Swaraj Engines Note as of 2011: Swaraj Engines makes engines (figuring this required sheer talent).

Ok, more importantly, it makes engines for Swaraj brand of tractors. Swaraj brand is owned by Mahindra (it used to be a brand of Punjab Tractors Limited (PTL), and PTL was taken over by Mahindra in 2007). M&M currently holds 33.2% stake in Swaraj Engines while Kirloskar Industries holds 17.39%. There was a buzz that M&M may buy out Kirloskar's stake and then make an open offer for rest of the shares.

Whats interesting? Getting to the point, how many Swaraj tractors are manufactured per annum ? 60,997 in 2011, giving it a market share of 12.7% in Indian tractor Industry. How many engines are supplied by Swaraj Engines - 47,413 - serving 77.7% of total Swaraj tractors produced. So, Swaraj Engines can easily increase its production by another ~ 28% and make additional profits. Not only this, Swaraj Tractors itself is growing at above average Industry growth and there is an additional plant being setup by Mahindra in Andhra Pradesh with capacity to produce 100,000 tractors (including Swaraj brand). Getting exact data for Swaraj tractors is quite difficult as Mahindra Management is absolutely tight lipped about Swaraj numbers and does not disclose any information on the same :( So, what we would normally get access to is data on overall Mahindra tractors. Now, what's preventing Swaraj Engines from producing more? Capacity!

Swaraj Engines had capacity of only 42,000 engines in 2011 and operated at 114% utilization ! And if it could increase its capacity, it would be able to grow at a decent pace. And that's exactly what the company is doing and that's exactly the reason why I got interested in the company in the first place. The capacity is being increased to 60,000 units per annum in FY 2012 and further to 75,000 units per annum be FY 2013. The total capex for this expansion is expected to be 94 cr. Adding icing on the cake is the fact that Swaraj Engines has cash and investments of 136 cr and the entire capex plans can be funded from internal accruals - no debt and no dilution. See this extract from the latest balance sheet:

Incremental returns: Now, this is the most important point, its all right to expand, but what the business will earn out the incremental capex of 94 cr. Lets do some rough calculations - at current sales of ~47,000 tractors, the company earned 43.9 cr in profits. Lets say same proportions continue, the company will earn 70 cr in profits for 75,000 units sold. Thats an addition of 26 cr to profits by an incremental capex of 94 cr, giving a return of ~27% on investment. Thats a great return to have on incremental capex, and that too without any leverage. So, here is a company with visible growth of 20-25% for the next 2-3 years, pure balance sheet, no debt, earning good returns on equity (30% plus), generating enough free cash flows and managed by Mahindras. The fundamentals look really good. What about the price?

Valuation: At a market price of 400 per share, the companys market cap is ~ 500 cr. The TTM P/E multiple is 9.84 Taking out cash and investments, the P/E multiple reduces to 7.14. Everything looks pretty good so far. My DCF estimate of valuation in no growth scenario (assuming company does not go beyond 75,000 tractors) comes out to be 435 per share.

All in all, I am buying at current levels as I am getting a good company for a decent price. The stock wont be a multi-bagger as over a longer period, the companys fortunes would be tied to the overall tractor Industry growth in India. That perhaps explains lack of interest in the stock. The domestic tractor Industry has grown by 8.5% CAGR over last 40 years and by 15% CAGR over last 8 years. This year, the growth might be around 12-14%, coming after a robust 20% growth last year.