Merger And EV Investments Will Streamline Operations And Improve Future Efficiency

Key Takeaways

• Streamlining operations via company consolidation is expected to boost efficiency and net margins.
  
• New business wins and EV focus are set to drive significant revenue and earnings growth.
  
• Dependence on few key customers and declining automotive trends risk impacting revenue growth and financial stability amid China JV sale and competitive market dynamics.

Catalysts

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

• The amalgamation of Varroc Polymer Limited with Varroc Engineering Limited simplifies operations and governance, potentially leading to enhanced operational efficiency and improved net margins.
  
• Significant new business wins with annualized peak revenues of ₹10,847 million, including 55% from EV models, suggest robust future revenue growth, particularly when production scales up.
  
• The company's focus on advanced electronics manufacturing capabilities, as evidenced by international business wins in inverter electronics and ambient lighting starting production in FY '27, is likely to drive future revenue growth and improvement in earnings.
  
• Continued debt reduction efforts and strong free cash flow generation, decreasing net debt by ₹1,967 million, are expected to reduce interest costs and improve net margins moving forward.
  
• The projected start of production for major overseas orders and investments in growth areas like EV components should enhance revenue and margin profiles as these initiatives come to fruition.
  

Varroc Engineering Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Varroc Engineering's revenue will grow by 11.2% annually over the next 3 years.
• Analysts assume that profit margins will increase from 1.2% today to 7.0% in 3 years time.
• Analysts expect earnings to reach ₹7.8 billion (and earnings per share of ₹49.65) by about March 2028, up from ₹975.1 million today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 16.6x on those 2028 earnings, down from 67.6x today. This future PE is lower than the current PE for the IN Auto Components industry at 27.1x.
• Analysts expect the number of shares outstanding to grow by 0.13% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 14.55%, as per the Simply Wall St company report.

Varroc Engineering Future Earnings Per Share Growth

Risks

• The declining trends in the automotive market, including degrowth in key vehicle segments like commercial vehicles and 3-wheelers, could negatively impact future revenue growth.
  
• The arbitration and subsequent sale of the China joint venture could result in financial losses and reduce potential revenue streams, affecting overall earnings and margins.
  
• Exceptional costs like those associated with the merger of Varroc Polymer Limited and potential tax impacts from the China JV sale might reduce net margins in the short term.
  
• Competition and market dynamics, particularly in the 4-wheeler and international segments, may impact future revenue potential if growth does not materialize as expected.
  
• Continued reliance on a few key customers, as seen with the high revenue concentration from Bajaj, poses a risk to revenue diversification and could affect financial stability if these customers' demands change.

Valuation

• The analysts have a consensus price target of ₹560.4 for Varroc Engineering based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of ₹710.0, and the most bearish reporting a price target of just ₹450.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be ₹110.4 billion, earnings will come to ₹7.8 billion, and it would be trading on a PE ratio of 16.6x, assuming you use a discount rate of 14.6%.
• Given the current share price of ₹431.75, the analyst price target of ₹560.4 is 23.0% higher.
• 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.