Accumulate Varroc Engineering; target of Rs 459: Dolat Capital Market

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Dolat Capital Market's research report on Varroc Engineering

Varroc Engineering (VAR) displayed a weak margin performance in 3QFY21 dragged by contraction in margin of VLS. Consolidated EBITDA de-grew by 13 % YoY at Rs. 2.26 bn with margin of 6.5% (-285bps YoY) on account of premium freight and overtime in Czech plants (due to labour shortage) and slower ramp-up in production of Poland and Morocco facilities. The management expects VLS margin to normalize in 4Q, however shortage of semiconductor may suppress the top line growth for VLS. India Business revenue increased by 29.2% YoY and EBITDA margin improved by 180 bps YoY to 13.3%. Expect revenue and margin continue to be strong. The near-term focus of the company is to de-leverage the balance sheet by optimizing cash flows through control on capex and opex both. The company reduced its net debt by ~7bn in 9MFY21 due to better working capital management and cost saving; Net Debt equity stands at 1.1x. In the past two years, high capex, leveraged BS and demand slowdown, both in India and global markets, impacted earnings and cash flows of Varroc Engineering (VAR). However, we expect that the worst is behind and project strong earnings growth over the next 2-3 years supported by 1) revival in demand across key global markets, 2) cut in capex will help generate strong FCF and de-leverage balance sheet, 3) incremental revenue from past capacity addition (capex of ~Rs 28bn in FY19-20) and 4) cost cutting measures to help in expansion of operating margin.

Outlook

We expect strong revenue/EBITDA CAGR of 13/52% in FY21-23E for VAR led by revival in VLS business, recovery of the domestic 2W market, sharp margin expansion and reduction in interest cost. We continue to maintain our positive view on the stock and recommend to accumulate with a TP of Rs. 459 (based on 20x for FY23E EPS).

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