Sterling Tools Ltd (STL) (NSE: STERTOOLS, BSE: 530759) is a supplier of cold forged high tensile (HT) fasteners to various automobile companies. STL is positioned as the second largest manufacturer of automotive fasteners in India, trailing behind only Sundaram Fasteners in terms of market share. The company enjoys a healthy share of business with leading automotive original equipment manufacturers (OEMs) in India, including Maruti Suzuki India Limited (MSIL), Honda Motorcycles and Scooters India Limited (HMSI), Tata Motors Limited (TML) and Ashok Leyland Limited (ALL). The company’s largest customer accounted for 22% of its FY2019 revenues, while its top five customers contributed approximately 60%.

In top line, 2-wheeler accounts for 5%, passenger vehicles 18%, commercial vehicles 29% and farm equipment 22% of total sales. Currently, sales to Original Equipment Manufacturers (OEM) form ~88%, after market form ~12% and exports constitute ~3% of total revenue. In spite of fasteners being a relatively low content per vehicle product, these remain critical from a safety perspective. STL has three manufacturing plants at Faridabad, Ballabhgarh and Palwal in Haryana and has set up its fourth manufacturing plant near Bengaluru, Karnataka. The company has a total installed capacity of approximately 50,000 MT per annum at its existing plants, and an additional 6,000 MTPA capacity at the new facility in Karnataka. In FY2018, STL entered into a business collaboration agreement with Meidoh Co. Ltd., Japan, to develop and sell high tensile fasteners in India. With Meidoh being one of the leading fastener developers in Japan, the collaboration is likely to enable STL to have access to product development in the fastener space and improve its business prospects with the Japanese OEMs. The company recently formed a joint venture with Chinese company Jiangsu Gtake Electric to design, manufacture and supply motor control units in India, especially for electric vehicles.

Auto Ancillary Industry

The fortunes of the auto ancillary sector are closely linked to those of the auto sector. Demand swings in any of the segments (cars, two-wheelers, commercial vehicles) have an impact on auto ancillary demand.

Supply – Generally supply is low for high technology products. Unorganized sector dominates the domestic component market. Normally, excess supply persists.

Demand – Domestic demand is linked to automobile demand. Export demand is linked to the increasing acceptance towards outsourcing.

Barriers to entry – Technology and capital are two major entry barriers in the auto ancillary industry. Being capital intensive, companies that are able to expand their capacity are able to meet sudden increase in demand and are better positioned to gain business relationships with OEMs. With the Government of India’s (GoI) initiatives like ‘Make in India’ and push for electric vehicles, companies are spending more on research and development than before. As a normal practise in the industry, bigger players tend to enter into joint ventures with global partners to develop and introduce new technologies in the country.

Bargaining power of suppliers – Bargaining power of suppliers to STL is low, as there are large number of steel and aluminium manufacturers.

Bargaining power of customers – The auto component manufacturers will have high bargaining power if they compete through specialisation by product type. With technological specialisation, OEMs will incur huge switching costs to change their suppliers. Hence, companies who specialise in certain products types will have high bargaining power. However, with low product differentiation as in the case of fastener industry, OEMs find it easier to switch between suppliers. The only catch in this scenario is that OEMs tend to partner with suppliers that provide the highest quality products, otherwise anything negative in the performance of vehicle will directly impact the reputation of vehicle brand itself.

Competition – The auto ancillary industry is highly fragmented. However, in most cases top 2 or 3 companies command majority of the market. In Indian fastener market, Sundaram Fasteners and STL together command ~ 80-90% of the market share.

	Mar-10	Mar-11	Mar-12	Mar-13	Mar-14	Mar-15	Mar-16	Mar-17	Mar-18	Mar-19
Net Sales (INR Cr.)	179.53	248.13	295.03	282.51	301.36	340.06	369.37	370.89	452.91	512.2
Growth % YoY	-	38.21	18.90	-4.24	6.67	12.84	8.62	0.41	22.11	13.09
Gross Profit Margins (%)	56.98	54.33	54.15	53.61	56.70	56.60	60.97	63.86	62.85	59.62
EBITDA (INR Cr.)	30.08	36.23	37.81	35.14	41.62	46.59	61.88	75.68	90.68	85.94
Growth % YoY	-	20.45	4.36	-7.06	18.44	11.94	32.82	22.30	19.82	-5.23
EBITDA Margin (%)	16.75	14.60	12.82	12.44	13.81	13.70	16.75	20.40	20.02	16.78
Net Profit (INR Cr.)	11.59	15.85	14.76	10.88	15.62	21.22	28.42	39.21	48.66	44.86
Growth % YoY	-	36.76	-6.88	-26.29	43.57	35.85	33.93	37.97	24.10	-7.81
Net Profit Margin (%)	6.46	6.39	5.00	3.85	5.18	6.24	7.69	10.57	10.74	8.76

• Even though STL doesn’t have any durable competitive advantage, they have been able to showcase decent financial performance over the years.
• The company has been able to fend off competition from organised as well as unorganised players in the highly fragmented fastener industry and grow into one of the preferable partners for various OEM manufacturers.
• Total revenues have only shown de-growth once over the past 10 years. The company has also been able to both grow and maintain good margins over the years.
• Over the past 10 years, raw material costs have been on an average 43% of the total sales values. Employee costs have been in the range of 7-9% over the same time frame.

	Mar-10	Mar-11	Mar-12	Mar-13	Mar-14	Mar-15	Mar-16	Mar-17	Mar-18	Mar-19
ROE (%)	20.84	24.27	19.25%	12.72	16.49	19.48	22.67	26.35	23.61	16.86
ROCE (%)	22.03	22.98	18.61%	15.54	18.88	20.30	25.36	32.42	32.34	22.00
ROA (%)	8.19	8.97	6.60%	4.51	6.85	8.89	10.57	14.15	15.56	10.99
Fixed Asset Turnover	1.68	2.16	2.23	1.93	1.9	1.91	1.88	1.72	1.76	1.74
Receivable days	57.54	47.74	45.34	44.92	39.04	35.62	33.17	30.89	31.31	31.23
Inventory Days	33.11	39.81	47.41	50.51	41.43	37.4	36.58	38.25	39.48	48.82
Payable days	24.57	26.09	26.54	25.12	25.74	28.71	30.98	33.4	32.36	28.1
Cash Conversion Cycle	66.08	61.47	66.21	70.3	54.73	44.32	38.76	35.73	38.44	51.96
Debt/Equity	0.95	1.08	1.14	0.99	0.65	0.62	0.52	0.24	0.14	0.35

• STL has been able to maintain a good set of numbers over the years which I believe is primarily due to its cost reduction measures.
• Although the receivable days have been decreasing over the years, with the ongoing auto sector slowdown and outbreak of COVID-19 I expect this to worsen during FY21.

From Slowdown to Lockdown

It is not a secret that the automotive industry in India is in a bad spot right now as the production and sales numbers continue to drop month after month. Part of the consequences include vehicle manufacturers having to cut jobs as they reduce their output in an attempt to maintain their own fiscal balances.

With one full-year of slowdown, the Coronavirus pandemic is literally the last hit on the back of struggling Indian automobile industry. Yet to come out from the slowdown crisis, the worst ever to hit the domestic vehicle manufacturers in the last two decades or so, adding to the woes is the Coronavirus outbreak dampening the fortunes of the entire automotive sector, its supply chain and all local connect. This pandemic will have the following impacts:

• Continued cash flow tightening
• Passenger vehicle and two/four-wheeler segment: Demand likely to continue to be muted, as this segment is significantly impacted by economic/market sentiments and consumer purchasing power.
• Commercial Vehicle Segment: With a shutdown of all non-essential services, the demand for commercial vehicles is expected to plummet. Liquidity and cash crunch have already put a dent in sales of fleet operators, which is expected to further widen in the coming months.
• Auto OEM manufacturers will need to delay any new launches by at least few quarters or till sentiments improve.
• After market spending by customers on discretionary items will be put off due to short supply of money in their hands to spend for essential items including food and medicines, for immediate period. Only essential repair related after-market services may continue.
• Auto component sourcing might get dearer due to disturbance in supply chain across the globe. However, Indian auto component industry can emerge in medium to long-term as an alternative source of supply if duly supported by policy framework.

STL comes out as a company with a rock-solid balance sheet and technological expertise to channel through the fragmented auto ancillary industry. However, with the current ongoing automobile slowdown and outbreak of COVI-19, we expect the profitability of the company to be sluggish in the coming quarters and if the situation prolonged, it will be continued in FY21.

The company provides a good opportunity for a long-term investor to tag along once the auto sector and the economy turns around. Even without any durable competitive advantage, the company has been able to put up numbers almost similar to the market leader, Sundram Fasteners. With increased capacity, strategic partnerships and improved cost measures, we expect the market share gap between STL and Sundram to reduce in the coming years.

STL is currently available at a CMP of INR 125.35 (as on April 07, 2020) at a PE of 16.63. Promoters held 65.7% stake in the company as of Dec 2019.

Team 3C Capitals

Sources

• Ratestar
• Value Research Online
• Financial Articles
• Blogs
• ICRA credit rating reports