return of about 20.90% per annum over the 5-year period. Dividends are additional cash and would increase the rate of return. Take it if you believe it. 

Debt to capital

The debt ratio as of 2015 was 19.14% in market value terms. This would change to 12.03% in 2020. This is after considering lease debt of Rs.2.29 b. The remarkable increase in return on capital would be the reason for this comfortable position.

The catch

Lofty targets set by management would be a challenge. If those are not met, revenues and earnings would fall; in addition, the PE multiple would fall too. Isn't this usually the catch with any firm?

The sensitivity of these values is captured below.

If revenues in 2020 are $10 b instead of $18 b, which is a growth rate of 14.14% per annum, the rate of return before dividends would be 2.43%.

If return on capital is at 25% instead of 40%, the expected return would not change; however, debt ratio will increase.

My guess on the future would be as good as yours. Heck, all wrong.