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Bartronics India Report by ICICI Direct

Thursday, 13 September 2007

Smart One!!

Bartronics India (BIL), one of the first Automatic Identification and Data Capture (AIDC) solutions company, is leveraging its existing client base and expertise to move up the value chain and emerge as the largest end-to-end AIDC solutions provider in the country.
It is investing more than Rs 270 crore into a new 80-million smart cards manufacturing facility, that would make it one of the biggest players in South Asia and enable revenue growth by 130% CAGR over FY07-09E.

The stock is currently trading at 10.32x FY09E earnings and 6.23x FY09E EV/EBIDTA, which we believe is very attractive considering the sharp earnings growth. We initiate coverage on the company with an outperformer rating with a target price of Rs 338.

AIDC segment – First mover advantage

BIL is one of the first organized players to provide end-to-end AIDC solutions in India with more than 1,600 clients and five international distribution centers. Strong technical know-how has helped the company move up the value chain from bar code to RFID solutions and increase realization per client. The company has also diversified into the retail space considering the low penetration of organized retail, a sector that is
clocking at 30% CAGR growth.

Changing gears with smartcards

Smart cards are expected to take the company into fifth gear with the South Asia’s largest manufacturing facility. Having an order book for more than 100 million smart cards over next two years is expected to generate 3.5x FY07 revenues from this segment alone.

Strong earnings growth - Outperformer

The stock is trading at 10.32x earnings and 6.23x EV/EBIDTA for FY09. We believe the valuations are attractive considering the changing business model, robust 73.2% earnings CAGR over FY07-09E, strong bargaining position in the smart cards segment and its ability to scale up AIDC segment. We rate the stock an outperformer rating with a target price of Rs 338, an upside of 44%.

Company Background

Bartronics was incorporated in 1990 and started its business in the field of bar coding and smart card technology. It later started experimenting with the new Automatic Identification & Data Capture (AIDC) solutions.

The company is involved mainly with the manufacturing sector and has implemented a number of projects across companies in their manufacturing set-ups. The projects primarily involved inventory & logistics management, time & attendance and asset tracking systems.

AIDC is seen as an enhancing technology as it automates the data collection for the main systems. Currently, the company offers diverse range of AIDC technologies – barcode, biometrics, radio frequency identification (RFID), radio frequency data communications (RFDC) and electronic article surveillance (EAS). The company has recently set up an 80 million smart card facility in Hyderabad to cater to the growing demand from the telecom sector and plans to enter the retail market soon.

INVESTMENT RATIONALE

Indian smart card market at inflection point

The Indian smart card market is at an inflection point with the demand coming from various sectors such as banking, retail, telecom, healthcare and government organizations which are likely to witness exponential growth over next three years with most companies looking at data security and collection.

We believe BIL will be the key beneficiary of this growth and move up the value chain by offering complex solutions across industries. A Frost & Sullivan Report on the smart card market in India estimates that the revenues from the smart card would grow at a CAGR of 48%. The smart card market in terms of revenues is expected to grow from current US$ 47.5 million to US$248 million by 2009.

Experimentations with smart cards have started across states and we believe the trend to catch up with others soon. Some of the notable smart card projects in India are

1. PetroCard issued by BPCL.

2. The Employees Provident Fund Organization (EPFO) and Siemens’ joint venture project to offer smart card facilities to EPFO’s 2.6 crore subscribers.

3. Initiatives by state governments in Gujarat and Madhya Pradesh to issue smart card-based driving licenses.

4. Rajasthan milk card project—the world’s first milk collection system based on smart card technology, and run exclusively by women.

5. The RBI-sponsored SMARS project, which involved the issuing of smart cards to the students and staff in the IIT Bombay campus.

6. The BEST project to solve the problem of small change, ensure better administration, and increase efficiency. This project was significant as it was the first time that a mass transport organization in India decided to go in for smart cards.

7. The Kerala ration card project to monitor the distribution of supplies through the public distribution system. The project has helped in cutting down pilferage of resources at various points in the system.

We believe India is the next hot spot for smart card applications as Asia- Pacific accounts for approximately 30 percent of worldwide smart card sales, and is the second-largest market after Europe. India is said to be the next big market after China and Japan for smart card growth.

Bartronics set to capture this opportunity

To capture the demand for smart cards estimated at more than 150 million units per year and growing at a CAGR of 48%, BIL company set up the first smart card manufacturing plant in India having a capacity of 80 million units.

We expect the plant to operate at around 40% capacity in FY08 and 90% in FY09. Initially, BIL plans to capture around 70% of the SIM card market, where the smart cards are priced at Rs 36 initially but are expected to decline to Rs 30.

A further fillip to the smart card market is expected from the proposed Multipurpose National Identity Card to be implemented by the central government. BIL is among the companies shortlisted and the pilot project in underway.

The banking sector will drive the industry with switch from the current magnetic tapecards as Visa & Master Card deadline will expire in next three years.

The company has tied up with HSBC and Corporation Bank for ATM cards on a pilot basis for Rs 99 per card. We believe these small steps will help the company in long run and gain market share before competition enters the market

Booming AIDC industry

The AIDC industry is rapidly moving towards the use of RFID in a number of high value and high volume market segment. The RFID market is expected to grow from $1.4 billion annually to $6.1 billion in 2010. The Indian market is estimated about Rs.100 crore in FY05, comprising of smart cards and bar codes solutions.

This segment is expected to grow at 20-30% annually. RFID and biometrics solutions are growing at a CAGR of 50% and are expected to have an exponential growth with retail and manufacturing growth in India.

BIL: Strong brand in AIDC segment

BIL has established a brand value amongst its clients (about 1,600) over a period of 16 years. The work includes system integration for barcode solutions, which has applications in areas such as inventory management, attendance recording, dispatch management etc.

The companies clientele includes Tata Steel, Tata Motors, HLL, ITC, Ashok Leyland, TVS, CMC, Ranbaxy, Compaq, VST, Whirlpool, ITW, Dr. Reddy’s to name a few. The company also provides services to the devotees of Lord Balaji (Tirupati) by managing the inflow logistics of the pilgrims.

Some of its multinational clients include Compaq, Panasonic, IBM, GM, Mercedes Benz, etc. The company has also started providing RFID solutions to the same set of customers and moving up the value chain.

De-risking geographies by going global

In order to have strong global presence the company has five international distribution centers. These centers cater to the growing AIDC demand in the countries such as Malaysia, Sri Lanka, Bangladesh and Dubai.

Having strong relations with clients has also helped the company expand to newer geographies as the clients moved to the other markets and wanted only BIL to provide solutions. We believe new geographies will help the company expand the market and gain market share.

Retail – the next big story

Organized retail contributes more than 40% to the barcode industry. BIL is currently in the pilot stage to move up the value chain in this space and gain a share in the Rs 100,000 crore retail industry.

The company has tied up with Intel and designed products and solutions for point of sales having starting price from Rs 32,000 onwards. These products are more than 20% cheaper to ones used by the industry currently and also more complex, which gives the retailer more information.

With implementation of VAT across the country, every organized and unorganized retailer will need the solution and hardware to cater to the customers in more efficient way and manage supply
chain.

BIL has already has got more than 900 request from across the country for dealers and distributors. We believe these products will be launched by end of Dec 2007. However we have not factored this in our estimates.

Acquisition the next trigger

BIL is scouting for acquisition since last two years in the USA. The target company is in the range of US$25 million. This will help the company achieve its vision of having Rs 1,000 crore turnover along with entry into the biggest market of the world where it could outsource work back to India and reduce cost and cross sell various solutions as well. We believe this acquisition will help the company build its brand across geographies and get into the new league.

Proactive management focusing on growth

We believe the management has been proactive in identifying new areas of growth such as smart cards, entry in the retail segment and grabbing export opportunities (tie-up with Watchdog and Hayleys group) much ahead of its competitors.

We believe they are capable of executing the larger vision of transforming the company and having Rs 1,000 crore turnover in next two years organically or inorganically.

Risk to our call

Obsolescence of technology

The products and services offered by the AIDC industry hinder on technological and scientific progress. The products and services so offered shall be rendered obsolete by increasingly advanced and efficient products and services. This could hamper company’s profitability if they are not able to scan the environment for emerging technologies.

Competition in smart cards

Currently, all the smart cards in India are imported from the US and Europe. With growing demand from various sectors we foresee competition entering the space, which could reduce the company’s competitive edge, as supply would increase. However, competition would increase the market size and penetration.

Smart card prices

Smart card prices are internationally driven. Over last three years, card prices have reduced by more than 55%. BIL manufactured cards are around 15-20% cheaper than international cards. However, a further reduction in prices may make imports cheaper which may affect the company’s profitability going forward.

Financials

Revenues to become 5x FY07 revenues

We expect revenues to be more 5x its FY07 revenues to Rs 336.57 crore by FY09 on back of new smart facility, which would contribute more than 64% to the topline. The company is well placed to capture the growth in the smart cads segment having the first mover advantage, expertise and capability to produce entire spectrum of products.

With increasing need for AIDC solutions in the manufacturing and retail industry, we expect solutions revenue to grow at a CAGR of 37.8% and smart cards from zero to Rs 216 crore in FY09E. Accordingly we expect BIL to witness 130.2% CAGR in revenues over FY07- 09E.

Margins to jump by 270 bps over next two years

BIL’s business has operating leverage as the company uses a cost-plus approach. Furher, its new smart card facility has fixed cost in terms of employees and infrastructure.

With rising utilization levels, operating margins are set to increase from 26.55% in FY07 to 29.19% in FY09E. However, we expect the PAT margins to reduce by 100 bps to 19.9% in FY09E on back of higher in depreciation on new capex and interest
charges.

73% earnings CAGR over FY07-09E

We expect BIL’s net profit to witness grow at a CAGR of 123.6% over FY07-09E led by strong revenue growth and expanding operating margins. However, equity dilution of 104% in last two years due to the recent fund-raising for the smart card facility should relatively mute EPS growth to a 73% CAGR over FY07-09E.

Raised Rs 270 crore for smart cards facility

BIL has raised Rs 270 crore through an FCCB issue, warrants and QIP placement. This amounts a full equity dilution of 104%. The fund has been primarily raised to meet the capex to set up a smart card manufacturing facility in two phases. Phase I was completed in July 2007 while phase II is expect to be completed by January 2008. Company would require Rs 210 crore for expansion while Rs 60 crore for working capital.

Return ratios to improve over FY07-09E

The company’s recent fund-raising would mute its RoCE and RoE to 12.4% and 12.2%, respectively, as it has invested in the new smart card facility. However, once the facility starts generating revenues with more than 90% capacity utilization in FY09 and starts contributing significantly to the bottom line, we expect return ratios to improve from FY09 onwards.

Valuations

We believe BIL, one of the first AIDC solutions company in India, is leveraging its existing client base and expertise to move up the value chain and emerge as the largest end-to-end AIDC solutions provider in the country.

It is investing more than Rs 270 crore into the new 80 million smart cards manufacturing facility making it one of the biggest players in South Asian. Revenues are expected to a grow at a CAGR of 130% over FY07-09E.

Currently, the stock is trading at 10.32x FY09E earnings and 6.23x FY09E EV/EBIDTA,
which we believe is very attractive considering the sharp earnings growth and strong position in the smart card market. There is no listed peer in the Indian market.

Other small companies are in the unorganized sector and have selected bouquet of products. We believe the valuation discount of BIL is unwarranted considering its double-digit growth rate and impressive return ratios. Very few global players are listed and command significant premium to current BIL’s valuations.

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We value the stock on two parameters

Method 1: Price to earnings

Most of the global players are trading between 15-28x FY09E earnings. Considering the exponential growth expect, we believe BIL should also command a similar premium, as it is the only listed company in India in this space. Using this method, we value the stock at Rs 340, 15x FY09E diluted EPS of Rs 22.66.

Method 2: Price to Sales:

We believe this industry is driven by sales and larger players command higher valuations. Big players such as Intermec command higher valuation than Oberthur.
We value BIL at 1x price to sales at FY09 sales and arrive at a target price of Rs 336.

Source : ICICI Direct

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