Result Update February 15, 2017 Rating matrix Rating : Buy Balkrishna Industries (BALIND) | 1180 Target : | 1400 Target Period : 12 months Healthy volume & margin continues to impress Potential Upside : 19% • Balkrishna Industries’ (BIL) revenues came in at | 882 crore (up What’s changed? 26.3% YoY) vs. our estimate of | 899 crore, as volumes grew 22.4% Target Unchanged YoY to 40,415 metric tonnes (MT) (our estimate: 40,093 MT for Q3) EPS FY17E Changed from | 77.7 to 77 • EBITDA margins came in at 31.5% (up 825 bps YoY but down 146 EPS FY18E Changed from | 93.2 to 83.8 bps QoQ) vs. our estimate of 29.7%. Despite higher input cost EPS FY19E Introduced at | 99.7 (average natural rubber prices were up 14.2% YoY to | 124/kg in Rating Unchanged Q3FY17), the gross margin expanded 268 bps YoY. Lower staff cost (down 37 bps YoY) & other expense (down 520 bps YoY) also lifted Quarterly performance the overall margins of the company (| Crore) Q3FY17 Q3FY16 YoY Q2FY17 QoQ • PAT grew 94.2% YoY to | 186 crore vs. our estimate of | 164 crore Revenues 882.2 698.7 26.3 932.5 -5.4 • As of Q3FY17, its outstanding debt was at | 851 crore while the cash EBITDA 278.0 162.5 71.0 307.5 -9.6 holding was at | 1193 crore, thus making it net debt free EBITDA (%) 31.5 23.3 825 bps 33.0 -146 bps • For FY17E, the management has given volume guidance of >165,000 Reported PAT 185.7 95.6 94.2 242.9 -23.6 MT vs. earlier guidance of 160,000 MT to 170,000 MT, with margins expectations of 28-30%, going forward Key financials Focused OHT player with room to increase market share in global pie | Crore FY16 FY17E FY18E FY19E Net Sales 3,242 3,753 4,446 5,315 BIL is a focused off-highway tyre (OHT) manufacturer with contribution of EBITDA 1,078.2 1,143.6 1,340.9 1,543.5 agricultural and OTR segments at 63% and 34%, respectively. With the Net Profit 567.7 744.6 809.9 963.4 OHT segment only 10-15% of revenues for global players like Bridgestone EPS (|) 58.7 77.0 83.8 99.7 & Michelin, BIL’s focus on this niche segment augurs well for BIL as it currently enjoys ~4.5% market share in a ~$15-billion global market. Valuation summary Also, the only focused global player, Titan, commands a hefty brand FY16 FY17E FY18E FY19E premium (~20-25%) over BIL’s products. Hence, this outlines the P/E (x) 20.1 16.8 14.1 11.8 headroom for growth in this highly capital & labour intensive segment Tgt P/E (x) 23.8 18.2 16.7 14.0 characterised by large number of SKUs and high degree of customisation. EV/EBITDA (x) 11.2 9.6 7.6 5.9 Continues to enjoy significant labour cost arbitrage P/BV (x) 4.1 3.3 2.7 2.3 RoNW (%) 20.3 19.6 19.3 19.0 Despite selling at ~20% discount to its global peers, BIL enjoys strong RoCE (%) 20.4 22.5 24.7 25.7 margins as its products are competitive due to lower labour costs in India vs. higher wage in European facilities. Labour costs form ~6% of revenue compared to its peers (like Titan), with labour costs at ~20% of revenues. Stock data Though it does not command pricing power, lower labour cost is helping Particular Amount Market Capitalization (| Crore) | 11405.7 Crore BIL to position its product at a discount vs. peers, thereby gaining share. Total Debt (FY16) (| Crore) 1,288.3 Margins to sustain, going forward Cash & Investments (FY16) (| Crore) 573.3 BIL benefited from euro depreciation (~51% of revenue is from Europe) EV (| Crore) 12,120.7 as it had hedged the currency at | 85/€ for FY16. The benefit of currency 52 week H/L (|) 1280/551 hedging was over in FY17. However, the company enjoyed the benefit of Equity capital (| crore) | 19.3 Crore low cost inventory which supported the overall margins in 9MFY17. With Face value (|) | 2 BIL likely to initiate some pricing action (in line with its peers) soon, we believe the rise in input cost will be passed on to consumers, thereby Price performance protecting its margins. Apart from that, better product mix, in terms of 1M 3M 6M 12M higher share of radial tyres (>40% vs. <30%) in addition with higher Balkrishna Industries Ltd 10.3 19.3 62.8 108.0 share of OTR tyres will cushion margins. The management expects Apollo Tyres Ltd -6.6 -9.0 3.0 18.5 margins to remain in the range of 28-30%, going forward. JK Tyres -11.7 -17.6 7.0 41.2 CEAT Ltd -7.9 -13.2 26.2 23.2 Volume recovery + margin expansion = maintain BUY! MRF Ltd -5.9 -4.5 38.9 57.8 We believe BIL is an export dominated niche play and is well placed to capture the demand revival opportunity. The demand revival can be seen Research Analyst from its healthy volume growth of 18% YoY in 9MFY17. Margins are also Nishit Zota expected to sustain, considering its ability to pass on the price of rising [email protected] input cost & due to better product mix, going forward. Its strategy of higher utilisation, repayment of debt & deepening its reach will further Vidrum Mehta supplement its growth. Thus, we value BIL at 14x FY19E EPS & maintain [email protected] our target of | 1400 with a BUY recommendation on the stock. ICICI Securities Ltd | Retail Equity Research Variance analysis Q3FY17 Q3FY17E Q3FY16 YoY (%) Q2FY17 QoQ (%) Comments Total Operating Income 882 899 699 26.3 933 -5.4 Marginally lower-than-expected due to lower than estimated ASPs Raw Material Expenses 358 386 303 18.4 367 -2.2 Despite higher input cost (average natural rubber prices were up 14.2% YoY to | 124/kg in Q3FY17), the company’s gross margin expanded 268 bps YoY Employee Expenses 56 53 47 19.4 54 4.1 Power & Fuel expenses 30 30 30 0.0 30 0.0 Other expenses 160 163 157 2.0 174 -8.5 EBITDA 278 267 163 71.0 307 -9.6 EBITDA Margin (%) 31.5 29.7 23.3 825 bps 33.0 -146 bps Lower operational expenses lifted the margins on YoY basis Other Income 28 44 10 179.4 45 -36.4 Depreciation 79 72 76 3.1 72 8.7 Interest 5 6 14 -65.8 5 4.5 Tax 72 70 41 76.7 91 -21.1 PAT 186 164 96 94.2 243 -23.6 Higher margins lifted the profitability of the company EPS 19.2 16.9 9.9 94.2 25.1 -23.6 Key Metrics Volume (MT) 40,415 40,093 33,010 22.4 42,550 -5.0 Volumes came in marginally lower than our estimates Average realisation also came in lower than our estimates after BIL did not 3,191 3,340 3,207 -0.5 3,216 -0.8 fully pass on the impact of higher NR prices to consumers Realization ($/tonne) RM/Sales 40.6 42.9 43.3 -268 bps 39.3 131 bps Source: Company, ICICIdirect.com Research; Numbers are as per Ind-AS Change in estimates FY17E FY18E FY19E (| Crore) Old New % Change Old New % Change Introduced Comments Revenue 3,816 3,753 -1.7 4,550 4,446 -2.3 5,315 Marginal cut in estimates for FY17E (largely in line with management guidance) EBITDA 1,153 1,144 -0.8 1,394 1,341 -3.8 1,543 EBITDA Margin (%) 30.2 30.5 26 bps 30.6 30.2 -48 bps 29.0 Higher-than-expected margins in Q3FY17, has prompted us to revise FY17 estimtaes upwards. The management expects margins to remain in the range of 28-30%, going ahead PAT 751 745 -0.9 901 810 -10.1 963 EPS (|) 77.7 77.0 -0.9 93.2 83.8 -10.1 99.7 Source: Company, ICICIdirect.com Research Assumptions Current Earlier Comments FY16 FY17E FY18E FY19E FY17E FY18E Capacity (MT) 300,000 300,000 300,000 300,000 300,000 300,000 Sales volume (MT) 148,244 170,271 192,576 215,685 170,423 192,578 Volumes likely to regiseter CAGR of ~13% over FY16-19E. Average realisation ($/MT) 3,335 3,232 3,388 3,622 3,297 3,494 Realisation likely to improve gradually on YoY basis Depreciation 281 308 333 372 299 305 Source: Company, ICICIdirect.com Research ICICI Securities Ltd | Retail Equity Research Page 2 Key conference call takeaways • The management has indicated that the current demand environment is stable and expects some improvement, going forward. BIL has seen a good demand improvement across regions (US, Europe, India), categories (replacement & OEM) and products (agriculture & off-the road) • BIL’s overall strategy is broadly to provide newer products (SKUs) to its existing customer, get into newer geographies, thereby gaining market share • For FY17E, the management has given volume guidance of >165,000 MT vs. earlier guidance of 160,000 MT to 170,000 MT, with margins expectations of 28-30%, going forward • The final judgement on anti-dumping of tyres has been announced by the US market regulator, which says there is no dumping of tyres by BIL. However, market regulators have imposed countervailing duty (CVD) of ~5.36%, which management is likely to pass on to consumers, going forward • As of Q3FY17, its outstanding debt was at | 851 crore while the cash holding was at | 1193 crore, thus making it net debt free • The management has guided that no major capex is planned over the next couple of years.