Saturday, July 25, 2009

FAG Bearings and SKF

FAG Bearings (505790.BO) is the subsidiary of the german Schaeffler group (the group that got into trouble last year for buying Continental). It is also a bearings company, like SKF India. Like SKF, they don't talk - so there is not enough information out there.

FAG and SKF had quite contrasting qtrs. FAG's rev is now growing yoy at low double digits, while SKF is declining at low double digit. This might be because FAG is largely automotive bearings, which might have seen a revival with the revival of domestic auto industry. SKF, on the other hand, is also heavily in industrial bearings, which are still to revive. QoQ, SKF is seeing growth, but still not yoy.

However, the story at margins is completely different. SKF's margins have bounced back - this qtr EBITDA margins are at 13%, up from 8% in CY1Q09. FAG margins, on the other hand, have declined from 19% in CY1Q09 to 15% in 2Q. FAG's margins have always been much higher than SKF historically - FAG has been in high teens, while SKF has been in low teens.

Considering both these companies import a lot of what they sell in India, one could have expected margin expansion in 2Q as rupee has appreciated from 1Q to 2Q. That has happened for SKF, not FAG.

FAG is trading at 10x PE on 2Q margins of 15%. If the margins bounce back to high teens (Maruti, Bajaj and Hero Honda are all now making tons of money, so their suppliers should also benefit), it is trading at 8x PE. That doesn't mean that stock will go up - it can easily trade at 5x PE too, like it was not that long ago.

From a little bit of what I have read, it seems like bearings is not a commodity industry. Auto manafucturing is an intensely competitive industry - anybody can make a car. But there are only a few big companies in the world that can make bearings.

The big question with SKF and FAG India is not about their long-term top-line growth prospects. It is about margins, and specifically this - how much money will their parent companies let their Indian subsidiaries make? The Indian subsidiaries import from 100% owned subsidiaries of the parent companies, so there is a transfer pricing issue. As a minority shareholder in the Indian subsidiary, we can get beaten over.

Still, I have gone ahead and purchased FAG. So far, the parent company has played fair. Now the parent company has a huge debt load and might play unfair. But FAG India makes only $20mn of profit every year. Playing unfair here won't make any dent in Schaeffler's billions of debt. I plan to hold this for some time, but it is a risky bet.

Disclosure: Own FAG

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