M&M upgrades itself as sole promoter of Swaraj Engines

What's Buzzing

In a regulatory exchange filing M&M informed exchanges about acquisition of 21,14,349 equity shares constituting 17.41% of the paid up equity share capital of Swaraj Engines (SEL) from Kirloskar Industries (KIL) for Rs 296 crore i.e. Rs 1,400 per share (~17% discount to yesterday’s closing price) 

Context

Swaraj Engines (SEL) is involved in manufacturing diesel engines for M&M's Swaraj brand of tractors. It is headquartered at Mohali (Punjab). It was earlier co-promoted by M&M (34.7%) and Kirloskar Industries (17.4%). With this acquisition, M&M now becomes the sole promoter at SEL with its stake increasing to 52.1% with SEL now becoming a subsidiary company vs. the classification as associate company in the past. 

Our Perspective

From M&M's perspective this is a small investment and things will not materially change for it. We view this transaction as more of providing an exit to erstwhile co-promoter i.e. KIL. Given that we model M&M on a standalone basis, which includes automotive business including farm equipment, this transaction will not alter its standalone financials. On the valuation front, it will have a small upside (~Rs 5/share) given that we used to value M&M’s investment in SEL at book value and can now switch to market value. From Swaraj Engines’ standpoint, this would result in change at promoter level with M&M now being sole promoter for the business. vs. its current classification as co-promoter. In terms of decision making, we do not foresee any change as the top management at SEL were all M&M veterans with automotive division head always on SEL board. With largely no change in operational prospects, we continue to like SEL given its superlative financials in terms of cash rich b/s, high return ratios profile (RoCE: ~50%, RoIC: ~100%), high dividend yield (~5%) and easy to understand/track business model of suppling diesel engines (22-65 Hp) to Swaraj brand of tractors at M&M. The current valuations at SEL (trades at ~15x P/E, ~10x EV/EBITDA on FY24E), however, have limited scope for upside given the low growth prospects in the domestic tractor space in the near term (industry expectation of ~3-5% volume growth for FY23E).