Atul Auto Management Q&A: Jan 2012

Management Q&A

Concall with Mr. J V Adhia, Vice President, Finance – Atul Auto

[Conducted and shared by active ValuePickr Ayush Mittal. His Value Investing blog is a prolific source of winning stock ideas in most market conditions!]

A brief background on the company shared by Mr Adhia, before taking up our questions.

Atul Auto has been in this business for almost 3 decades now and were pioneers in low cost vehicle known as “Chhakada”, introduced in year 1975. To make a better multi-purpose vehicle, they set up a plant in the year 1991. In 1992 the production had started and the vehicle was known as Mark 2. They were quick to understand the changing needs of industry and could foresee need for lighter and better vehicles – the 3 wheelers we see today. In 2000 the production of 3 wheelers of 350-500 kg capacity started and they along with Piaggio were the early players.

Questions for Atul Auto Management

1.     IF WE LOOK AT 2007 -2010, SALES HAVE BEEN RATHER FLAT AT ~120 CR. HOWEVER ATUL AUTO HAS BEEN REGISTERING HEADY GROWTH OVER THE LAST 2 YEARS. 68% IN FY11 AND 1HFY12 HAS SEEN SALES GROWTH OF OVER 56%.

Kindly take us through this journey of the last 5 years. What has the company done differently in the last 2 years? What are the main contributors to this recent success?

The right way to look at our company would be to look at it from 2001 when the actual 3 wheeler production started. During the period 2001-06 the company had been growing at about 70% p.a. Till then we were a front-engine 3-wheeler company. In 2007 we decided to go pan India and introduced the more predominant rear-engine 3-wheeler segment by sourcing engines from Lombardi.  Some things went wrong and the company faced a rough patch, and that is the reason you notice stagnant sales for the period 2007-10. However in June 2009 period we introduced Atul Gem the rear-engine vehicle (with engines sourced from Greaves Cotton), and it has been received very well in the market. The growth is back on track.

2.     ATUL SHAKTI (FRONT ENGINE 3 WHEELER) AND ATUL GEM (REAR ENGINE 3 WHEELER, INTRODUCED IN FY09) COMPRISE ~94% SALES. THE CONTRIBUTION OF ATUL SHAKTI HAS COME DOWN FROM 63% IN FY10 TO 43% IN FY11. ALSO IN VOLUME TERMS ATUL SHAKTI HAS GROWN ONLY BY 6% OVER FY10. SEEMS LIKE ATUL GEM IS A SPECTACULAR SUCCESS, AND THE PRIMARY DRIVER OF GROWTH FOR THE COMPANY.

Kindly explain the dynamics of the 3 wheeler market. Why is a rear-engine 3 Wheeler preferred over front-engine 3 wheelers?

Technology wise there is not much to choose between Front Engine & Rear Engine vehicles. However there are very distinct market-specific preferences, for e.g. Gujarat, Rajasthan & some parts of UP usually have front engine vehicles while most of the other states have preferred rear engine vehicles.

It’s also a mind-set thing. There is more use of front-engine in Cargo (the payload at the rear will balance out) and rear-engine vehicles are more used for passenger vehicles. But overall 91% of the total autos are rear-engine vehicles.

If rear-engine 3 wheeler is a overwhelming favourite, why did the company work on introducing front-engine 3 wheeler (Atul Shakti)– especially when market leaders like Bajaj, Piaggio always had only rear-engine 3 wheelers?

Unlike other player in the industry, we were very small players with limited resources. We could do things, only gradually. Our home base is Gujarat, naturally first focus was Gujarat & neighboring markets, and hence we first introduced atul Shakti – the front-engine 3-wheeler.

Our rear-engine 3-wheeler Atul Gem introduced in 2009, as we expanded to other markets. It scores very well on most of the parameters when compared to competition. It has been about 2.5 years now in the market. The response is overwhelming and we have seen exploding growth in that segment.

What is the Sales mix between Passenger and Cargo Vehicles? Is it any different for front-engine and rear-engine vehicles?

About 70% is towards passenger and rest towards cargo.

3.     THE 2006 COLLABORATION WITH LOMBARDI DIDN’T WORK OUT. THE PROJECT WAS A FAILURE AND THE COMPANY HAD TO RECALL AND REPLACE ENGINES IN NEARLY 8500 VEHICLES EVENTUALLY.

What went wrong? What are the lessons learnt by the company? How did you handle the financial impact?

Yes, it was a really challenging and rough time for the company. The company had done all the initial homework like road-testing, etc on assembled vehicles with Lombardi engines. The first lot was imported from Italy and those were good engines and passed all the tests. But later with engines sourced from Lombardi’s initial local production in Aurangabad, the quality didn’t match up and there were several issues. Production volumes had to reach certain levels, before quality issues could stabilize.

What is the legal situation on the court cases filed by both sides? What’s the company’s view on risks posed by the contingent Liability of ~11 Cr?

The company has filed cases against Lombardi worth 40 Cr. The legal system, the way it is, Lombardi has also filed ounter-cases. Lombardi’s claim is of hardly 2-3 Cr (vs 11 Cr shown) due to interest cost, C form requirements, etc. We don’t see much risk on this front.

How did you solve the technology/engine sourcing problem subsequently?

Atul Gem – assembled with Engines sourced from Greaves Cotton worked perfectly!

Greaves Cotton supplies all your engines today – and Atul is on a spectacular growth trajectory – why has this alliance worked out so well?

Greaves Cotton is the best and has a sort of monopoly in these engines. Our company has a good relationship with them for over 30 years, on many products.

What is the nature of relationship with Greaves Cotton on this front? Without any binding contracts, how do you mitigate risks on this front? Are there any competing 3-wheeler manufacturers also sourcing engines from Greaves Cotton?

It’s a very good relationship. All the auto companies expect Bajaj & TVS (as they are lower payload, different category) source from Greaves Cotton. After M&M & Piaggio, we are their 3rd biggest customer. M&M & Piaggo have their own plants to manufacture engines. Atul Auto has no such potential conflict of interest. We don’t see any risks.

4.     COMPETITION. ATUL COMPETES AGAINST BIGGER AND MORE ESTABLISH RIVALS IN THE 3 WHEELER SPACE LIKE BAJAJ AND PIAGGIO. IN GUJARAT ATUL AUTO IS #1 3 WHEELER MAKER AND ITS #2 IN RAJATHAN.

Apart from the home advantage in these 2 states, what are the factors that has helped Atul best competition in these 2 states?

The company has had small beginning and limited resources unlike competition since the very beginning and yet we have managed to do very well. Our focus has only been 3 wheelers unlike competition who have a basket of products. Also 3 wheelers is a small portion of their overall business.

With our single-minded focus on the 3-wheeler segment, we provide more value to the end user in terms of better products, pricing, cheaper spare parts, quality after service etc.

What are the key technology parameters that serve as Sales drivers – Load-bearing capacity and mileage? Do Atul products offer any advantage vs competing products on these 2 fronts?

Yes, mileage of Atul Auto 3-wheelers is better than competitors. The  vehicle scores better than the competitors on several parameters.

How does the company keep pace with technological advances in its field? How strong is the Pune R&D facility? Please give an idea of the quality/skill levels of the R&D team? Any new models planned for launch soon?

The facility at Pune has experts from the automobile sector who in past have been in the field of product development and improvement. It has about 12 people.

5.     IN RURAL MARKETS, 3 WHEELERS – ESPECIALLY IN CARGO SEGMENT- ARE ROUTINELY ABUSED. ROAD CONDITIONS ARE BAD AND ALMOST ALWAYS VEHICLES ARE OVER-LOADED. DESPITE THIS ATUL AUTO OFFERS EXTENDED WARRANTY OF 2 YEARS, WHILE COMPETITION OFFERS ONLY 6 MONTHS WARRANTY.

Is this correct? How long has Atul Auto been providing the 2 year warranty and what has been the experience so far?

Yes, as compared to others, Atul Auto offers 8 month manufacturer warranty and the rest is provided by insurer. The market has given a good response to these schemes.

How does Atul balance the trade-off risks?  If Insurance covers are the answer, that will only inflate the cost (known risks), why are competing companies not following suit?

Our experience has been good. So far, we have not had major liabilities on account of the extra 2-month warranty. Can’t say why Competition has not followed suit.

6.     INDUSTRY GROWTH. THE ENTIRE 3 WHEELER MARKET IS GROWING AT A MUCH FASTER PACE IN THE LAST 2 YEARS. THIS WAS NOT THE CASE IN EARLIER YEARS.

What are the reasons for the change in fortunes? Is it because the rural economy is growing much faster due to govt-funded schemes like NREGA, increased spends on improving rural infrastructure like better roads & connectivity?

Yes, industry has in-itself grown over the years and lot is due to the infrastructural development etc. There is need for low cost transportation for the masses.

What are the main growth drivers for Atul Auto for the next 2-3 years?

Yes, the market has enough demand and is growing. As of now, the only limitation is production. The company has been taking a very cautious approach since the 2007 debacle and hence taking every step with lot of caution. We are in process of ramping up capacities by way of de-bottlenecking. We can also increase no. of shifts to increase production, as needed.

7.     SALES & DISTRIBUTION NETWORK. THE COMPANY HAS BEEN FOCUSING ON INCREASING ITS DEALER NETWORK IN THE LAST 2 YEARS.

Kindly elaborate on your Sales & Distribution model. In how many states are you present? Other than Gujarat and Rajasthan, which is your next biggest market and why?

The company leads in Gujarat & Rajasthan. We are No #1 in Gujarat with about 44% market share & No #2 in Rajasthan with about 30% market share. Kerala & Assam are our next big markets.

What are the challenges when you try to expand into a new state? Aren’t there permits/controls imposed that vary from state to state. Usually these come with political patronage, and competitors we assume are already entrenched. How do you tackle these issues when expanding into a new territory?

The company has all the national approvals and presence in the following states: Bihar, Jharkhand, Chattisgarh, Assam, Some part of UP, Punjab/Haryana, J&K, Andhra Pradesh, Kerala, Karnataka & Maharashtra.

For Cargo vehicles, national level approvals are enough. But for passenger vehicles, yes, state level permits come into play.

What is the current Dealer network strength? What are the plans for the next 2 years?

Current dealer newtwork is about 120 dealers. A year back we had 100 dealers but only 30-40% were active! Now more than 80% are active. Plan to have 140-150 dealers by this year end and 250 in 2 years.

What kind of incentives do you offer to new dealerships while entering a new market? What kind of market mapping exercise is done within the company before you take a decision to enter a new market?

Incentives are decided on market to market basis. Atul’s dealers provide all the services like arranging finance, RTO work etc so they get benefit in that work also. Plus servicing is a good area and 3 wheelers require the same due to high wear and tear.

8.     DEALER ADVANCES ARE NOW A SIGNIFICANT FACTOR IN IMPROVED WORKING CAPITAL SITUATION.

Kindly explain your Dealer Advance Policy. Why has it shot up from 36 lakhs to 3 Crs in FY11?

100% Dealer Advance indicate strong demand and product acceptance? Are you meeting with the same success in all the new markets you have entered?

The dealer deposit/security is not high – at about 2 lac. As of now the company is seeing a very strong demand and there is a waiting period of about 10 days. As per policy the company is taking orders on advance basis only. Hence the high advances on Balance Sheet.

Do you foresee this happy situation as an established aspect of your business model from here on? Is this likely to continue for the next 2-3 years? Will the Advance base keep growing as you expand into newer markets and appoint more dealers?

The base will probably keep growing as we expand the dealer network.  But you need to keep in mind the current Advances situation is because of the waiting period! Once we have expanded capacities, this may not remain at same levels.

2Q Fy12 saw Working Capital situation turning negative. Is this sustainable?

Covered above.

9.     PRODUCTION CAPACITY. THERE WERE PRESS REPORTS AND ARTICLES QUOTING THE COMPANY WANTING TO DOUBLE ITS PRODUCTION CAPACITY FROM EXISTING 24000 VEHICLES CAPACITY.

Kindly inform on the progress on the same? Is this being done in existing location or this is a new location being planned?

All expansions are planned at existing location. Our plant is on 13 acres and we have sufficient spare land. As mentioned before, we are expanding capacities by ongoing de-bottlenecking exercises. We are already at 20-25% higher production and the rest of the de-bottlenecking increases should happen over next 3-6 months.  Also as mentioned before, we have options of introducing a double shift, as and when deemed necessary.

What is the outlook for FY13 on the production front? Will it be able to match rising demand from the expanded sales & distribution network? What kind of Sales growth is the company aiming for in FY13?

We can discuss on this aspect later, during March.

What is the outlook on the margins front? Are operating margins sustainable at the current 9-10% range for the next 2-3 years?

We think current margins are sustainable and can only get better as operational efficiencies kick in.

10. 1000 CR TURNOVER TARGET BY FY2015-16. A 5 FOLD INCREASE IN 5 YEARS.

Is this a realistic target for a company of your size? What will be the main growth planks and what are the milestones to be achieved along the way?

Yes, it is quite a realistic target for us and we are gearing up to achieve the same. Majority of the growth should come from 3 wheeler space itself.

What contribution is expected to be forthcoming from your Sri Lanka and Bangladesh forays?

The initial response has been very good from both the areas. The company has already appointed a dealer in Bangladesh who has been trained over last 6 months to assemble the SKD there and sell forward. The dealer should set up a facility there soon. Sri Lanka has immense potential as a market for us, but the plans are under process.

We have often heard of the company’s LCV plans. Given that there are entrenched players in this segment – there are products like Tata Maxis, and Magic 4 wheelers –positioned well for the rural/semi urban market, what are the companies strategies for the same?

To put it simply, the company is planning 3 wheeler with one more wheel. We are targeting – Ultra low cost CV – in between Tata ACE and current 3-wheelers. We believe this will be a viable new segment. We have done our research and groundwork. This may take another 2 years for us as land acquisition has been a hurdle.

Bajaj Auto has recently launched the RE60, exactly for this segment. They are saying don’t call it a Car – It’s a 4-wheeler but not a car! Your comments, and does this require any modification of plans, especially as you say you are atleast 2 years off!

Atul’s presence is more into open heavier 3 wheelers which are used for low cost bulk transportation i.e. about 8-10 people sit in. The RE 60 can at max accommodate 3-4 people so it will cater to a totally different category. In a country like India, there is a huge demand for low cost of transportation.

Talking about company’s LCV plans, RE60 is of lower tonnage while we are targeting the commercial vehicles segment. So the right comparison would be to the likes of Tata Ace etc.

Technology collaboration would be necessary for the company’s entry into LCV segment. Has the company tied up with any technology partners? Or, is the company planning to enter this market on its own home-grown technology? How far are we from some action on the ground on this front?

Things are under process and all options are open.

What kind of Capital Expenditure will be necessary for the LCV project? How has the company planned to fund this?

As of now things are open and under-consideration. The total cost is estimated to be about 200 Cr.

11. RIGHTS ISSUE. 1 EQUITY SHARE FOR EVERY 4 EQUITY SHARES HELD. 14,62,880 EQUITY SHARES AT RS.30 FOR RS. 4.39 CRS. ONE SHARE FOR EVERY 4 SHARES HELD. RECORD DATE 15TH SEP, 2011.

As of Sep 30, 2011 the company had negligible debts of 3.75 Cr coupled with a healthy Current Liabilities (Payables) position of 32.25 Cr! Kindly explain the rationale for the rights issue.

We had applied for the rights issue in June 2010 and expected to get clearances in a couple of months.  But it took more than a year!. The cash flows and debt position were very different then from what it looks now.  We had almost 15 Crores in debt as on 30 Sep 2010!

So after getting the approval as most of the work had already been done and it was a small issue, we decided to go ahead. In a way it was also to reward the small shareholders.

This is a substantial 20% dilution for just Rs. 4 Cr (which the company did not need at the time of offer). This is a very expensive deal for any company. You could have chosen to defer/scrap the rights issue. Kindly comment

From a strict financial standpoint, you are right. Would we have gone for a rights issue in the current financial situation, at these terms? Absolutely not!

However you may like to see it in the right context. When we applied for the rights issue in June 2010, it made sense. The company had debts of ~15 Cr, we were thinking of raising money for Capital Expenditure. The prevailing share price of the company was ~40-50, and we offered the rights issue at a discounted price of Rs.30. You can’t find much fault with this, right?

Now when the approvals came a year late, one point of view was to scrap the rights issue. The other viewpoint that also emerged was that it is good for small shareholders, especially as the share price had appreciated a lot since then. That the company should keep in mind small shareholders who have stayed with the company for several years. We did sample surveys with small shareholders in Ahmedabad. The results seemed to indicate that they welcomed the rights issue.

The company decided to go ahead with this option.


Disclosure(s)

Ayush Mittal: Less than 5% of Portfolio in the Company; Recent Entry;
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Atul Auto

Background

Incorporated in 1986, Atul Auto is a leading manufacturer of 3-wheeler commercial vehicles based out of Gujarat. Passenger auto rickshaws (3-6 seaters), pick-up vans and delivery vans (diesel, cng and lpg) are manufactured in a large number of variants.

Atul Auto’s Manufacturing plant situated at Shapar, 18 Kms. away from Rajkot has a production capacity of 24000 vehicle per annum on single shift basis. It is equipped with CNC machines, fabrication shop, high quality paint shop and test house. Atul auto’s R&D center is based in Pune.

Atul Auto has wind turbine generators of 1.25 MW capacity at Village Soda, near Jaisalmer, Rajasthan and another of 0.6 MW at Village Gandhavi, Jamnagar Gujarat.


Main Products/Segments

The Rear-Engine 3-wheeler Atul Gem is its fastest growing platform comprising ~57% of Sales in FY11. The front-engine 3-wheeler Atul Shakti is the other main platform bringing up ~42% of Sales in FY11. Atul Smart is a new brand of front-engine 3-wheeler launched in FY11.


Main Markets/Customers

Autorickshaw operators, transport operators and Corporates


Bullish Viewpoints

  • Growing 3-wheeler segment – This is a segment that has many growth drivers going for it. The government’s focus on road infrastructure development, restriction of heavy vehicles in the city, and the growing rural economy are important growth triggers. Over the years, Atul Auto has developed itself as a one-stop source for all 3-wheeler needs. It has made it’s versatile platform highly customizable to suit almost every kind of need and budget.
  • Impressive Growth -In FY11 Atul Auto registered a 68% growth in Sales and over 107% growth in Net Profits. 1QFY12 has seen the growth momentum continuing with both Sales and Net Profits registering ~56-60% growths. The company has guided for 40% growth in sales for FY12.
  • Reducing Debt – Debt is down to just 6 Cr in FY11 from ~23 Cr in FY10. That such stupendous growth is being achieved while reducing debt is heartening to note. Debt-to-Equity stands at just 0.15. With the ongoing rights issue proceeds, the company intends to repay its term loans and become a DEBT-FREE company in the near future, as per its 2011 Annual Report .
  • Reducing Working Capital requirements – Working Capital/Sales reduced to an astonishing 3.38% in FY11 as compared top ~15% of Sales in FY10. This is achieved on the back of increasing dealer advances and is a positive trend.
  • Increasing Cash Flows – Atul Auto has been increasing its cash flows handsomely in recent years. Cash flows from Operations grew to 16.72 Cr in FY11 from 9.58 Cr in FY10. With Bulk of the Capex undertaken in FY07-09 (~8 Cr each year), the company has been registering good levels of free cash flows. Capex requirements for existing platforms looks to be easily funded from current cash generation levels.
  • Increasing Dealer Network – With a current market share of less than 3% of total 3-wheeler market in India, Atul Auto is striving to increase its distribution reach beyond Gujarat. The company is expanding its presence in Andhra Pradesh, Rajasthan and Maharashtra while entering new markets such as Kerala, Karnataka, Bihar and Assam.
  • Export Foray – Atul Auto Ltd has started exports in Nigeria, Kenya, Egypt, Tanzania and some other African countries. It has also recently introduced Atul Gem Diesel & CNG variants in Bangladesh. Exports touched 3.2 Cr in FY11.
  • Expansion Plans – Atul Auto has been actively exploring expansion plans. It is in the fray to acquire the ailing Scooters India Ltd which also manufacturers front-engine 3-wheelers. It is also actively looking for technology partners for manufacturing 4-wheeler LCVs.
  • Strong sales in Q2FY12- Atul Auto Ltd has informed BSE that the Company has recorded total Sales of 6794 Vehicles in the quarter of July -September 2011, as against 4814 Vehicles of July-September 2010 Quarter, or a 41% growth in number of vehicles sold. This is on the back of the ~60% sales growth registered in Q1FY12.
  • Increasing dividends & yield – The company has consistently increased dividends in the last 2 years leading to a 5yr dividend CAGR of over 44%. At CMP of 98, the dividend yield is 3.27% (post rights capital basis).

Bearish Viewpoints

  • Heavily dependent on Suppliers – Atul Auto sources its engines from Greaves Cotton. Although this has been a long-term relationship, this complete dependence on one supplier can be a big risk.
  • Aggressive expansion plans – Although nothing concrete has yet been announced but the company’s expansion plans are a source of concern – whether it is acquiring the ailing Scooters India or investing into greenfield 4-wheeler LCV manufacturing, a much more competitive and technology intensive segment. There are big execution and market risks associated.
  • Litigations against the Company – 67 cases of litigation is filed against the company totaling 12.83 Cr. Of this 11.17 Cr is against one case filed by Lombardini, Italy with whom the company had entered a technical collaboration in 2006. To be fair, the company itself has filed a litigation against Lombardini for 43.08 Cr. The company had suffered heavy damages and had to recall and replace eventually some 8500 engines by 2009, due to this ill-fated venture.

Barriers to entry

  • Entrenched Players – The 3-wheeler market is dominated by entrenched players like Bajaj and Piaggio. Setting up manufacturing and a country-wide dealer network from scratch is an uphill task for new players.

Interesting Viewpoints

  • Strong Dealer Advances – As on 31st March, 2011 the company has 3.37 Cr as advances from dealers against 36 lacs in the previous year. This reflects good acceptance of Atul’s products in the market and is a very positive development for the company. If sustained, this could be key to reduced working capital needs of the company.
  • Rear-Engine 3 wheeler growth – India is pre-dominantly a Rear Engine 3-wheeler market. Atul had started with Front-Engine technology (Atul Shakti) and introduced rear-engine 3 wheelers in 2007-08 in collaboration with Lombardi which faced trouble with the engines (Read this case study for a great backgrounder on the company). These problems seem to have been bested and the rear-engine 3-wheeler Atul Gem (recorded a 144% growth in Sales in FY11.

Disclosure(s)

Donald Francis: Less than 5% of Portfolio in the Company; Holding for more than 2 years