COMMENT: Watch for Wabco while it is still weak
Amid the scrappage policy approval for old trucks and buses, let's take a look at Wabco India's ability to maintain competitive advantages.
News reports say the scrappage policy for old trucks and buses has been in-principle approved by a Committee of Secretaries. The policy will most likely be implemented, since it will create fresh demand in the economy and help the environment through less pollution.
And it is good economics for almost everybody concerned - owners get excise concessions on new vehicles, besides some some cash on the old vehicles, government earns revenues as new vehicles are sold (despite concessional excise), it has a positive rub-off on GDP and lowers the oil import bill as new models guzzle less fuel.
Assuming a 20-year vehicle life, overall Medium & Heavy Commercial Vehicle population in India is around 3.95 million units. Of this, 1.3 million vehicles (33 percent of overall population) are older than 10 years and approximately 0.53 million are older than 15 years. Close to 0.34 million MHCVs were sold last fiscal, and so if the policy proposes to scrap vehicles older than 15 years it could imply significant volume growth over the next five years and benefit CV players and their ecosystem.
We, therefore, examine the ‘economic moat’ of Wabco India (one of the key suppliers to the CV industry). Wabco India (Market Cap: Rs 10,432 cr, CMP: Rs 5500) is 75% subsidiary of Wabco Holdings, a global leader in anti-lock braking systems (ABS) for MHCVs. The company pioneered air brake systems for CVs in India and currently enjoys a dominant market position, with over 85 percent share in braking systems.
India adopted ABS (anti-lock braking system) for wider categories of MHCVs (above 12T for goods, 5T for buses), effective October 2015. Thus FY16 turned out to be a good year for Wabco. FY17 hasn’t been too great - an increase in the royalty payment to the parent (from less than 1 percent to 4 percent) coupled with slower growth in CV have hurt performance with the stock underperforming the Nifty.
We, nevertheless, see some compelling strengths in the business model of this debt-free entity:
Wabco India has been outperforming the growth in M&HCV, thanks to its effort to improve content per vehicle. In the latest reported quarter (Q3 FY17), while the growth in the industry was a meagre 4 percent, Wabco’s sales to OEM (Original Equipment Manufacturer) grew 10 percent - the gap attributed to improved content per vehicle.
The content per vehicle in India, nevertheless is still low at USD 500/vehicle compared to Europe, US & Brazil, which are at USD 3200, USD 1500 and USD 1000, respectively. The company is focusing on new products like wiring harness, pole wheels etc to improve the content per vehicle. Given the big technology gap between MHCVs from India and other developed countries, there is significant head room to grow.
Wabco Holdings is increasing the share of sourcing from low cost countries with an eye on cost rationalization and diversification of sourcing. India has been identified India for its engineering capabilities and cost effective cost structure. Exports should also get a fillip from increase in infrastructure spending (in countries like US) leading to higher production of trucks.
The company enjoys the benefits of its global parent's strong technology dominance among OEMs globally. Access to technology, long gestation involved in building OEM relationships and network, acts as a significant entry barrier and results in stable margins across cycle.
While the near-term fortune is largely tied to the CV cycle, some of the ‘unique moats’ make it a compelling proposition that justifies premium valuation of 34 times FY18 earnings. Given the solid long-term story, any weakness in stock price could be a blessing in disguise.