Jyoti CNC Automation: Remember Fundamentals Amidst Automation's Allure

The year 2023 was the breakout year for AI, Automation and Industry 4.0, as they made their way into the mainstream. It was also the year when IPOs made a smashing comeback. 

With Jyoti CNC Automation’s IPO,  this year began with a fitting fusion of both.  The first company to make its debut on IPO mainboard of 2024 operates in CNC machinery, which is currently at the forefront of Industry 4.0. The IPO garnered a good response, having been subscribed by more than 40 times. 

Naturally, investors are bullish on the industry, but there is intense competition and this impacts the financials of the company.

Let’s explore industry structure before diving into the company.

Since covid, automation in manufacturing sector accelerated as companies were exposed to supply chain vulnerabilities and started taking all possible measures to increase efficiency. Companies realized that modernizing is not a sufficient condition for gaining competitive advantage but a necessary condition for survival as all the firms in the market are doing it.

Nowadays, most traditional manufacturing companies are pivoting towards building their in-house IT teams. This might potentially explain why standalone IT services firms are facing headwinds. If traditional firms establish their in-house team, they are less likely to rely on  IT firms like TCS, Infosys.

Industry 4.0 is a culmination of the digital world and physical factories. In essence, factories have incorporated a digital twin.  In this, virtual prototype of a factory is connected to the actual factory through sensors, IOT. This allows for better and finer tracking. 

You can make changes in virtual prototypes and that will lead to changes in the actual factory. Under Industry 4.0, factories are consistently transmitting data. 

This allows for constant monitoring of the factory, which in turn, decreases lead time and allows for quick changes in batch. Machines go as far as diagnosing the issues they’re facing and self-correcting them. 

This is where CNC machines fit in.  There are two ways manufacturing happens. One is known as additive manufacturing. Here, multiple layers are added to create a product. This is also known as 3D printing. 

The other is known as subtractive manufacturing, where a product is manufactured by sculpting a material. CNC machines come under subtractive manufacturing.  

CNC machines take in virtual designs created in software like auto CAD and then sculpt metal or other designated material per the provided design. 

There are various versions of CNC machines, ranging from 2-3 axes to 7 axes. A higher axis means greater movement and rotation along more axes, enabling sculpting of more complex designs. Modern CNC machines also have self-diagnostic  features.

At the same time, In case you need to change the material from metal to say, plastic, it would generally mean a drastic change in the properties of the material, and you need to adjust manufacturing process accordingly. However, CNC machines are able to adapt quickly and accurately.

As more and more companies try to modernize their factory floors, they will be on the lookout for the latest versions of CNC machines. Between CY23 and CY27, the global CNC market is expected to grow at 10.3%. On the domestic front, CNC machine consumption is expected to grow at 11% CAGR between FY23-FY27. 

However, the CNC market, both domestically as well as globally, is quite fragmented. Globally, the top 13 players account for 39.9% of market share. In India, the top 5 players occupy a 45% market share.  

With this background, let’s look at Jyoti CNC Automation 

It is the 3rd largest manufacturer of CNC in the country with a 10% market share and 12th biggest firm in the world, holding less than 1% global market share. It has 3 manufacturing plants (two in Rajkot, India and one in Strasbourg, France). 

The company caters mainly to the Indian market,  as exports account for less than 20% share of its revenue. In the Indian CNC machine market, more than 40% of demand is fulfilled by imports (Although, the share of import is falling gradually). This is mainly because more than 60% of Indian firms focus on catering to the automotive segment, which creates a supply-demand mismatch in other industries. 

Indicating intense competition from Indian as well as global firms. , which, in turn, leads to low pricing power. Thus, the focus shifts to non-price competition like product differentiation, relations with customers and efficiency

Given that Jyoti CNC Automation has been in business for a long time and still doesn’t hold a dominant market position, it is clear that the company’s products are not that different or superior to its competitors. 

This implies the lack of USP (Unique Selling Point) for the company. Also, it doesn’t have long-term contracts with customers. Since long-term contracts and USP are indicators of consumer stickiness, their absence is a concern.

One bright spot is its huge order book, exceeding Rs 3,000 cr. In this, close to Rs 1,900 crore comes from the defense sector. This ensures revenue visibility in the near future. Also, the company has increased its R&D expenditure from 2.28% of revenue in FY21 to 4.47% of revenue in FY23. Huge R&D expenditures may help the company in gaining a competitive advantage and consequentially, a significant market share.

But there is a caveat. The CNC machine industry has characteristics of a monopolistic market. Such market structure with huge growth potential, incentivizes all the firms to invest heavily on innovation. This means that Jyoti CNC Automation’s competitors are also likely to invest significantly in R&D and go all guns blazing to save their market share.

Coming to financials

High debt levels caused strain for the company. High finance cost led to net losses for it in FY21 and FY22. However, the company’s gross margins have been stable for the past 3 years.  With growth in its revenues, the company has attained economies of scale, which led to consistent improvement in its EBITDA margins from 5.46% in FY21 to 10.48% in FY23. This also allowed the company to become net profitable in FY23. 

It seems that the growth in its order books has also helped the company in utilizing the benefits of integrated operations for attaining higher efficiency, its asset turnover ratio jumped from 0.43x in FY21 to 0.63x in FY23. This growth also improved the company’s debt service coverage ratio from 0.41x in FY21 to 0.88x in FY.  Now, the company is looking to use the proceeds from the IPO for reducing its debt, which might further fuel improvement in profitability, along with a betterment in its debt service coverage ratio.

Let’s talk about IPO

As per FY 23 EPS of Rs 1.02 and issue price of Rs 331 at upper level, its P/E ratio is 324, while the average industry P/E is 49.55, and the highest one is 67.76. 

After looking at its competition, the company’s position in the industry and its financials, it begs the question of  whether such a valuation is justified or not. Decide for yourself.