Smooth operator

Ask Dharmesh Arora, CEO of Schaeffler India, to name some of the company’s big customers, and the response is atypical. With a big smile, he candidly says, “Everyone”. It’s not exaggeration or hubris. Whether it’s the giants in the two-wheeler space such as Bajaj Auto, TVS Motor and Royal Enfield or the big vehicle manufacturers in the country such as Maruti Suzuki, Mahindra and Mahindra, Tata Motors, Hyundai Motor, Renault, Nissan and Kia Motors — the Germany-based Schaeffler Group’s India arm provides auto components to almost all the established brands. 

But Schaeffler India is more than an auto component manufacturer. With 40,000 products, the Schaeffler Group makes components for steel, cement, power, renewable energy, railways and aerospace manufacturing factories. Currently, the industrial segment accounts for around 39% of the revenue and provides protection against the cyclicality of the automotive segment, which contributes 51% to the top line. In industrial segment, growth has been led by industrial distribution, raw material and railways. 

“Our revenue is very evenly split between automotive and industrial segments (see: The perfect mix),” says Arora, who joined Schaeffler India in 2012. 

While he agrees their business model doesn’t insulate the company from the ups and downs of the auto cycle, Arora says strong growth in the industrial segment in the past six months has helped them maintain their impressive growth. In that period, the auto industry faced a severe slowdown because of factors such as high crude prices, rise in insurance cost and credit crunch. Despite this, in 2018, the company registered sales growth of 11.27% to Rs.45.61 billion. The automotive segment grew by 15% (YoY) and the industrial by 19%. The export segment, which comprises mainly of industrial products and contributes 9% of the top line, went up by 9%.

Diversification is a strategy they employ even within categories. “We supply to all segments of automobiles — from two-wheelers, passenger cars and SUVs to utility vehicles, trucks and tractors. And if you extend mobility to aerospace and railways, we are present there too,” says Arora.

Their growth in the industrial segment was also attributed to its varied client base — from infrastructure, off-road construction and industrial automation to renewable energy, power transmission and railways.

United Force

To manage cyclicality risk, in October 2018, Schaeffler India merged subsidiaries INA Bearings India and LuK India with their listed FAG Bearings India. 

INA Bearings and LuK have been the growth drivers for the company and are expected to continue their upward trajectory. Between 2017 and 2019E, profits of INA Bearing are expected to surge 30% to Rs.1.05 bil-lion, while LuK India’s bottom line is likely to rise by 71% to Rs.1.32 billion. In the analyst conference call of Q1CY18, Arora had attributed growth of LuK to a “very strong demand for commercial vehicles and agriculture tractor products”. For INA Bearings, strong growth in passenger vehicles has driven profitability. 

“FAG Bearings is primarily an industrial component manufacturer. LuK is completely an automobile component manufacturer, making clutches and transmission components. INA Bearings also largely makes automotive components with a small portion of industrial parts. So if we didn’t merge the three companies there would be large business cycle risk,” says Arora. There is a slowdown in auto sales but the management believes it will be a “near-term hiccup”. 

Analysts concur with the management’s idea of creating a powerful combined entity. “Uniting all India entities under one umbrella can help provide combined solutions and increase transparency,” says Sandeep Tulsiyan of JM Financial in a report dated August 2017, when the announcement of the merger was made. He adds that it helps in creating cost synergies in departments such as logistics, distribution, sales, marketing and administration services (see: Smart choices). 

Arora agrees. “The scale of the business makes it possible for us to improve our efficiencies by having larger purchase and leverage better prices for what we buy. Similarly, on the cost side, we are able to achieve efficiencies. In the past, we had three HR organisations, finance departments and sales teams and so on. But now we are able to synergise that and improve the efficiency of operations,” says Arora.

This can also help the company to maintain a healthy Ebitda margin expansion. “They are managing production well, and their pricing strategy has been spot on. These are margin levers, and 1% addition in margins can happen because of the synergy,” says Priya Ranjan, an auto analyst at Antique Stock Broking. 

Analysts at Kotak Institutional Equities also believe that there is further room for growth in the margins. “We expect Ebitda margin to improve by 210 bps over the next three years aided by operating leverage and potential for improvement in profitability of INA Bearings through increased localisation,” a Kotak Institutional Equities report predicts (see: Racing ahead). 

New Frontiers

With four manufacturing units, 29,000 retail networks and 320 distribution partners, Schaeffler has rapidly expanded its footprint in India. In 2001, the German group acquired bearing maker FAG Bearings, which had a presence in India since 1969. In the same year, the Schaeffler Group’s subsidiary INA Bearings set up a plant in Pune’s Pirangut and also acquired Rane LuK (renamed LuK India). “It was to strengthen Schaeffler’s presence in India for long-term opportunities,” says Arora.

The company’s expansion spree demonstrates Schaeffler’s bullishness about the Indian market. The management is relying on the government’s thrust on infra development to drive growth. In its first budget, the Modi government allocated Rs.1.91 trillion for the sector and, in the last budget, the allocation went up to Rs.5.97 trillion. As the construction activity peaks, more commercial vehicles (CV) such as trucks will be required, fuelling demand for its components. According to industry experts, CV sales are expected to grow by 10-12% this financial year. “We provide bearings for the trucks and components to reduce emission and make engines more efficient. We will also provide advanced solutions on clutches and automating transmission components, which are used for manufacturing of trucks,” says Arora.

In fact, one of the high margin products of the group — dual-mass flywheel (DMF) — is used in the production of trucks as well as passenger cars. It decreases the vibration of the engine leading to a reduction in fuel consumption and noise, which also makes driving experience comfortable. While the sales of DMF are higher in advanced geographies, the product is witnessing traction in India as the automatic transmission technology is in demand.

The group has already sold 100 million units. “Production of DMF, which goes into high-performance diesel or fuel engines, is increasing in India. Till now, consumer expectation has not been that high, but as buyers are seeing more refined products, their expectation will keep rising,” says Arora. 

Other products that are receiving good traction in India are cam phasers, which improve fuel efficiency, and electronic clutch management (ECM) system, which gives a more comfortable drive. 

These kind of innovations are the company’s strength according to market experts. In 2017, Schaeffler had invested Rs.477 million for research and development (R&D) and increased the investment to Rs.577 million in 2018; the company currently has two integrated R&D facilities in India. “The products of Schaeffler add value to the vehicles. They reduce pollution and make driving more comfortable giving a vehicle a distinct advantage,” says Atul Chandel, CEO, Autobei Consulting Group. Judging them on parameters of pricing, quality and reliability, he also adds that Shaeffler India’s products are better than its competitors. “They have a cost advantage in terms of pricing because they manufacture products in India. Second, in terms of quality, they are superior because the maintenance cost is less. The reliability also matters because Schaeffler’s component gives stability to a vehicle, which is extremely important,” he adds. 

Export Driver 

While the auto vertical is improving their revenues with innovation, industrial segment drives their exports. 

Industrial products dominate Schaeffler India’s exports since automotive components are tougher to ship. Arora explains that OEMs are more demanding and source products every day or even every hour, making it impossible to export. “You cannot have two or three months worth of supply chain because you will not be able to respond quickly to changes that are happening,” he states. 

But customers in the industrial segment function differently. “For example, if a steel company gives an order to a machine manufacturer, typically, period for contract execution will be around 12 or 24 months. So we have sufficient time to provide the parts,” says Arora. 

One of their oldest acquisitions — FAG Bearings —manufactures bearings, which go into the making of industrial parts or machines. Around 51% of its revenue comes from this segment, of which exports account for 14%. Schaeffler India says they export “various types of bearings and mainly cylindrical roller bearings (CRB) as India is a Centre of Excellence.” These products are mainly shipped to parts of Europe and North America. 

Greener Pastures

Schaeffler India has continued to clock stellar growth numbers in both these segments, and a new wave of demand for cleaner vehicles will carry them forward. 

Once the Bharat Stage (BS)-VI norms come into effect from April 2020, OEMs will have to manufacture vehicles that reduce carbon emissions. To meet the requirement of these stringent norms, they will have to upgrade their powertrains (enables power transmission from engine to axle). “That is a big enabler for us in terms of providing new kind of solutions,” says Arora adding that the solutions can be cam phasers, which the company already manufactures. 

While other auto ancillaries may struggle to upgrade the technology, Schaeffler is already on that path. “Many of the powertrains may have to implement cam phasers — these are all solutions to improve combustion efficiency within the engine,” says Arora. Apart from cam phasers, DMF and pendulum-based flywheel are some of the other solutions, which the company has to make the engines more efficient. Schaeffler has also developed the thermal management module, which provides precise control of fuel and coolant temperatures. “In the past we had directly mounted fans that were always running; now we have thermal controls that allow the fans to run only when the temperature reaches a certain point,” says Arora adding that this technology is already being applied to Euro 6 or higher levels of engines. 

Industry experts too are optimistic about Schaeffler India’s prospects. “BS-VI norms require new technology and Schaeffler has that expertise such as wheel-module optimisation which is maintenance free for life. It also leads to fuel reduction which is also good for meeting the carbon emission targets,” says Chandel. The competitors do manufacture these technologies but Schaeffler’s quality is far superior. 

As the automotive industry begins the journey towards electrification, Schaeffler is preparing for the transformation. “Let’s face it. If electrification was to happen tomorrow, some of the products we make today might not be required. But it is also a fact that it won’t happen tomorrow. However, what we need to do is to be prepared,” says Arora. 

In a bid to get ready for electrification, the parent entity of Schaeffler India will be installing an electric vehicles engineering unit in India. It has already acquired Compact Dynamics and Elmotec Statomat to expand its portfolio with hybrid and electric vehicle products. The global auto giant has been working on developing products such as electric motors, clutches and damper systems, as well as complete electric axle systems for electric vehicles.

Mohan Krishnaswamy, an independent investor, who has been tracking the company, claims that MNCs such as Schaeffler are best placed to adapt to the disruption in technology. “The shift towards electrification will be gradual. So MNCs such as Schaeffler, who have a strong balance sheet, have the time and firepower to buy these technologies and implement them,” says Krishnaswamy. He also adds that products such as bearings and dual-mass fly wheels will continue to a part of vehicles and hence some of the high margin products of the company are insulated from disruption by electrification.

At the same time, the company continues to pump money into building infrastructure and innovation. The management states that it has invested around €20 million each year, which has been used for machinery procurement, improving infrastructure, as well as R&D. And they are also keen on ramping up the investment in India going forward. “As a part of One Schaeffler programme, we would like to be more aggressive. We have confidence in the India story,” says Arora. 

While the automobile sector and the economy have slowed down, Schaeffler India continues to be upbeat about its prospects in the country. While the net sales are expect-ed to expand at 14.30% CAGR from Rs.53.15 billion in 2019 to Rs.69.45 billion in 2021, the margins are expect-ed to expand from 17.7% to 18.3%. The double digit growth could come from capex recovery in the industrial segment, stable growth in CVs and tractors, and higher investment in railways and industrial automation, according to analysts. 

“In the long-term everyone believes that India will continue to grow at a rapid pace. But in the short term, there are some hiccups, and it’s about how well we are prepared,” states Arora. And with the groundwork already laid to battle near and long-term challenges, it seems as though Schaeffler India will continue to race ahead of the industry.