Divgi Torqtransfer Systems: At the Forefront of Drivetrain Innovation

There is an interesting auto-ancillary company based out of Pune that is carving a niche for itself in the automobile industry: Divgi Torqtransfer Systems. Recently listed in March 2023, the company’s market cap has surged by 60% from its IPO price.

What has contributed to this upmove? What distinguishes Divgi in the fiercely competitive B2B auto-ancillary segment? We will delve into these questions in this post.

The Origins: Divgi TTS

The company was founded by Ramrao Divgi and Bhaskar Divgi in 1964. It began as a modest manufacturer of gears, fasteners, and machined components for gearboxes. Their first major breakthrough came in 1995 when they entered a joint venture with Borg Warner to produce drivetrain components for the South-Asian region.

This JV lasted until 2016, after which Divgi TorqTransfer Systems operated independently. Over the years, the company has built capabilities in designing, developing, and manufacturing advanced drivetrain components and systems. Their customers include M&M, Tata Motors, MG, Toyota, Maruti Suzuki, BorgWarner, etc. They operate three manufacturing facilities in Pune & one in Sirsi, Karnataka.

Their product portfolio includes torque transfer systems (4WD and AWD products), synchronizer systems for manual transmissions and DCT, and related components. Additionally, they are developing transmission systems for EVs. Keep this EV thing in mind, we will come back to it.

Segments they serve:

A Glimpse into Divgi’s Future Plans

Capex of 169 Cr spent; 350 Cr upcoming in 3 yrs

As a small B2B player, the only way for Divgi to showcase its capabilities to prospective clients is by adding additional capacity (on a small scale) and presenting it to customers. Engage with them, pursue them, develop a prototype, and ultimately secure the order. This has been Divgi’s approach. That is how they secured most of their international customers in Russia, China, Korea, and the US.

In the last three years, Divgi invested 169 Cr in capex, bringing their current Gross block to 212 Cr. The company plans to invest another 350 Cr in three years, with brownfield expansion at the Sirsi plant and a new facility in Shirwal, Pune.

EV Transmission: The Next Big Jump for Divgi

Remember the EV thing we parked earlier? A few years ago, Divgi chose to prioritize EV transmission as its key growth strategy. The company conducted a pilot project with Tata Motors, manufacturing 2,000 units of the Tata Tiago EV, which received positive feedback. Subsequently, they secured an order worth approximately 100 Cr for EV transmissions from Tata Autocomp (intended for Tata Motors).

They are ramping up to a production capacity of around 1,20,000 units per year, with an expected price realization of approximately 10k per unit. These products will be integrated into Tata’s EV models, including the Tiago, Tigor, and Punch.

Additionally, Divgi received a 219 Cr order from the Mahindra Group for their EV models, scheduled for delivery over the next five years.

*Click on the image to enlarge

Strong Order Book (2.5x Sales) Offers Clear Growth Visibility

Currently, the company has a promising order book of 719 Cr, mostly from their existing customers like Mahindra, Tata Motors, and Borg Warner. They are set to execute these orders over the next five years, offering a glimpse into their growth potential.

A point to consider: At this stage of their growth, the company isn’t producing steady free cash flow. Their approach is simple. Set up the necessary capacity, secure orders, then expand and do it again. This will continue until they reach scale and the growth becomes more stable.

Strong Margin Profile & Sticky Customer Base

The average realization for a Transfer case (about 70% of their revenue) is approximately 31,000 per unit. A back-of-the-envelope calculation suggests that this product constitutes around 2-3% of the overall manufacturing costs for customer models like Mahindra N, Thar, XUV, etc. These products are critical and highly customized.

This positioning allows Divgi not only to foster strong long-term relationships with its customers but also to maintain a robust margin profile of approximately 28%, one of the best in the industry.

Divgi commands the best margin profile among its peers and has consistently maintained it. Sona BLW is Divgi’s closest competitor, given its primary focus on drivetrain products. Despite being only 1/10th the size of Sona BLW, Divgi still enjoys better margins.

Maintained a healthy balance sheet despite continuous capex

Since 2018, the company has consistently maintained a debt-free balance sheet. The management is generally conservative and favours sustainable growth over leverage. You might wonder how they managed a capex of 169 Cr in the last three years. The answer lies in equity dilution.

Divgi raised approximately 130 Cr from Private Equity (NRJN Family Trust & Oman India Fund in 2016 & 2018, respectively). They funded their growth capex through this equity dilution. The PE partners continue to own 15% of the company, according to the shareholding pattern as of June 2023.

Now that we’ve covered the interesting aspects of Divgi, let’s also look at one major risk the company is dealing with.

Key risk: High client concentration

Divgi gets around 74% of its revenue from M&M, and the remaining is spread across three to four clients like Tata Motors, BorgWarner, etc. This presents a huge concentration risk. The management has acknowledged it and said they are diversifying. However, it seems the risk is going to stay for some more time.

Even though the company is launching new products, they are receiving incremental orders from the same customers: M&M, Tata, and BorgWarner. So, unless the company secures a significant contract from a new customer (domestic or international), this high client concentration will remain for the foreseeable future.

We saw this impact the latest quarter (Q1FY24) as well. The company’s revenue decreased by -5% YoY mainly because M&M faced some quality issues with their Engines (Thar model) from another supplier (not Divgi). This issue caused a supply delay of a quarter. We must anticipate these occasional challenges until they reduce their dependency on a single client.

Stretched valuations

The company is trading at a market cap of 3100 Cr with a TTM PE of 61 times. In March 2023, it was listed at 37 times PE. It initially received a lacklustre response, and the price dropped by about 9% on the listing day. However, over the past six months, due to a strong upswing in mid & small-caps, the company’s rating shifted from 37 to 61 times, even though it underperformed in Q1FY24.

While the company appears promising, carving a niche in the drivetrain segment and maintaining a healthy balance sheet and margin profile, we shouldn’t overlook our entry valuations. The stock seems overpriced, with its anticipated growth already factored in. It would be wise to closely monitor the company and consider investing when there is a pullback or when valuations become more appealing due to a broader market correction, and then hold it long-term to play the emerging EV theme.

Summary

Three Upsides:

• Divgi is focusing on EV transmission systems and has a strong order book from Tata Motors and Mahindra for their EV line-up

• They are gearing up with a 360 Cr capex for a specialized EV facility in Shirwal, Pune

• They boast the industry’s top margin profile, backed by a sticky customer base

Three Downsides:

• Excessive dependency on M&M for orders, accounting for 73% of revenue

• Challenges in securing new major clients; even additional orders come from existing customers

• Valuations look stretched. Near-term growth might already be factored in

Divgi daily chart:

Please note that, we own Divgi TTS in our Capitalmind Focused Portfolio.

Subscribe to the Capitalmind Focused smallcase for access to the full portfolio

Capitalmind Focused smallcase by Capitalmind Momentum

This article is for information only and should not be considered a recommendation to buy or sell any stocks.

For immediate access to the best platform in India for active investors, join Capitalmind Premium: Model Portfolios, Premium Research, and a vibrant member community.

For any questions, tweet / DM us on Twitter or email us at premium [at] capitalmind [dot] in.