Majestic Auto Ltd

A magical turnaround

Amar Ambani 5675 4479 (amar@indiainfoline.com)

September 2004

Dealing
Sandeepa Arora Biren Patel 92234 09033 92234 08601

ITS ALL ABOUT MONEY, HONEY!

Majestic Auto Ltd: A magical turnaround

Recommendation CMP 52 week H/L Market Cap BSE NSE Reuters Bloomberg Business house Face Value Equity Dividend

BUY Rs 47 Rs 65/19 Rs 509mn 500267 Not listed MJST.BO MATO@IN Munjal Rs 10 Rs 108mn Nil

Majestic Auto Ltd (MAL), a part of the Munjal family (Hero Group) is undergoing a magical turnaround. It is hiving off its loss making plant at Ghaziabad by transferring it to Hero Auto Parts Ltd (HAPL). The preference capital and inter-corporate deposits (ICD) will get converted into fully convertible debentures (FCD) and transferred to HAPL. Post this scheme of arrangement; MAL will operate its Ludhiana unit, a profit making one with a clear focus on auto ancillaries and a healthier balance sheet. The company has extended its financial year to eighteen months in the current year to work out the arrangement. The business of making mopeds above 75cc and other activities conducted at Ghaziabad will be transferred to HAPL. MALs equity will be reduced to Rs104mn from Rs108mn and the shareholders of MAL will get 10.39 shares of HAPL of face value Rs10 for every 100 shares held in MAL. Therefore, an investor who buys 100 shares of MAL will own approximately 95 shares of MAL and 10 shares of HAPL post restructuring. The standalone (post demerger) entity of MAL is expected to report PAT of Rs95mn for the eighteen-month period April 2003 to September 2004 against a loss of Rs280mn in FY03 for the consolidated entity.
60 55 50 45 40 35 30 25

Shareholding pattern
Share Holding Pattern Indian Promoters Institutional Investors Public Others % 76 6 14 4

Share Price Chart

Majestic Auto (49.7500, 56.4000, 48.1000, 55.3500, +8.35000)

15000 10000 5000

x10

Investments held by the company post demerger will include holdings in Hero Honda Motors Ltd (HHML) with a market value of Rs70 per share of MAL. Dividend income from HHML alone accounts for Rs32mn, which translates into an EPS of about Rs3 per share of MAL. Thus, the company enjoys a cash flow cushion that can mitigate uncertainties of the manufacturing business to some extent. We expect the structured MAL to generate EPS of Rs10.8 in 09/FY05. The pre restructuring stock trades at a multiple of 4.4 times 09/FY05 earnings, which does not reflect the true potential of the restructured auto ancillary business and value of HHML shares. We expect the stock to get re rated as the market understands the restructuring and reacts to the September results of the stand-alone entity.
Table 1: Key Financials of MAL (Post demerger)
Apr - Sep 04E (18) 1,298 130 38 95 9.1 Standalone Oct - Sep 05E (12) 1,498 151 44 112 10.8 Oct - Sep 06E (12) 1,715 175 46 128 12.3

2004

February

March

April

May

June

July

August

September

(Rs in mn) Net Sales Operating profit Other income PAT EPS (Rs)
Source: India Infoline estimates

September 14, 2004

Majestic Auto Ltd: A magical turnaround

Restructuring arrangement
The company has two units: Ludhiana, established in 1973, that manufactures mopeds up to 72cc, health equipments, cycle parts and auto components, and Ghaziabad, set up in 1988, that manufactures high-end mopeds and scooters comprising of 2 stroke & 4 stroke engines. On a consolidated basis, MAL has been loss making. The Ludhiana facility has been profit making whereas the Ghaziabad unit is loss making, mainly due to large investments in infrastructure, technology and marketing.
Table 2: Financials at both plants

Source: Company data

For the eighteen months ended April 03 September 04, MAL is estimated to make a profit of Rs95mn from its Ludhiana plant, while the Ghaziabad plant is estimated to incur a loss of Rs360mn.

Merger of loss making unit with an unlisted entity

HAPL was incorporated in 1998, in a 50:50 joint venture with Briggs and Stratton International, USA for manufacturing two-wheeler engines. The company became a deemed public company in August 1998. The supplies were primarily to the Ghaziabad unit of MAL for its scooters and mopeds. However, HAPL has been posting losses due to de-growth in moped and scooter markets. In June 2001, the company become a private company. Briggs and Stratton International exited the joint venture in FY03 and all technology for manufacturing engines was absorbed by HAPL. MAL has agreed to sell its Ghaziabad unit to HAPL and has received approvals from the courts.

The split on manufacturing facility, location-wise

Under the proposed restructuring, MAL will be split into two companies. The erstwhile MAL will continue operating the Ludhiana facility while the Ghaziabad unit will be hived off and transferred to HAPL. Investors holding 100 shares of MAL (prior to restructuring) will get around 95 shares of the restructured MAL and 10 shares of HAPL. The restructured entity of MAL will have equity of Rs104mn as against Rs108mn earlier.
September 14, 2004

Majestic Auto Ltd: A magical turnaround

Pre-restructuring, MAL had ICDs worth Rs470mn and 6% non-cumulative preference shares of Rs230mn, which will get converted into 0% FCDs worth Rs350mn (remaining Rs350mn as share premium) and transferred to HAPL. Due to losses MAL has not paid any preference dividend over the years. The FCDs of Rs100 each are convertible at the option of the holders within a period of five years into equity of HAPL at face value of Rs10 at a premium of Rs10. If the preference shareholders do not opt for their debentures to be converted into equity, then their dues would be repaid over the next five years in equal installments along with 6% pa premium on reducing balance from April 1, 2003 onwards. All activities at the Ghaziabad plant along with the assets and liabilities will be transferred to HAPL. All trademarks, copyrights, designs relating to the Ghaziabad unit to be transferred too.

Rationale for demerger

The Ludhiana plant is a profit making one except in FY01, when it registered a loss due to large investments in new auto components. The Ghaziabad unit has been registering losses due to low sales of high-end mopeds, large investments in infrastructure and technology and marketing costs. The Ludhiana unit is focused on the auto components business whereas the Ghaziabad unit is primarily engaged in the manufacture of high-end mopeds and scooters. Synergies of integration with the Ghaziabad unit will benefit HAPL, which is the sole supplier of engines to two-wheelers manufactured at the Ghaziabad plant. Being located in Ghaziabad itself, serving the customer base in UP and having a common management will help further. Besides, the products manufactured at the Ludhiana unit have their main market in Andhra Pradesh, Punjab and Haryana.

September 14, 2004

Majestic Auto Ltd: A magical turnaround

Increased focus post demerger

The two units of MAL are focused on completely different products, market, segments and customer base. Post the restructuring; MAL would primarily be an auto component player that also manufactures mopeds below 72cc, which contributed about 20% of sales. The company would focus on consolidating its position in the health equipment division, bicycle component division, fine blanking, silencers and other auto component businesses in both the domestic market as well as exports. HAPL already supplies engines to the existing Ghaziabad unit and hence is dependent on the same for its performance. The integration will help HAPL attain operational efficiencies. It can also look at supplying engines to other manufacturers in the domestic and export markets. For MAL, this arrangement will lead to a healthier balance sheet with no losses. The removal of debt along with the preference capital will result in substantially lower finance charges for the restructured company. The company will record net profits in coming quarters, which were buried under the huge losses at the Ghaziabad plant earlier.

Hidden value of investments

Table 3: Investment break-up (as on March 31, 2003)
At cost Unquoted Hero Global Design (P) Ltd Equity shares (FV Rs10 each) Hero Financial Services Ltd Equity shares (FV Rs10 each) M/S Brijmohan Lall and Associates Quoted Hero Honda Motors Ltd Equity shares (FV Rs2 each) Total
Source: Company Reports

(Rs mn) 60.0 1.8 1.6 1.3 64.7

Hero Global Design (P) Ltd is the auto-designing subsidiary of the Hero Group. It offers engineering services related to new product development, design, engineering and manufacturing. It has business agreement with Target Design of Germany and is the exclusive representative of Porsche design GesmbH studio in India. Hero Financial Services Ltd is part of the Hero Groups initiatives in providing twowheeler financing support to customers and is into the business of financing all Hero Honda motorcycles.
September 14, 2004

Majestic Auto Ltd: A magical turnaround

Post demerger Investment allocation

MAL Hero Honda Motors Ltd Hero Financial Services Ltd M/S Brijmohan Lall and Associates

HAPL Hero Global Design (P) Ltd

Holds Rs750mn of HHML

MAL has 1,625,010 shares in HHML at cost and face value of Rs2 each. At the current market price of Rs460 per share, the total value of the investment in HHML stands at Rs750mn compared to the total market capitalization of Rs509mn for MAL. Further translation reveals that, value of HHML per share of MAL stands at Rs70 compared to MALs current market price of Rs47 per share. It clearly implies that a share of MAL bought at Rs47 gives exposure to HHML to the tune of Rs70 per share. MAL will also enjoy high other income in the form of dividends. HHML management believes in maximizing income of its shareholders and therefore has a history of high payouts.
Chart 1: Hero Hondas equity dividend (%) and payout
5000 4000 3000 2000 1000 0 FY00 FY01 Payout FY02 FY03 FY04 Equity dividend (%) 1200 1000 800 600 400 200 0

LHS Payout, including dividend tax (Rs mn), RHS Dividend (%) Source: India Infoline, Company Reports

In FY04, it paid a total dividend of 1000% on its Rs2 face value share. MALs holdings in HHML will ensure a dividend income of around Rs35mn every year in line with HHMLs high dividend policy.

September 14, 2004

Majestic Auto Ltd: A magical turnaround

Improved financial ratios

Post demerger, MAL is estimated to witness significant improvement in its ratios.
Table 4: Key ratios for MAL
Consolidated Standalone FY02 FY03 Apr 03-Sep 04E Oct 04-Sep 05E Oct 05-Sep06E (6.7) (14.1) 10.0 10.1 10.2 (11.5) (15.0) 7.3 7.5 7.4 (7.3) (16.5) 26.7 28.3 27.9 (39.9) (153.0) 27.9 24.9 22.9 4.2 (22.2) 0.4 0.2 0.1 (17.1) (25.9) 9.1 10.8 12.3 21.6 (4.3) 32.6 43.4 53.6 (23.1) (12.4) 3.6 2.8 2.3

OPM (%) PAT % ROCE RONW Debt / Total equity EPS (Rs) Book value per share EV/PBIDT

Source: India Infoline estimates

Concerns Single dominant customer

The company faces the risk of supplying to a single client. It supplies its silencers to HHMLs range of bikes that contribute to a significant portion of its revenues. Any downturn in HHMLs sales will adversely impact its performance. Our talks with management reveal that the management is sensitive to this issue and is looking at reducing dependence by targeting exports. This will take some time to fructify.

Transfer of brands/ trademarks

The combined sales value of mopeds at both plants contributes to around 35% of MALs total revenues. Even with the Ghaziabad unit being hived off, the below 72ccmoped segment would contribute around 20% to the new MAL. The moped segment has been witnessing a declining trend due to increased affordability and lower prices of entry-level motorcycles. Although MAL maintained its market share at 12.3% in mopeds for the between April 04 July 04, compared to the same period previous year, the future for the segment remains uncertain. As per the arrangement, HAPL will take away some trademarks that belonged to MAL - HMC labels, Hero Puch trademarks among others, which might impact marketability.

September 14, 2004

Majestic Auto Ltd: A magical turnaround

Company background
MAL is a part of the Hero Group, which is a US$2bn entity controlled by the Munjal family. It started operations in 1973, by setting up a plant for manufacturing of spokes for cycles having annual capacity of 5lac units pa at Ludhiana. In 1978, it diversified into the business of manufacturing mopeds up to 50cc with an annual capacity of 40,000 units. Today, it is one of the leaders in mopeds in India and also successful in some markets abroad like Africa, USA, Europe and the Far and Middle East. Hero Effy, Hero Panther Super 60, Hero Power, Hero Student, Hero Gizmo and Hero Stallion are MALs major moped models in the up to 72cc range. In 1988, it set up a plant in Ghaziabad for manufacturing high-end two-wheelers and later diversified into scooters in 1995-96. In 2002-03, it also began producing 4stroke mopeds in Ghaziabad.
Table 5: MALs Management
Mr. O. P. Munjal Mr. S. D. Sood Mr. Vijay Munjal Mr. Suman Kant Munjal Mr. Dr. D. R. Singh Mr. Mahesh Chander Munjal Mr. Pankaj Munjal
Source: Annual Report

Chairman Director Director Director Director Managing Director Managing Director

Divisions
Bicycle components The company manufactures spokes and nipples for the bicycle industry and particularly for Hero Cycles. It has an installed capacity of 293.8mn units pa and operates at 97% capacity. Health equipments MAL is one of the leading manufacturers of Jogger, Steppers and Twistpro. It exports some of its equipments and is looking to gain a stronghold in this segment. Fine Blankings Fine Blanking is an advanced stamping process that enables one to produce a component with precision, thus eliminating the need for any further secondary operations. MAL established this segment in 2001 by obtaining technical know-how from Feintool, Switzerland. It is used to develop precision products like door locks, gear boxes, seat adjuster, brake shoe, disc brakes, window wiper drives and so on. MICO, HHML, Tata Ficosa Automotive Systems etc are some of its major clients.

September 14, 2004

Majestic Auto Ltd: A magical turnaround

Silencers The company earns a major portion of revenues from this segment. It supplies silencers to all models of HHML.
Chart 2: MALs estimated revenue split post restructuring

Source: India Infoline estimates

September 14, 2004

Majestic Auto Ltd: A magical turnaround

Projections Income statement

Period to (Rs in mn) Net Sales Operating expenses Operating profit Other income PBIDT Interest Depreciation Profit before tax (PBT) Tax Profit after tax (PAT) FY02 (12) 1,607 (1,715) (108) 66 (42) (78) (63) (184) (1) (185) FY03 (12) 1,867 (2,131) (263) 142 (122) (81) (80) (282) 2 (280) Apr - Sep 04E Oct - Sep 05E Oct - Sep 06E (18) (12) (12) 1,298 1,498 1,715 (1,168) (1,347) (1,540) 130 151 175 38 44 46 168 196 221 (16) (7) (5) (42) (43) (49) 110 145 167 (16) (33) (39) 95 112 128

Balance Sheet
Period to (Rs mn) Sources Share Capital Reserves Net Worth Loan Funds Total Uses Gross Block Accd Depreciation Net Block Capital WIP Total Fixed Assets Investments Total Current Assets Total Current Liabilities Net Working Capital Misc. expenditure Total FY02 (12) 338 125 464 981 1,445 1,523 (477) 1,046 75 1,121 75 685 (668) 17 231 1,445 FY03 (12) 338 (155) 183 1,040 1,223 1,608 (544) 1,065 48 1,112 65 705 (810) (105) 151 1,223 Apr 03-Sep 04E Oct 04-Sep 05E Oct 05-Sep 06E (18) (12) (12) 104 235 339 132 471 575 (221) 354 18 372 8 332 (256) 76 15 471 104 347 451 86 537 622 (264) 358 14 372 14 408 (268) 141 11 537 104 453 557 59 616 661 (313) 348 9 357 22 521 (292) 229 8 616

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Majestic Auto Ltd: A magical turnaround

Cash Flow Statement

Year to (Rs mn) Net profit before tax and extraordinary items Depreciation Interest expense Interest income Dividend income Operating profit before working capital changes Add: changes in working capital (Inc)/Dec in (Inc)/dec in sundry debtors (Inc)/dec in inventories Inc/(dec) in sundry creditors Inc/(dec) in other current liabilities Net change in working capital Cash from operating activities Less: Income tax Misc expenditure w/off Net cash from operating activities Cash Profit Cash flows from investing activities (Inc)/Dec in fixed assets (Inc)/Dec in Investments Interest received Dividends received Net cash from investing activities Cash flows from financing activities Inc/(Dec) in debt Inc/(Dec) in equity/premium Direct add/(red) to reserves Interest expense Dividends (inc)/dec in loans & advances Net cash used in financing activities Net increase in cash and cash equivalents Cash at start of the year Cash at end of the year 03/03 (12) (282) 80 81 (3) (20) (144) 09/04E (18) 110 42 16 0 (33) 135 09/05E (12) 145 43 7 0 0 196 09/06E (12) 167 49 5 0 0 221

(12) 41 141 1 171 27 2 80 109 109 (71) 10 3 20 (38) 58 0 (0) (81) 0 (22) (45) 27 10 37

190 107 (551) (3) (257) (121) (16) 136 (1) (1) 698 57 0 33 788 (908) (234) 296 (16) 0 61 (801) (14) 37 22

(26) (22) 12 0 (37) 159 (33) 4 130 130 (43) (6) 0 0 (49) (46) 0 0 (7) 0 (19) (72) 9 23 32

(30) (33) 25 (1) (38) 182 (39) 3 146 146 (34) (8) 0 0 (42) (27) 0 0 (5) (22) (31) (85) 19 32 51

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Majestic Auto Ltd: A magical turnaround

Ratios
FY02 (12) Per share ratios EPS (Rs) Div per share Book value per share Valuation ratios P/E P/BV EV/sales EV/ PBIT EV/PBIDT Profitability ratios OPM (%) PAT % ROCE RONW Liquidity ratios Current ratio Debtors days Inventory days Creditors days Leverage ratios Debt / Total equity Component ratios Raw material Staff cost Other expenditure (17.1) 0.0 21.6 0.0 0.6 (9.2) (23.1) FY03 Apr 03-Sep 04E Oct 04-Sep 05E Oct 05-Sep 06E (12) (18) (12) (12) (25.9) 0.0 (4.3) (10.9) 0.8 (7.5) (12.4) 9.1 0.0 32.6 5.2 1.4 0.5 4.8 3.6 10.0 7.3 26.7 27.9 1.3 43.5 26.9 71.7 0.4 58.2 6.5 25.3 10.8 0.0 43.4 4.4 1.1 0.4 3.6 2.8 10.1 7.5 28.3 24.9 1.5 44.1 28.7 65.0 0.2 58.2 6.4 25.4 12.3 2.1 53.6 3.8 0.9 0.3 2.9 2.3 10.2 7.4 27.9 22.9 1.8 44.8 32.1 62.1 0.1 58.2 6.1 25.5

(6.7) (14.1) (11.5) (15.0) (7.3) (16.5) (39.9) (153.0) 1.0 75.8 55.3 57.9 4.2 72.6 10.1 24.1 0.9 67.5 39.6 157.5 (22.2) 73.6 8.3 32.1

Ratios for the period April 03 to September 04 are for an 18-month period.

September 14, 2004

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