ZFCVINDIA — earnings call

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Prepared remarks

SYSTEMS INDIA LIMITED · MS. M. MUTHULAKSHMI - COMPANY SECRETARY - ZF

MS. M.

MUTHULAKSHMI - COMPANY SECRETARY - ZF COMMERCIAL VEHICLE CONTROL SYSTEMS INDIA LIMITED ZF Commercial Vehicle Control Systems India Limited November 10, 2022

Moderator · Conference Operator

Good morning, ladies, and gentlemen, and welcome to the Q2 FY 2022-23 earnings conference call of ZF Commercial Vehicle Control Systems India Limited hosted by Batlivala & Karani Securities India Private Limited.

As a reminder, all participant lines will be in the listen only mode and there will be an opportunity for you to ask questions after the presentation concludes.

Should you need assistance during the conference call, please signal an operator by pressing “*” then “0” on your touchscreen phone.

Please note that this conference is being recorded.

I now hand the conference over to Mr. Annamalai Jayaraj from Batlivala & Karani Securities India Private Limited.

Thank you and over to you Sir!

Annamalai Jayaraj

Thanks.

Good morning, everyone.

Thank you for joining us today and welcome to ZF

Questions and answers

Moderator · Conference Operator

Thank you very much.

We will now begin the Question-and-Answer session.

We have the first question from the line of Vimal Gohil from Alchemy Capital.

Please go ahead.

Vimal Gohil

Thank you for the opportunity.

My first question is on AIS-140 you spoke about a few products over there just wanted to know what has been the progress there, have we added almost all the Indian OEMs for these mandated products that need to be installed in their vehicles?

So, what is the progress there and if you can just talk about what are the various products which are mandated as per this government mandate, and the second one is on profitability while we have improved our profitability we understand the commodity pressure as well, but what is our desired level of profitability where we will be comfortable going forward?

P Kaniappan

AIS-140 actually it is a mandate and basically it requires that you should have a tracking device and a push button so that in case of emergency people can press the push button, then the signal will go to the government control center, etc., so it is essentially meant for passenger safety.

So, this has been mandated now in all the passenger carrying vehicles so for us it is largely related to the bus segment.

We are partnering with one of the OEMs and that OEM has decided to fit the FMS solution or telematics in their system from August 2020 and thereafter we are only steadily increasing our various functionalities and the robustness of the solution and again partnering with them and then see how this will be benefiting the fleet ultimately in the market.

Actually, our AIS-140 is a part of this offering that we give.

It calls for registering at a national level or empanelling ourselves as a service provider because here the work involves registering those vehicles in various states and it gets into the portal, Vahan portal and all those things and then of course we do a service in the field for this vehicle.

So, this is the business model that we have for that we get a subscription paid.

Our focus is to firstly get empanelled at national level; that happens when every state government is coming out with the requirement because each state has its own requirements so we are trying to make sure that, that part we complete and ensure that we provide service to all the fleets because here it is not that you have to only provide for that supply customer with whom you are partnering you have a huge aftermarket opportunity as well because if you are an empanelled player nationally and if the service is good you can actually fit it in the field as well for many players.

So this is a possibility, but right now we are only focusing on the partnering with the OEM and reaching out to the market and providing the service to them because the solution that we are offering is not only the basic AIS-140 but we provide much more services so it is a little expensive so while we are providing the service but we do not compete with small players in the market the only player is the AIS-140 so that is the current thing.

So on an average we have overall about 4000 to 5000 vehicles we are adding to our platform, today we have 107000 vehicles are connected to us in our platform of which of course initially we started the business with the startup in India but now we have a much more robust global platform which we call it as SCALAR so almost 40% of this 107000 vehicles are now in our global platform, more and more we are trying to connect to that.

That provides many opportunities for those fleets or those vehicles that are connected to avail the global services, ZF Commercial Vehicle Control Systems India Limited November 10, 2022 again there are possibilities for us to upsell the subscription.

So, on an average probably we do on the AIS-140 to the tune of the bus production alone maybe around 500 or 1000 buses out of the 5000 connections every month.

I hope that clarifies your point so AIS-140 is one part of the overall service that we provide, and we are limiting ourselves to that OEM because our solution is more expensive than other low cost players because we are providing more services than the AIS-140 itself like that so that is the way because we want to position ourselves as a technology player and a high-end player in the market.

On the profitability as I have been saying in one of the earlier earnings call we at least want to go back to our earlier position.

So, if you see we have been steadily improving, we are taking many actions to improve our margin and now because the commodity inflation also to some extent softening in commodities like aluminum to some extent on steel as well so it is also favoring there is stability in the business as well.

So, our plan is to get back to our earlier position on the margin side.

Vimal Gohil

So that would be 14% to 15% I would imagine?

P Kaniappan

Yes, that is right.

Vimal Gohil

Last question was on if you can just talk about you have always spoken about some of the other products like Hill Hold or the ESCs which probably help the vehicle with better control especially the heavy commercial vehicles on steep roads what has been the traction there maybe over the past one year what has been the acceptance levels by the OEMs?

P Kaniappan

One important trend that we see is the adaptation of advanced technologies in the vehicles now because after the BSVI now the customers are looking at how to differentiate.

When you have some sort of technologies you become a differentiator.

So, segment wise if you look at it in the truck segment we are moving into in the lift axle solutions, if you see very intelligent lift axle solutions which means when the truck is playing without load, for example you can actually lift one axle so that the tire life can be saved and again now we have the vehicles have certain intelligence so it will decide when to lift, etc. In the last few months, we have also expanded that from a single tyre to twin tyre type of environment as well.

So, we have launched this product with one of the global players the global customers in India and our focus is to extend it to other customers going forward this is essentially again done in a heavy duty segment.

Number two, you also might be aware that India is moving going forward the electronic stability control mandates from April 2023.

So, our focus is to get a strong position with Indian OEMs and do the homologation for all the vehicles, support them and make them ready for the mandate.

Again we have been quite successful in securing portion of that opportunity because normally initially it comes with only bus segment, we expect that may be followed to the truck segment in the next one or two years.

It is a good opportunity, and we are very well positioned and ready to launch the product customers are ready.

The next change is even in the connectivity area we are now going to be soon releasing our FOTA, FOTA is firmware over the air update meaning you can like our mobile it gets all their updates so we are working on this and soon we will be launching our FOTA possibility which will help us to really again differentiate ourselves in the market.

On ZF Commercial Vehicle Control Systems India Limited November 10, 2022 the electric domain even in the safety side itself, the next level is advanced driver assistance systems.

We have with the support of our global colleagues again we are now launching this product some OEMs have made a launch of the adapted solution we expect this to really come to the market in the next one or two years progressively from the OEMs.

It involves even the advanced emergency braking systems some of the passenger cars are now having the feature alert system first and then even a full braking system.

So those things we are now working at all OEMs and then progressively those functionalities will come to the market.

On the EV as I have read out that we have secured a stronger position on the electric compressor.

So, we have also convinced the customers to go for a electronic braking system which is much more applicable and relevant for the electric vehicles because of its intelligence to efficiently use the energy mainly by regeneration or other preparation that we are reducing the load on the battery system.

So, these are some of the technologies and market is now rapidly adapting or working towards and really launching these products, so we are well positioned to support the customers and probably next one or two years this will be the major products in the market.

Vimal Gohil

Got it Sir.

Thank you so much and all the very best.

I will fall back in the queue.

Thank you.

Moderator · Conference Operator

Thank you.

We have the next question from the line of Mukesh Saraf from Spark Capital.

Please go ahead.

Mukesh Saraf

Good morning and thank you for the opportunity.

My first question is to the same point that was earlier asked regarding margins so last time around you were mentioning that we have not yet taken the entire price, the price pass through yet with many customers and negotiations are going on so just trying to get a sense of where are we in that process, have we been able to now get most of those pass throughs or is there still a backlog there?

P Kaniappan

Actually, we have secured by and large the material cost impact, we have about one quarter time lag, but otherwise we have secured up to that point on the commodity inflation.

Mukesh Saraf

On exports we have seen a single digit kind of growth 5% to 6% growth Y-o-Y given that you have exposure to both Europe and US can you give us some sense on the environment over there, there are a lot of talks about the recession, etc., so could you tell us how is your order book looking like, are your customers scaling back on production or is it just a chip shortage that is right now impacting?

P Kaniappan

Actually, in a way it is mixed.

Number one the demand situation is quite strong in the passenger car segment, we are supplying air supply unit for one of the important global passenger car OEM, it is a luxury segment, so demand is steeply increasing, and we are actually building the capacity.

We used to supply 1000 numbers per day and by sometime last year December now we are in the range of 1500 per day.

So that is an increase in that segment on the other hand in certain products like our actuators, in those type of products there is a stock correction going on because it is an inventory correction temporarily, we have the reserve too because of our global organization ZF Commercial Vehicle Control Systems India Limited November 10, 2022 wanted to state, but otherwise I would say the demand is quite strong as of now.

Chip shortage is affecting a small segment of now it used to be a major issue but now some of the valves that we are producing here for other markets there is a chip shortage in a way still we are in allocation mode and its impact is comparatively less and the indications are at least for the next six months or up to the first half of next year the demand is expected to be strong.

We have to wait and watch thereafter but as such there is no immediate impact on our demand in the short-term.

Mukesh Saraf

The third one is on the PLI scheme, could you give us some understanding on how the incentive will work, how will it be calculated because as we understand you will have to have certain production targets as well for each of the years for the next five years so what percentage of that will be the actual incentive how would that work if you could just give us a broad sense?

P Kaniappan

I will request our CFO Mr. Raja to answer that.

R S Rajagopal Sastry

The PLI works as for the products which are categorized within the advanced automotive products which get an incentive of 8% to 13% for the growth in sales for base year and if the product belonged to the e-mobility sector there are certain products which are categorized as well.

The incentive can go up to 18%.

Now in our case against the base year of 2021 we are seeing that we are meeting or even exceeding our target as far as the sales is concerned but we are also closely monitoring our investments because there is certain long lead time which takes over because the PLI demand that is not to be work in progress it has to be capitalized.

So we are working on the investment asset also we will be updating as and when we are making progress on the investments and meet the threshold of the 250 Crores and that is when we will start getting our incentives or even when we meet our committed target, so we still are a bit away from our financial year 2022-2023 target as far as the investments are concerned where we are pretty much ahead of target as far as sales is concerned but we will keep the team posted as and when we make progress on that.

Mukesh Saraf

This 8% to 18% will be based on how well you achieve the production versus your own stated target so will you be at the bottom end of it?

R S Rajagopal Sastry

The way PLI is designed is if for a selected product on the base year you had 100 and if you have 110 for the current year you will get 8% to 18% of the 10.

Mukesh Saraf

The percentage how is it decided what will you get will it be 8% or will it be 18%?

R S Rajagopal Sastry

There are some calculations if you are exceeding the 10% it is 8% if you are exceeding the 250 Cr it is 9% it progressively goes up, based on the level of increase of your sales versus the base year so it is better the sales bigger the incentive.

Mukesh Saraf

Got it right Sir thank you so much I will get back in the queue.

ZF Commercial Vehicle Control Systems India Limited November 10, 2022

Moderator · Conference Operator

Thank you.

We have the next question from the line of Sonal Gupta from L&T Mutual Fund.

Please go ahead.

Sonal Gupta

Thanks for taking my question, good morning, Sir.

Just on the export side could you give us a sense of how much is euro denominated versus dollar denominated?

R S Rajagopal Sastry

We have almost equal mix euro and dollar.

Sonal Gupta

So then the currencies for this quarter would be approximately offsetting right then we should not have…

R S Rajagopal Sastry

Yes, from our export receivables foreign exchange impact perspective we are neutral.

Sonal Gupta

No, I was just trying to understand like the rupee exports versus the underlying exports to calculate the constant currency growth that is what I was trying to understand and secondly could you sort of give us a sense in terms of exports what is the split between the passenger vehicles versus the commercial vehicles?

R S Rajagopal Sastry

As I just said we do sell one product for passenger car so roughly the mix is about 15% to passenger car and about 85% to commercial vehicles.

Sonal Gupta

Got it Sir.

Thank you so much.

Moderator · Conference Operator

Thank you.

We have the next question from the line of Harsh Gemavat.

Please go ahead.

Harsh Gemavat

Good morning.

Thanks for taking my question.

I just wanted to ask what was the revenue mix for Q2 FY2023?

R S Rajagopal Sastry

Revenue mix we have 348.8 Crores coming from OEM, 102.8 coming from aftermarket and 262.7 coming from exports.

Harsh Gemavat

Just wanted to ask what is the adoption rate of the newer products and what kind of content increase are we looking at from each segment exclusively buses, passenger cars, etc.?

P Kaniappan

On specific few products there is the content increase and these products many of them just we are entering into the market except ESC which is coming through a mandate for all the buses of certain class most of the things it is essentially I would say for example I talked about the electric compressor.

Electric compressor the content itself is typically high per electric compressor but then the size market is only electric vehicles, electric vehicles we expect probably next year about 7000 may be produced.

So, the volume is less but the content is quite high, same case with the electronic braking system typically we sell is higher than the ABS.

On electronic stability control, we do expect a delta over conventional ABS, but ESC will be a mandated thing for the bus segment, EBS is only for the EV domain.

So, we are positioning it in the EV, we are now ZF Commercial Vehicle Control Systems India Limited November 10, 2022 focusing and making sure we get a stronger position as more and more EV vehicles come in we see our content will steeply increase.

On the other hand, if you look at lift axle control system which we are actually putting it for the higher tonnage vehicles it is the same 48 ton or 55-ton type of vehicles it is not only at 48 maybe even at the level from 42 ton or etc. So typically there the application is all the vehicles that the customers produce in that range generally they fit it.

It is very difficult to give you overall picture but most of these products are high content product and the volume increases and of course when we localize more and more, the delta may definitely come down but today that is the situation.

Harsh Gemavat

So basically these products will be more towards the EV segment and will be lesser adopted in the ICE portfolio correct?

P Kaniappan

Yes, that is correct.

Harsh Gemavat

Under the PLI scheme so I believe that the normal mandate that the government has given is that your content in the vehicle should be around 50% localized so what is our current localization levels for these EV components?

P Kaniappan

For each product there is a specific local value content for domestic value addition and we normally meet at about 45% I think is the initial requirement, most of the product if it is fitted on the government tender program you need to meet the standard so by and large we will meet it with the localization and without that generally you do not get into that business.

Harsh Gemavat

Okay understand thank you so much for that and the last question I will just end it on a basic book keeping question so what is the capex guidance for this year and the next year?

R.S Rajagopal Sastry

We are continuing to be in the range of 100 Crores for this year and you will see the capitalization of the new factory coming up next year which will that is another 150 Crores over the 100 Crores which we see this year which we have in normal condition.

Harsh Gemavat

Okay thank you so much Sir I will just get back in the queue.

Moderator · Conference Operator

Thank you.

We have the next question from the line of Lakshminarayanan from Tunga Investments.

Please go ahead.

Lakshminarayanan

Sir if I look at your services business which comprises software services, R&D services, and other business support services and you mentioned that there is a growth in this segment and I see that there is a center which was inaugurated in Hyderabad also couple of months back or so, so from an organization point of view how do you see the scale up of this particular thing and whether it is going to be margin accretive for our overall business?

ZF Commercial Vehicle Control Systems India Limited November 10, 2022

R.S Rajagopal Sastry

From the perspective of the expansion you saw in Hyderabad, ZF in India have got various entities and the Hyderabad expansion belongs to ZF India Private limited which involves the existing entity in India already.

P Kaniappan

Ours is actually in Chennai and we have really moved to a new location that is DLF from the RMZ location because we found that the current space is not adequate.

So in the new location we have 840 seats, so there is a clarity that we may progressively increase the numbers in the engineering software team and today close to about 500 so it will go to 840 number, so that is why we have opened a new site so this service will continue to increase and it will be part of this listed entity.

In addition, we also have the global business services or a back office there we are doing a lot of IT innovation, robotic process automation such things we do for global requirements.

The services continue to be increasing if you see in the last few years few quarters we have been growing at about 30% at a CAGR of around 25% to 30%, this may continue at that rate and you asked a question on the margin side maybe you can clarify I could not understand that question.

Lakshminarayanan

So my question is from a margin point of view the services are on a cost plus basis or you actually get margins as good as selling to OEs and exports right and I see that the growth of these services have been quite steep that it is almost one third of the past revenues, so that is the question in terms of how margin accretive or it is dilutive for our overall business?

R S Rajagopal Sastry

The margin for the service business are based on the cost plus as you just mentioned it is based on the transfer pricing model and there is no straightforward answer to say whether they are accretive to or they would dilute the margin percentage because that will not be a detail which I will be allowed to share what I can say that as you would see they expand on the overall quantum of margins definitely on absolute terms and they also aid in better absorption of the overall overheads that is what I can write now.

Lakshminarayanan

The second question is that what are the three important strategic areas for you for looking between now and 2027 or so, if you can just outline in terms of the OE business as well as exports what are the couple of key initiatives or thoughts you have on if you look at five years?

P Kaniappan

We believe of course the commercial vehicle industry will continue to grow as anybody’s guess but with Indian economy growing and this will definitely grow so with the technology side our main focus is to really increase our content, content increase is largely driven by this business is more and more on the braking and the autonomous driving area, also now we have added the digital business and EV.

So autonomous, connected, electric, these are the three segments will be playing a key role in India for Indian customers, export I will come back.

Right now we are secured a very strong portion in the braking side of the business and we believe few regulations will come in this segment because safety is largely driven through regulation first is ESC I just spoke about it so from April 2023 ESC for all the buses meaning above I think there is a second class M3 buses even before the regulations for the truck segment some of the Indian OEMs are ZF Commercial Vehicle Control Systems India Limited November 10, 2022 getting ready to launch ESC for the truck segment as well.

We believe it will be the application of ESC for the truck will also be followed by the bus segment.

Already we are expecting a draft regulation for the autonomous emergency braking as a next step of the safety is expected anytime soon because this is the normal path probably happening.

So already we are partnering with many OEMs in India in this area and started the work with them.

So that regulations will come so adapt and we are also expecting that EBS and ABS will get adopted in most of the trailer segment, trailer segment we see a significant pickup in the technology adoption in the volumes as with all this Gati Shakti and other major initiatives from the government we believe the logistics sector will play an important role and these technologies will come.

We have already started seeing in the trailer segment very good technology adoption whether it is a lift axle system or it is a ABS trailer or a trailer EBS, even the digital business in the trailer segment we have already launched we call it trailer pulse essentially a hardware that is connected somewhere you collect all the data, again monitor the data, analyze the data and try to help the fleets with the improved safety efficiency and operating margins.

In the area of digital business there are opportunities for us to help the customers essentially in this case fleets to set up uptime centers and they will be able to really manage that fleet uptime.

Also we have certain capabilities building globally for orchestration, orchestration is essentially you will be able to manage a fleet from a central command efficiently all that so that is a capability available with SCALAR.

So all these things will drive our growth from now to 2027 plus say 2030 and on the electric domain as I said we have positioned ourselves as a key player for certain areas like the electric compressor, ABS and disc brake.

So, we are very well positioned to support the customers as the market evolves.

Our rough idea even though we do not normally give a guidance but we are targeting about a billion euro type of sales in all the segments including export by 2030.

Lakshminarayanan

In terms of your co-products which could be the entire braking system and the new things you have been dealing has it been in terms of a market share in the last three to five years do you see that your market share is intact and even in the new line of business you would hold sway in terms of market share and how is that shaping up whether the Haldex or Knorr-Bremse of the world are also ramping up in India how do you see that?

P Kaniappan

Again we are strengthening our position I would say competition will always be there new competitions can come what we are doing is now becoming a part of setup so we have much more competencies , our investment on Oragadam and there is a facility in Pune again if needed we can use that also to support the footprint all that possibility is there so if anything I believe that either at least we will retain our position that is the view with which you are moving or in some cases we further improve ourselves.

Lakshminarayanan

Thank you so much I will get back in queue.

Moderator · Conference Operator

Thank you.

We have a followup question from the line of Vimal Gohil from Alchemy Capital can we take that question please.

Mr. Vimal Please go ahead.

ZF Commercial Vehicle Control Systems India Limited November 10, 2022

Vimal Gohil

Thank you for the followup opportunity Sir.

Just one clarification on PLI you said that while the company is meeting the sales targets, the investment targets are yet to sort of fructify, if you can just explain this in a bit more detail my understanding is that the sales and the investment targets should go in tandem if I am wrong please help me correct that and the second question would be the content per vehicle given the fact that we are talking of multiple products across the current ICE and the EV segment as well would it be fair to say that our content per vehicle which is around $550 to $600 that is expected to grow quite rapidly going forward?

Thanks.

R S Rajagopal Sastry

On the PLI side you are right if you are talking about a Greenfield product the investment and sales will have to go in tandem, but we already have been selling these and we also are promoting the domestic value at percentage with minimal investment, but what we have as a commitment and also as you know PLI requires a minimum commitment for the automotive component side to meet the levels we also have in the pipeline significant levels of localization, value add within the company so on and so forth and those are slightly long lead time and they have like a bigger gestation period as far as completing the investment.

So that is taking time it is not that while they have to go in tandem but it is taking time to meet the levels as required by the PLI scheme for bigger player.

P Kaniappan

On the content side, it is just I have been spending time to explain so much of pipeline of technologies that we are brought to India working with customers many of the customers have released but the actual content is largely driven by the way the market will evolve more of EV production will definitely support us and of course the regulations and all those things will drive but in principle yes our view is that now that the inflection points of adoption of technologies in India so it should definitely support us to achieve a rapid improvement in the content which in my view probably should start from the ESC regulation onwards.

Vimal Gohil

Perfect thank you and lastly just on the capex I missed that number for FY 2023-2024 total capex you spent?

R S Rajagopal Sastry

For 2022-2023 we will be at the range of 100-104 Crores and the capital realization of the new factory and the associated that will happen in 2023-2024 which will go anything like 250 Crores of overall put together.

Vimal Gohil

Perfect thank you so much once again Sir and wishing you all the best.

Moderator · Conference Operator

Thank you.

Ladies and gentlemen that was the last question for today.

I would now like to hand the conference over to Mr. Annamalai Jayaraj for closing comments.

Annamalai Jayaraj

On behalf of B&K Securities we thank all participants for joining the call.

Special thanks to ZF Commercial Vehicle Control Systems India management for taking time out for the call and giving us opportunity to host the call.

Have a good day.

ZF Commercial Vehicle Control Systems India Limited November 10, 2022

P Kaniappan

Thank you.

Moderator · Conference Operator

Thank you.

On behalf of Batlivala & Karani Securities that concludes this conference.

Thank you for joining us.

You may now disconnect your lines.