Separation Will Optimize Capital Allocation And Manufacturing Efficiencies

Key Takeaways

• Separation into independent companies aims to optimize capital allocation and efficiencies, potentially boosting earnings for each sector.
  
• Localization and market share growth in industrial and automotive sectors signal potential revenue and margin improvements over time.
  
• Planned division separation and margin pressures could impact earnings, with reliance on traded products and competitive pressures further straining revenue and profitability.

Catalysts

Provides bearings technology and solutions to industrial and automotive sectors in India and internationally.

• The separation into two independent companies for the automotive and industrial sectors is expected to optimize capital allocation and enhance manufacturing efficiencies, potentially leading to increased earnings for each division.
  
• Localization of production, with automotive already at 95% and industrial just at 40%, suggests significant potential for higher margins in industrial as localization increases, improving net margins over time.
  
• The strong growth in key industrial segments such as distribution, renewables, and general machinery indicates potential for substantial revenue growth in these areas as infrastructure spending continues to rise.
  
• The ongoing rationalization and management of traded products margins, along with price stabilization, may help in gradually improving gross and operating margins in upcoming quarters.
  
• Increased market share in the two-wheeler and general machinery segments, as well as the introduction of new OEM relationships, suggests continued revenue growth across these sectors.

SKF India Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming SKF India's revenue will grow by 10.4% annually over the next 3 years.
• Analysts assume that profit margins will increase from 11.0% today to 11.1% in 3 years time.
• Analysts expect earnings to reach ₹7.3 billion (and earnings per share of ₹147.65) by about April 2028, up from ₹5.4 billion today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting ₹8.4 billion in earnings, and the most bearish expecting ₹6.5 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 44.6x on those 2028 earnings, up from 36.1x today. This future PE is greater than the current PE for the IN Machinery industry at 32.2x.
• Analysts expect the number of shares outstanding to grow by 0.22% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 13.88%, as per the Simply Wall St company report.

SKF India Future Earnings Per Share Growth

Risks

• The company faces risks associated with the planned separation of its auto and industrial divisions, which could lead to inefficiencies in capital allocation, affecting future earnings.
  
• Indications of a decreasing margin in its automotive division, partly due to lower local content, could impair net margins if not addressed.
  
• The delay in rationalizing traded product costs has already led to margin contractions, posing potential risks to future net margins if not effectively managed.
  
• A significant reliance on traded products and exchange rates regulation, especially with high costs, could continue to pressure gross margins.
  
• Competitive pressures in the industrial segment due to new capacities from competitors could lead to market share loss or reduced pricing power, affecting revenue and profit margins.

Valuation

• The analysts have a consensus price target of ₹4501.222 for SKF India 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 ₹5719.0, and the most bearish reporting a price target of just ₹3565.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be ₹66.0 billion, earnings will come to ₹7.3 billion, and it would be trading on a PE ratio of 44.6x, assuming you use a discount rate of 13.9%.
• Given the current share price of ₹3931.9, the analyst price target of ₹4501.22 is 12.6% 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.