Increasing EV Adoption Will Erode Outdated ICE Segments

Key Takeaways

• Overexposure to legacy ICE components and slow diversification leaves Varroc vulnerable to market shifts and technological obsolescence, weakening revenue and pricing power.
  
• Heightened regulatory costs, competitive pressures, and supply chain changes threaten profitability, free cash flow, and long-term financial stability.
  
• Strong order wins in EV and electronics, operational improvements, and global R&D focus could drive sustained growth, margin expansion, and profitability across core and international markets.

Catalysts

Designs, manufactures, and supplies exterior lighting systems, plastic and polymer components, electrical and electronics components, advanced safety systems, and precision metallic components worldwide.

• Global acceleration of electric vehicle adoption is expected to sharply erode demand for internal combustion engine components, which still constitute more than one quarter of Varroc's revenue mix, resulting in structural revenue declines and a shrinking addressable market.
  
• OEMs increasingly prefer vertically integrated supply chains, squeezing independent Tier-1 suppliers like Varroc; this trend, combined with intensifying competition and margin compression in core segments, threatens to erode future net margins and restrict the company's order pipeline.
  
• Regulatory and ESG pressures are set to raise compliance costs and necessitate expensive upgrades for Varroc's manufacturing processes, which will likely compress margins and could lead to diminishing free cash flow and earnings over the medium to long term.
  
• Slow pace of diversification beyond legacy lighting, plastics, and ICE components exposes Varroc to technological obsolescence just as rapid shifts toward automotive electronics, ADAS, and software-driven features make many of the company's core offerings less relevant, impacting both revenue growth and pricing power.
  
• Ongoing weakness and delayed recovery in overseas operations, particularly in Europe, will continue to weigh on consolidated profitability, and high working capital requirements, combined with limited ability to quickly scale up R&D in future growth areas, further elevate long-term financial risks.

Varroc Engineering Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Varroc Engineering compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Varroc Engineering's revenue will grow by 9.6% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 1.6% today to 5.7% in 3 years time.
• The bearish analysts expect earnings to reach ₹6.2 billion (and earnings per share of ₹42.42) by about August 2028, up from ₹1.3 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 17.6x on those 2028 earnings, down from 58.3x today. This future PE is lower than the current PE for the IN Auto Components industry at 29.7x.
• Analysts expect the number of shares outstanding to decline by 0.1% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 14.64%, as per the Simply Wall St company report.

Varroc Engineering Future Earnings Per Share Growth

Risks

• The company's focus on growing its order book, including significant wins in EV and electronics-related segments, positions it to capitalize on the acceleration of vehicle electrification, potentially supporting revenue growth and earnings stability.
  
• Ongoing improvements in operational efficiency, such as increased localization, vertical integration, and the reduction in net debt to historically low levels, could lead to margin expansion and improved net profitability over the coming years.
  
• Strategic investment in global R&D capabilities, including setting up dedicated teams in overseas locations, enhances Varroc's ability to develop advanced lighting and electronics products, which can help secure new high-margin business from global OEMs and diversify revenue streams.
  
• Management expressed confidence in winning substantial new business, especially in high-growth areas such as EVs and four-wheeler electronics for both Indian and international markets, suggesting potential for above-market revenue growth and top-line acceleration as new orders ramp up.
  
• Recovery plans for overseas operations, backed by a healthy pipeline of order wins and world-class manufacturing capability, may result in a turnaround in those segments, positively impacting consolidated earnings and improving overall ROCE in the medium term.

Valuation

• The assumed bearish price target for Varroc Engineering is ₹480.0, which represents the lowest price target estimate amongst analysts. This valuation is based on what can be assumed as the expectations of Varroc Engineering's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of ₹725.0, and the most bearish reporting a price target of just ₹480.0.
  
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be ₹109.0 billion, earnings will come to ₹6.2 billion, and it would be trading on a PE ratio of 17.6x, assuming you use a discount rate of 14.6%.
  
• Given the current share price of ₹510.95, the bearish analyst price target of ₹480.0 is 6.4% lower. Despite analysts expecting the underlying buisness to improve, they seem to believe the market's expectations are too high.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.