Daljeet Singh Kohli

It was in August 2014 that Force Motors made headlines when the Bajaj group sold around three fourth of its stake (16%) in the Firodias-owned company. But in the interview following the news, the more interesting comment came from the chairman (Abhay Firodia) that, in addition to hiking the family’s stake by 9%, the company was planning to incur a capex of ₹1,000 crore in three years mostly from internal accruals. This was surprising given that the-then market cap of the company was close to ₹1,000 crore and the only notable pile on its books was the ₹200 crore that it received from its stake sale in MAN Force Trucks JV in 2012.

Around the same time, the company mentioned that it will be seeking approval for a manufacturing facility at Chengalpattu in Tamil Nadu to assemble engines and other components for one more OEM. Though the company refrained from disclosing the OEM’s name, I was certain that it was none other than BMW India as the German carmaker had its plant at the same location. Incidentally, Force Motors has been assembling and testing engines for Mercedes for the past 18 years at the same unit. What was astonishing about the announcement is that BMW and Mercedes are aggressive competitors in what is largely a three-player race (Audi being the third) in the Indian luxury car market. BMW’s association with Force Motors definitely meant that the company had some technical capabilities and also offered the assurance of keeping proprietary information safe, which big players expect from any vendor. More importantly, with this tie-up, Force Motors is the only company in the world to assemble engines for both BMW and Mercedes.

Now the next obvious question is why BMW and Mercedes are not assembling the engines themselves and instead giving the contract to Force Motors? The answer to that goes back to 2000, when luxury carmakers were directly importing cars in India and paying a hefty 125% custom duty. As a first step towards localisation, foreign manufacturers started importing cars as semi-knocked down (SKD) units with a pre-assembled engine, gearbox and transmission mechanism, following a cut in custom duty to lower double digits. To promote local manufacturing further, the UPA government in 2011 excluded mounted units from the tax exemption list and notified that if companies wanted to enjoy the benefit of lower (10%) duty, they have to import complete knocked down units. With this incentive in place, it was but natural that Force Motors would be a prime beneficiary of the new rule, thanks to its alliance with Mercedes.

But the answer to the question as to why luxury carmakers are coy of assembling the engine themselves lies in the fact that going in for higher than 60% local sourcing of parts means that you get into full-fledged production and not assembling. For the luxury automobile makers, to begin full-fledged production, they need to clock sales of 70,000 to 100,000 units of a model every year and that seems like a difficult proposition at least in the medium term. To put things into perspective, currently no model of luxury car in India has sales in even a high four-figure.

Now, the next question is regarding the growth potential of the luxury car market in India. Luxury car sales in India have grown nearly four-fold from 8,516 units in FY09 to 32,362 units in FY15. Mercedes-Benz, BMW and Audi put together have around 90% market share. Discretionary spending across the economy typically starts surging when a country’s average income — in terms of purchasing power parity — crosses $5,000 and will continue to soar until $10,000, according to a McKinsey study. India’s per capita income on PPP basis is at $5,850 and China’s at $11,850, according to World Bank estimates. China had crossed the $5,000 mark in 2004 and the Chinese luxury car market from that year grew at an astonishing rate of 36% CAGR for the next few years. A similar trend is expected in India.

According to consulting firm Frost & Sullivan, India’s luxury car market is currently at stage two of the product life cycle and transitioning from stage two to stage three in the luxury product cycle will lead to exponential growth. This transition (China made the same transition from 2002 to 2012) is the phase of maximum growth because at this stage people are price insensitive and scramble to buy the luxury products so that they possess something which makes them stand out among their peers.

Currently, luxury models account for less than 2% of all passenger vehicles sold in India; this compares to 7% in China, around 10% in Brazil and around 11% in the US. The gap will narrow down significantly over next few years with nominal GDP/capita expected to cross $2,000 in 2017. A similar trend was seen in 2002 in China when the share of the luxury car market was 1.5% which increased to 7% in the next decade reflecting a CAGR of 36% for the next 10 years. Assuming the market share of the luxury car market in India increases to just 2% from the current 1.5%, it would mean that by 2020, the total luxury car market in the country will be around a lakh units (2% of 50 lakh vehicles in India) from current 32,363 units. This would mean industry growth of close to 25% CAGR for the next five years. Thus, I believe that the luxury car market is at an inflection point in India and will grow at a healthy pace in the coming years.

The recent developments at Volkswagen AG, wherein illegal devices have been found in 85,000 Audi engines could have an impact on Audi sales, which in turn could mean an additional upside to BMW and Mercedes sales. 

Domestic edge

Force Motors’ other segment — automotive — comprises small and light commercial vehicles, multi-utility vehicles (MUVs), and tractors. The strong demand for LCVs, Traveller model, is the main reason for improvement in performance of the automotive segment. Force Motors enjoys more than 75% market share in the less than five-tonne category, even as its two main competitors — Mahindra Tourister (10% market share) and Tata Motors (15% market share) — are de-growing. The reason for Traveller’s success apart from its versatility is its Monocoque design structure (normally seen in cars and SUV’s but rarely in buses) which leads to better performance, road dynamics, fuel efficiency and guarantees a superior and comfortable ride. 

Key drivers of growth for the Traveller class of vehicles are: ambulances, bus aggregators, school buses and diversified segments. FML is among the largest ambulance makers in the country and had registered a growth of almost 12% in this segment in FY15. Various hospitals such as Fortis, Nanavati and organisations such as GVK Emergency Management and Research Institute and Ziqitza Health Care are among its major customers. GVK EMRI, operating under the public private partnership mode, is the largest professional emergency service provider in India with a fleet of nearly 10,000 ambulances and 42,000 employees. I expect this segment to continue growing at a healthy pace in the coming years as there is still a huge demand-supply gap.

Force Motor’s Luxury Traveller is fulfilling needs of the organisations that provide transportation facilities to their employees. Force Traveller is slowly replacing other vehicles in companies both as a shuttle to the workplace and as cabs for picking up employees. Furthermore, the lack of a public transport system in cities such as Gurgaon has opened up a huge market for startups such as Shuttl, ZipGO, Cityflo and MOJO, which according to experts will be the next big thing in the transportation space. Shuttle buses are typically 12-seater air-conditioned Tempo Travellers. Ola plans to use air-conditioned buses which will have 12-20 seats fitted with other value-added services. FML’s Traveller segment buses seems like a perfect fit for such a demand. According to experts, the emerging bus service market is going to be larger than the taxi market, which is estimated at ₹600 billion. Even globally, bus aggregation models such as — China’s largest cab aggregator Didi Kuaidi and Bridj in the US — have been growing at an exponential rate.

The school bus segment is getting highly sophisticated, and both schools and parents are prepared to pay a premium for safe and comfortable travel. Earlier there used to be one school bus for a particular route but now-a-days with the average class size going down, demand for smaller buses is increasing. In 2015, the company launched its new Traveller range of school buses with features such as the innovative “Child Bus Tracker” (CBT) and RFID facility. The CBT feature is aimed at enhancing the safety of school children. In the school bus segment, the company’s volume increased from 2,000 units to 3,000 units in 2014-15, I expect this segment to continue growing strongly for the next couple of years. The company has also launched new firefighting and rescue vehicles and has till now received orders for a few hundred vehicles from five state governments. Besides, Force Motors has a presence in the defence vehicles space too and is already supplying paramilitary ambulances to armed forces. 

 2016 and beyond

Considering the growth in the luxury car segment, I see strong revenue growth from the auto component business that will help in overall margin expansion. Strong demand for the Force Traveller from multiple industries will ensure strong growth of the automobile segment. Currently, auto components contribute 30% to total revenue and automotive sales contribute 68%. However, over the next five years, I expect this ratio to almost reverse to auto components contributing 54% and automotive contributing only 44% of the total revenue. With higher volume, operating leverage would kick in further leading to operating margin of close to 10% and net margin of around 7% by 2020. 

The company is net debt free, sitting on cash and cash equivalents of around ₹400 crore (₹305/share) as on September 30, 2015. I expect the company’s sales and profit to clock CAGR of 22%, and 37%, respectively, which means earnings per share of ₹334 by FY20. Now, that translates into a multiple of 30x and a stock price above ₹10,000 over the next five years. From its CY15 low of ₹1,967, which it touched in September, the stock is already up 68% at ₹3,300. But considering the potential in store, Force Motors is an investment idea and its rewards are not just confined to 2016, but beyond.

The author does not hold the stock in his personal capacity, but has recommended the stock to clients of IndiaNivesh Securities

This is Daljeet Singh Kohli's best pick for 2016, you might be interested in what he recommended for 2015