1. Bearings Industry Structure

The Indian bearing industry is estimated at Rs30bn. The Industry has established a highly diversified product range of around 1000 types of bearings, having high volume demand. The domestic industry caters to almost 70% of total demand for common varieties and sizes of bearings. The remaining demand to the tune of 30% is being imported, essentially for industrial applications and special purpose.

Bearing Industry in India can be divided into three segments – the organized sector, unorganized sector and imports. The organized sector primarily caters to the OEM segment, which are predominantly automotive, railways and other industrial users.

The replacement, market is dominated by unorganized sector. Exhibit1 shows the industry structure of bearing industry.

Organized Sector

The organized sector comprises of 12 leading manufacturers who contribute to over 55% of the total turnover. The total investment in the organized sector is about Rs17bn with an annual installed capacity of 234mn bearings and employs more than 14000 people. Most of the big players are having either technical or financial collaboration with leading auto manufacturers. International collaboration gives access to best technology in the world. Exhibit 2 represents the strong domestic presence and international collaboration of few big domestic players.

Exhibit: Global collaboration

Huge Unorganized Sector

The unorganized sector includes the small-scale manufacturers and manufacturers of spurious bearings. The unorganized sector contributes to almost 15% of total industry turnover. The unorganized sector players have a strong regional presence and mainly cater to the needs of the replacement market.

Imports

30% of total demand for bearing industry is met by imports. While a part of the imports come through official channels, there is also a huge volume of illegal imports. Legal Imports generally represent the specialized bearings not manufactured in India. There are a large variants of imported bearings, each holding a small market share in India. Though, the quality of bearings manufactured by large players in India is comparable to world standards, domestic manufacture is not viable due to the small size of the market segment. It becomes uneconomical to manufacture such type of bearings as it includes huge capital expenditure.

Illegal imports generally represent the entry of spurious imports of bearings. In the past, the Indian bearings industry was highly protected on account of very high import duties ranging from 150% to 240% ad valorem. As a result, an illegal import via smuggling and under invoicing of imports was the order of the day, accounting for a high 45-50% of total imports. While duty rates have come down over the last few years, a few countries like China, Russia, Eastern Europe dump their excess production at a very low rate. This leads to a huge price differential between domestic and imported bearings (almost 40-50%), encouraging imports. Exhibit3 shows the current duty structure on bearings.

Exhibit: Present Duty Structure

Source: nic.in.budget

2. Market Dynamics

Original Equipment Manufacturers (OEM) Market:

The OEM market for bearing represent the demand arising out of the original vehicle and industrial manufacturers. The demand for the OEM market directly depends upon the growth in user industry. OEM market accounts for 40% of total demand of bearing industry. This market is characterized by requirements of high quality, stringent delivery norms and lower margins.

OEM’s have been facing price competition in their own markets, continue to exert price pressure on the local bearing suppliers. The bearing capacity available in the country is in excess of demand, resulting in price reduction. The OEM bearing market is likely to witness better days ahead on account of up swing in automobile industry and manufacturing sector.

Replacement Market:

The replacement market represents the demand arising on account of replacing the used and worn-out bearings. The size of replacement market is dependent on equipment population and frequency of maintenance. Replacement market accounts for 40% of total demand for bearing industry. The margins in this market are relatively higher placed as compared to OEM market. The replacement market is highly price sensitive and has higher share of unorganized players and cheaper imported bearings. Exhibit4 represent the bearing demand per sector.

In the last two years, Indian automobile and industrial sectors were facing a slowdown. This has led to lower growth in OEM segment and higher growth in replacement demand. The organized players have been concentrating on improving share in the replacement market.

3. Key Industry Players

The bearing industry in India is dominated by 12 organized players accounting around 55% of industry sales. SKF Bearing is the major player in the Indian bearing industry with a market share of 12%. However, as seen from the table, the share of major players has been declining, indicating entry of small payers and imports into the industry. Exhibit5 represents the trend in market share of leading bearing manufacturers.

Exhibit : Changing Industry Trends

Source: CMIE/ India Infoline Research

Sales Revenue of Key Players

Source: CMIE/ India Infoline Research

4. Growth Drivers

The demand for bearing industry is derived from demand in two key user segments – automobile and industrial sector growth. The automobile industry is the largest growth driver for OEM market as it accounts for almost 45% of total bearing market.

Engineering sector, which accounts for 28% of total share, holds the second growth driver. Considering the high reliance of bearing industry on automobile sector, the fate of bearing industry is largely dependent on production of vehicles. The demand of bearing is also linked to heavy-duty industrial application in rolling stock, rolling mills, heavy earth moving equipments and other heavy machinery, accounting for 21% of total bearing market. However demand in the latter category is met through imports and therefore does not have significant impact on domestic growth .Exhibit 6 shows the contribution of various user segments to the total bearing industry demand.

Up Swing in Automobile Sector

The Indian Automobile sector has grown 16.5% in FY03 contributed by export growth of 65.3% and domestic growth of 14.8%. The automobile industry comprising of commercial vehicles, passenger cars, multi-utility vehicles, two/three wheelers and tractors has performed extremely well in FY03. The sharp growth of this sector has been partly driven by the impact of lower interest rate on demand, intermediated by a competitive financial sector, which has steadily cut prices of automobile loans as interest

rates went down.

Infrastructure has received a fillip in last 2 years through N-S-E-W corridor and Golden Quadrilateral projects. The transformation of road transport industry through these initiatives will lead to higher demand for commercial vehicle industry. Passenger cars continue to grow in double digit driven by rising aspiration levels and easy availability of cheap finance. Within two wheelers, we expect motorcycle industry growth to continue on its growth path. After two bad years, the tractor industry is also likely to witness a revival with completion of inventory correction phase and good monsoons likely to drive demand. The positive outlook for auto sector augur well for bearings demand and we expect all segment of automobile industry to report strong growth in the coming year.

Export Potential

Exports of bearings companies has increased at a CAGR of 13% in last seven years from 1995-96 to 2001-02 at Rs2.5bn.Big players in Indian ball and roller bearing have been already exporting a part of their production to developed countries like US, Europe etc. Domestic players are already sensing the outsourcing opportunity and have initiated the process of manufacturing a range of bearings for meeting the requirements of global customers. The Indian bearing industry, especially the companies having technical/ financial collaboration with global players like SKF Bearings, FAG Bearings, Timken India, ABC Bearings and NRB Bearings are expected to garner higher pie in export market. Exhibit7 shows the export trend of bearing companies over the years.

5. Company Background

SKF is the world’s leading technology & solutions provider of bearings, seals, related products, systems and services to the Aerospace, Automotive, Electrical and Industrial sectors.

SKF AB, Sweden is the world leader in bearings and has an annual turnover of around SEK37bn. SKF AB was formed in 1907 when it invented self-aligning ball bearing. Almost all the bearings available in the market today have been designed and developed by SKF AB. Its business operations currently span over 130 countries and 90% of its turnover comes from overseas ventures.

SKF began operations in India in the ’30s as a sales company. It was incorporated in its present form in 1961, jointly by the international giant SKF Sweden, SKF UK and Investment Corporation of India (of the Tata group). SKF Sweden holds 51% of the equity. SKF in India is a Rs 6000 M business with three production facilities and employs over 2000 people. With an extensive and growing network of over 225 distributors across the country, the company enjoys a majority market position.

The company offers integrated mechanical and engineering services, preventive and predictive maintenance, thereby enhancing the total life cycle of the customers’ assets and helps reduce their ‘total cost’. With its forward thinking approach, the organization has continuously maintained customer satisfaction by developing new high quality products and solutions.

Manufacturing activities began with the commissioning of the Pune plant, which currently has a capacity to manufacture 22.25mn bearings. Its second plant came up in 1990, at Bommasandra at Bangalore, with an installed capacity of 40mn bearings. This state of the art plant is one of the most modern, with a high degree of automation. In FY94, Skefko India Bearing Co Ltd (Skefko), a group company engaged in trading of bearings was merged with SKF. The merger now enables SKF to cater to customers requirements of both domestic and imported bearings.

6. Tune up, Tie up & Turn around

Some of the initiatives taken by the management of SKF Bearings have proved to be timely. These steps included the company’s voluntary retirement scheme and the opening of the Rs 88-crore rights equity-cum-non-convertible debentures issue about a year back. These steps have begun bearing desired results over the recent quarters.

The company has made a turnaround. In Last year ended December 2001, it did well through improved operational efficiencies and major cost cutting in interest costs. It benefited through the across-the-board revival in most segments of the automotives sector, particularly commercial vehicles. With SKF Bearings now starting to lay greater thrust on the replacement market where it was lagging behind earlier, the company has shown an impressive performance for the 12 months ended December 2002.

Turnaround factor:

From 1994-1997, India’s bearing demand grew at a compound 22% rate, but in 1997 the economy dipped into recession which has gradually worsened.

FOR SKF Bearings, one key development has been the management’s decision to float a Rs 88-crore rights equity-cum-NCD issue about 15 months back. The rights issue was floated when the company was in dire straits and minority shareholders were unwilling to subscribe to the rights issue.

And since its debts were mounting year after year at that time, the company wanted to use a major part of the funds (mopped up through the rights issue) for repayment of borrowings, thus cutting its interest burden.

The company was closely monitoring sales and administrative costs. The funding moves are designed to allow the company to pay down its existing debt load and fund unspecified future expansion projects.

The rights issue is an integral part of the company’s comprehensive restructuring and allowed it to proceed with its investment plans in India, and at the same time allowed to reduce borrowings and thereby our financial cost. This, in turn, helped to improve bottom line.

This proved to be a masterstroke and the issue was fully subscribed. The company paid back Rs 87 crore in borrowings by December 2001. It used some part of internal accruals for modernizing its plants. Since then, growth in the auto sector picked up. All these factors helped SKF Bearings achieve a healthy 13.6% growth in sales and 127% surge in bottom line in the year ended December 2002.

The company’s debt equity has also gained from the premium on equity rights, and repayment of Rs 90 crore in debts over the past two years.

Even with a combination of factors, within and outside, heightening competition, SKF Bearings India has drawn up a three-pronged strategy to stay ahead of others in a situation where margins have come under intense pressure.

The new game plan has already seen SKF Bearings

• Cut costs wherever possible,
• Reach out to end customers
• Take prudent recourse to outsourcing.

The company started outsourcing low value components from `competent suppliers’. In fact, it had even wound up its IT (information technology) wing and begun outsourcing the service. The IT wing “has been taken over along with its personnel by Electronic Data Systems, Chennai. The objective was to ensure that the company remained focused on its core business.

With the automotive industry going through a rough time, SKF Bearings, was consciously striving to pare its dependence on this sector which was “experiencing big swings in business cycle.” The company trained its eyes more on other segments such as industrials, after-market sales and the like.

At present, about 40 per cent of its revenue comes from sales to the automotive segment. In this context, the CEO explained the efforts taken by the company to provide new solutions like the introduction of a complete bearing hub to retain its share in the automotive field.

In fact, the company had invested heavily over the past few years in its Pune facility to design new bearing solutions.  Ford, Telco and Fiat were among the car makers who got supplies from SKF Bearings. The company had now started supplying to Volvo too. An upgraded Pune facility had started exporting as well. The Bangalore unit had already been catering to the needs of select overseas markets.

Over the last three years, the manpower had been slashed by around 800. Simultaneously, the Pune factory was upgraded so as to make high value bearings. It had drawn up a series of initiatives aimed at improving customer interface. A significant constituent of this exercise would be alliances with distributors so as to become a part of their network, which sold `packaged kits’ and not just a single bearing. SKF also endured a strike during mid-1999 at the Bangalore plant.

SKF India has been battered by India’s continuing economic slump, combined with an ongoing battle against widespread counterfeiting of SKF bearings in the Indian market.

The company is also shifting focus away from dependence on automotive demand, expanding its focus on India’s export markets and working to protect domestic market share by aggressively attacking counterfeits. Counterfeit bearings alone account for up to 40% of the Indian market.

That restructuring created three business units:

• Automotive Unit,
• Electrical Unit
• Industrial Unit.

In 2000, SKF India exported only 10% of its production. The Pune plant’s modernization, along with an increased emphasis on unitized hub assemblies, will open capacity and quality to export markets more readily. The Bangalore factory currently exports a third of its production.

Demand for automotive applications has weakened dramatically in the recession, so SKF is moving production capacity away from automotive applications toward more stable general industrial equipment and service markets.

India’s automotive sector currently absorbs 45% of SKF’s output. They are continuously broadening our product portfolio. SKF and other Indian bearing manufacturers are also facing a growing challenge by cheap imports from Eastern Europe, Southeast Asia and China. Bearings from those countries are often sold into India below cost, a tactic known as “dumping”.

7. Results of Strategies Adopted

Investment rationale

Strong Presence

SKF Bearings has strong presence in the Indian bearing industry, commanding highest share of 12.3% in total 23mn industry. It serves to almost each and every segment of the industry. Automobile industry accounts for 35% of its total revenue. SKFs strong presence coupled with growth in automobile industry is likely to improve company’s growth.

Innovative Product Launch

Company is planning to launch a series of new products in the Indian replacement market, which accounts for 40% of total market. The company has successfully launched a new wheel-bearing kit for Maruti 800.In order to further increase it presence in the same segment, it is planning to introduce similar kits for Sumo Model. Simultaneously, it plans to offer imported wheel bearing kits, clutch release bearing kits, timing belt kits and other products from its groups overseas plant in Indian market. This move will prove instrumental in increasing its revenue share in the market for automobile spare parts.

Debt Re-Structuring

In order to retire high cost debt instruments, SKF Bearing made right issue in the FY01.This move resulted in significant reduction of interest burden. The debt/equity ratio for the company has decreased from 2.1:1 in 1999 to 0.5:1 in 2002, which is likely to reduce further. Secured redeemable non convertible debentures of Rs200mn were due to retire in August 2003.Capital restructuring resulting in reduction of interest cost burden is likely to improve the company’s profitability.

Valuation

At the current price of Rs87, the stock is trading at P/E of 15x FY03E earnings of Rs5.7. We expect the company to exhibit better results, on account of its strong presence and implementation of growth strategies.

Current Financial Analysis

SKF Bearings has for the first time crossed the Rs4bn.The top line grew by 13.5% to Rs4.1mn,as against RS3.5bn in 2001.The net profits of the company has shown a remarkable growth of 128%. Net profits for the 2002 stood at Rs204.2mn against net profit of Rs89.2mn in 2001.Working capital of the company have significantly improved and huge focus is given on receivable front. The company increased its production capacity by 17% in 2002 (62mn Nos.) as compared to 2001 (53mn Nos.). EPS for 2002 stood at Rs4.5 against EPS of Rs2 in 2001. Sales for the H1 F12/03 stood at Rs2171mn as against Rs1995mn in H1 F12/02, an increase of 9%. Net profit after tax for the same period was at Rs112mn against Rs59.7mn for the corresponding period of 2002,a significant increase of 88%. The robust increase in the net profit recorded for H1 F12/03, is the result of increased volumes in the automotive and industrial sectors, as well as savings from the debt restructuring undertaken earlier. Net interest payments for H1 F12/03 stood at Rs17mn, down 48 % from Rs32.8mn in H1F12/02.

Financial Highlights:

December Ending Company

Production Trends & Segment wise Revenues