Results above expectations, demand softens a bit
Balkrishna Industries (BKT) reported a robust Q1FY13 performance above their expectations. Net revenues grew by 42.7%YoY and 5.4% QoQ, of which 29%YoY came from volumes, while the rest came from growth in realizations and product mix. Volumes for the quarter were at 37,001 MT, up 29% YoY. While there was no price hike taken in the quarter, the YTD prices were high on improved dollar v/s rupee and favorable product mix. Sequentially, the volumes grew by 1.8%. Although the volumes have grow robustly yoy, the growth is getting stunted on a qoq basis. This is also getting reflected in the order book of the company which has come down from 70,000 MT (6.5 months) from Q2FY12 to 51,000 MT (4 months) in Q1FY13. This has been due to softness in demand in US due to drought and Europe due to the general slowdown. However the management also admitted that the production runrate has increased now and will be able to maintain order book to the minimum of 3 months in any case. This signifies resilience in replacement demand as OEM demand is falling. With new capacities at Bhuj commencing from September 2012,LKP expects better volume performance on the growing replacement OTR market which will remain insulated from any downturn in the macros. In line with the reducing order book size and some concerns on the European and American business,LKP has slightly cuttheir volume estimates from 163,000 MT/189,000 MT in FY 13/FY14 to 158,000 MT/183,000 MT in the same period.
Margins bounce back to 18.9% in Q1, crude oil prices may play spoil sport
EBITDA margins grew 280bps sequentially at 18.9% on softening rubber prices and improving product mix, despite other expenses to sales increased to 21.5% of sales. RM to sales fell to 56.6% of sales from 58.9% sequentially on fall in natural rubber prices. PAT came in 30.3%YoY while it fell by 4.2%QoQ at Rs731 mn on robust operational performance and healthy topline growth. Exceptional items worth Rs203 mn marredBalkrishna Industriesas performance at the bottomline depite robust operational performance. Management beilieves that the rubber prices will soften further and hence have maintained lower level of inventories ~ for just 3 months. BKT expects the rubber prices which are USD3,500/T to come down to USD3,200/T. In spite of taking significant price hikes prior to Q1FY13, BKTas product prices are still at 30% discount to the market leaders, thus providing BKT an edge over its competitors in times of slowdown and also allow BKT to take any further price hikes if required. With capacity expansion at Bhuj, operating leverage is bound to come and assist margin growth. Also, the long term view rubber prices remains soft as rubber prices are expected to move down in FY13 on increased supply coming from growth in plantation and yield. Furthermore, with additional capacities coming on the high margin OTR side in the next couple of years, the margins are slated to expand by at least 200bps by that period with the Bhuj plant coming up with an in built power plant and rubber mixing plant which would save at least 150 bps of power and transportation costs. Also the increase in radialization from current 20% to 30% projected for the next year will also help margin growth. With robust Q3FY13 margins and expectation of improvement going forward,LKP has maintainedtheir margin estimate for FY 13E/14E to 18.3%/19.4% respectively.Their FY13E margins are slightly lower than Q1 margins due to bounce back in the crude oil prices seen off late due to which synthetic rubber prices will somewhat negate the benefits observed in NR price getting softer.
Agri-OTR growing in tandem, emerging economies future growth drivers
Healthy replacement demand mainly in the agri segment (64% of volumes) is the major revenue driver for BKT. Inspite of the slowdown in the mainstream auto segment in Europe and US, agri demand has not taken a hit. Owing to BKTas presence in the agri sector, BKT has witnessed a market share hike of 0.5% to ~4% over the last one year and aims to reach 6%-7% by 2015 in th USD8 bn OTR global market. However, in the last one year, the OTR segment has increased it share to 33% from 30%, which shows that the OTR segment is growing at a greater pace and is showing nice pickup along with agri segment. Strengthening of business in the CIS countries, Russia and India will drive the business further. Also, the new capacities at Bhuj will contain 30% of production for the OTR segment, of which 9-10% will be mining which is showing increasing demand in the global markets.
Outlook and valuation
Although Q1 results were in line with their expectations,LKP is slightly pruningtheir estimates for BKT on the back of reducing order book and concerns mentioned by the management in Europe and the US. At CMP, the stock trades at 6.1x times its FY14E EPS of Rs45.LKP now values BKT at 7.5x times on FY 14 earnings, while increasingtheir target price to Rs340 andmaintains BUY rating on the stock, asLKP roll over to FY14E estimates. The entry of several institutional investors in the stock is a definite positive intheir view.
Thanks Tcx. Lot of useful data there in the reports. Let's start monitoring key data points as below
|Sequential Volume Growths|
Having gone through the management q&a, BKT story seems quite strong.
Some concerns in the bigger picture of things could be:
1). High debt. Currently it is at very low interest rate with libor being very low but what happens if libor goes up. How much impact does 1% hike in libor have on the company’s interest payment?
2). Currency fluctuations: These days there are wild swings in currencies and company can be caught on the wrong foot in the cross fire of currency swings.
3). Demand scenario as pointed by management does look quite strong with BKT catering mainly to replacement market. Dont know what can affect this demand? Is the position here really really invincible??
4). Fast expansion for small and midcap companies or for that matter any company is always fraught with risks often unforeseen. Just as rubber prices have gone down, they may go up and then sometimes companies might find it difficult to pass on the price hikes.
above arguments are for playing the devil’s advocate.
Currently at around 285 and expected eps of around 35 stock is there at a PE of around 8 plus. How high can the rerating go is what one must ask oneself.
Donald, very wellsummarized yet again. BKT has been an excellent story…its rare to find cos which have grown at 30% CAGR for last 15 yrs! and now BKT is becoming a global meaningful player…very few Indian cos can be counted in the same league. It has evolved into a brand and now targets to be a 7-8% global market share holder.
Though over longer term the co should do well and their plans seem to be well drafted but still a couple of conerns on my mind are:
1). The co is debt heavy now - No matter how good a company has been, things do go wrong and this remains a risk. They need to control the debt:equity.
2). The global environment is worrisome - I feel there has been significant slowdown in europe etc and if things don’t pick up soon, the cos aggressive plans may get affected.
3). Currency risks - Like Hitesh mentioned, I agree these are big risks. Co has already suffered some major forex M2M losses which have been capitalized. But in actual these are cost no matter that they are termed “notional” in our industry
On the positives, I think the co has some serious lead overcompetitionand hence a sustainable business model. Don’t think rubber price inc is a major risk, as the co has superior margins and has been able to handle the same beautifully several times. Onexecution, the co has an excellent track record and I don’t worry much on that front.
If they are able to ride out next 1-2 yrs and utilize the new capacities, the stock should be in a new league and a major re-rating can also happen as they would be a 6500-7000 Cr+ turnover co by 2015 and should attract bigger investors and FIIs.
During the previous 2011, Q&A the management had indicated 3 risks
2). Raw material
Seems like the past year has made the management confident of handling the further expansions.
Raw material is declining, hence it is not a concern at the moment.
I do not understand why currency is not considered as a risk by the management. If there was a contribution of about 13% from currency to the topline in the last year, it could also hit the other way. Perhaps what they mean is that if Indian currency depreciates, they benefit. If the currency appreciates, the topline increase would be affected, but margins may not be affected.
Risk of higher leverage is also considered to be manageable.
All in all reflects a string confident management. Just hope they are not overconfident.
So, donning the sceptic hat:—
1). The risk that the management has highlighted (of unforeseen demand crash) is a first-order risk. To my mind, it speaks poorly of management ability to understand or articulate 2nd or 3rd order risks.
2). D/E is still an issue and is a significant drag on the stock price. Not sure what net cost of borrowing of 3% means? Does it mean they pay 3% interest? The only way they can get money is to borrow outside India through ECB/FCCBs, and then you get a forex situation with a fluctuating rupee… so, Donald if you could elaborate…BTW, today’s USD Libor rate is 1.04650% for 12 months.
3). Another point I did not understand fully, was a 4-5 year labour agreement… Does the company primarily work with contract labour?
Comments received from a senior investor.
The stock has two- risks and is expensive on a operating cash flow basis.
Of âcourse the positives are well known.
These are important comments. We haven’t dissected the lumpiness of BKT’s cashflows. FY11 Op Cashflows were down to 60 Cr from ~200 Cr in FY10. FY12 Op Cashflows is ~55 Cr.
The lumpiness is caused by the burgeoning Working Cap requirements of the business. Working Capital is today financed at 2% levels. What if this were to go up significantly?
How much of a risk does this pose? What are the odds on interest costs rising significantly for BKT, if operating cash flows keep at these low levels?
The other significant risk is on the demand side. What if there is a sudden demand crash/degrowth? What are the odds on that?
1 Debt : As per Management, the $175 Mn they borrowed last year was at Libor+2.65 . 3m libor of 0.4 makes the total interest cost at 3%. This years $100 mn is tied up at libor+3.2% . 3m libor would mean 3.65% or so
2). 4-5 year long term wage agreement! by the way they pay higher wages than Maruti:)
2QFY13 Earnings Conference Call - Balkrishna Industries Ltd.
20th November, 2012 16:00 hrs (IST)
Ambit Capital is pleased to invite you to the 2QFY13 Conference Call of Balkrishna Industries Ltd
Mr B K Bansal - Director, Finance
The teleconference will be moderated by Dharmen Shah, Institutional Equities, Ambit Capital.
Conference Call Details
Time: 16:00 hrs IST | Date: November 20, 2012
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Secondary Number: +91 22 3065 0160
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Available in - Delhi, Bangalore, Chennai, Hyderabad, Kolkata
Accessible from all major carriers except BSNL/MTNL.
Local Access Number:3940 3977
Available in - Gurgaon (NCR), Bangalore, Kolkata, Cochin, Pune, Lucknow, Ahmedabad, Chandigarh
Accessible from all carriers.
USA: 1 866 746 2133
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Playback ID 813535#
Yearly Volume targets have been brought down to 140000-145000 MTPA from 160000-165000 MTPA guided in Q1. Orderbook visibility has come down from 51000 MT to 32000 MT.
Here's some data I extrapolated on sequential growth across the regions. The de-growth in Europe is worrying, and seems to be the main reason for lower orderbook?
|Sequential Volume Growths|
Let's see what the Management has to comment on these developments.
BKT Q2FY13 Concall Notes- 20 Nov : Salient Points
libor+285 basis points – 275 Mn $
156000 MTPA current capacity
2 months of natural rubber stock is being maintained
slowdown globally. Agriculture sector slowdown in Europe & US
Mining sector is seeing good growth
pressure on orderbook size - 32000 MTPA ~ 2.5 months Sales
Sales guidance for FY13- 140000-145000 MTPA
Demand situation is down - there is de-stocking in the market
slowdown impact is across the globe. Europe is the most affected
Margin Guidance - 1H EBITDA margin ~21%;2H also we expect the same
Revenue Guidance for FY13 - 3400-3500 Cr
shipping 60-75 days to US and EU. BKT customers place orders in advance. So the Orderbook reflects these advance orders
Guidance change 140000-145000 from 160000-165000
Q. You have said, situation is likely to change in the next 2-3 months. So is there a chance of revision down the line
)- As of now we think we should be able to do atleast 140000-145000.
Q. So production will be rationalised? you are already running at 37000 per Qr
Yes. we will be producing as per demand only.
Q. Why is Asia region showing a decline sequentially from 6400, 5500, to 4800
I have the H1 figures of FY12, and on that basis Asia has also grown compared to last year. But yes the slowdown effect is there globally
Mostly covered by Donald. Some qualitative pointers
Improved margin realizations mainly on the basis of improved product mix and currency realization in Q2FY13.
Things have started looking up in the US. Slowdown should be temporary phenomena. The current phase of muted demand is attributed to de-stocking at dealer levels. Demand should revive over next 2-3 months.
Things were bullish earlier, mood has dampened over last 2 months, some slowdown in the order flow. Taken a cautious view and downgrading the guidelines Things should revive back by Jan-Mar 2013. Oct-Dec quarter will be harsh. All the OEMs are doing very well. Slowdown is not that deep as perceived by the market. In US mining is doing good.
Balkrishna volume growth is 20%+ compared to industry growth rate of 3-4%. From whom are they taking market share and how ?
Mostly from all biggies Michelin, Goodyear(now acquired by Titan Tire), Bridgestone.
Based on mainly two accounts:
o Lower cost of production
o Higher margin pass on to distributors
o Lower labor cost
o Lower SG&A cost
Constant spend in brand building. So while earlier it was PUSH for BKT. But now it is more of PULL dominated demand.
Brand building at broad market and adding distributors/ trade fairs/magazine ad/organizing fair with customers
EBITDA to remain in the 18-20% level.
Interest cost for Bhuj capacity will come to P&L from next quarter
Sales are booked at custom determined rates. At the time of payment/settlement difference against spot/futures with custom rates are looked into and accordingly profit/loss is booked as other income/expenditure.
Overall growth of 40% in topline. Volume growth is21%,Currency benefit19% (Prices are constant in $ and Euro.)
For Bhuj plant, out of Capex of 1800 Cr, already incurred 1100 Cr by Sep. Remaining in H2FY13 will employ 300-400 Cr, balance in FY14.
Long terms loans and advances now consists of
o capital advances for purchase of capital equipment for new plant
o advance taxes
A firm NO WAY.
Planning to penetrate Russia and CIS countries as new geographies. Penetrate deeper into existing facilities
Cash balances have increaseddue to issue of new ECB of $100mn which is lying in the bank as unutilized on Sep 30, 2012. Will be used over H2FY13
Indebtedness should remain at this level, except some WC requirements
Since exports to Europe and US take shipping of 60-75 days, so without advance orders it is very difficult to sale. Tire manufacturing takes 2-3 days. Production plan based on orders in hand. Order books keep changing on daily basis.
Dealer inventory are de-stocking. so order book are coming down.
If we take the Revenue guidance, and EBITDA guidance, take into account higher interest and depreciation costs for 2HFY13 (on account of Bhuj Plant 1st phase commencing production - henceforth cant be capitalised, etc), there is still a 25-30% EPS growth in FY13 happening.
Some conservative projections from my side. A quick job, so please comment if you find any holes in data/projections.
|# of Shares||1.93||1.93||9.67||9.67||9.67||9.67||9.67||9.67|
a) Those holding on from lower levels can hold on for next 6 months easily - situation needs to be watched; and anyways FY13 prospects remain good, so the stock isn’t likely to tank or anything; BKT is extremely good on the execution front - so unless situation deteriorates further, they will find ways to boost sales - focus on mining which is growing, better product mix thru higher contribution from OTR ( existing plant can do 35% OTR, and Bhuj plant 40-45% OTR)
b) FY14/15 doesn’t look too good; currently US market is making up for the growth slack in other Regions; If there is more degrowth in Europe (44% share), that will be difficult to make up; on the flip side most folks say agri tyres demand slowdown cannot continue for long - has to revive
c) The risks are increasing - the debt burden and capex plans are not going away. If sales growth doesn’t happen as originally planned by the company - there are problems ahead.
This needs a thorough review. From a long term perspective - I have raised questions on the overall economic characteristics of BKT’s business as well- I need to come to terms on that as well, before coming to the longer-term decision.
Welcome/Invite comments from everyone.
I didn’t notice it initially after the results but after going into details noticed that the order book has decreased and guidance has been cut by 10%.
The current situation seems tough as the co is facing demand slowdown at a time when a major capex is underway. Luckily only a small capacity would be coming up in near time and hence things might be manageable if demand comes back in 2-3 months. Though given the past track record and current order book, FY13 may go out well…I’m expecting them to do a turnover of 3350 Cr and net profit of 345 Cr.
The good thing was that the mgmt seemed transparent.
But despite that it will be very important to monitor the order book position and mgmt comments regularly. As the debt position is high, if this slowdown continues for long and they are not able to get orders, the co can get affected.
Haven’t been able to decide on the strategy to handle this situation but I think to be safe, one shouldn’t have a very high exposure.
Some recent changes in the share holding pattern, with strong interest in BKT from the institutional side.
From Jun 30, '12 to Sep 30, '12
FII stake has gone up from 6.57% to 10.77%
DII stake has gone up from 14.32% to 19.93%
Institutional holdingup from 20.89% to 30.7%.
|HDFC Bank Ltd||9.33|
|HDFC Equity Fund||4.89||4.89|
|Manoj H Modi||3.93||3.93|
|ICICI Pru Discovery Fund||2.17||2.17|
|HDFC Prudence Fund||1.49||1.49|
|ICICI Pru Dynamic Plan||1.41||1.96|
|HDFC Long Term fund||1.32||1.19|
|Credit Suisse (Singapore)||1.2||1.2|
|Templeton Global Investment||1.02||1.02|
|Franklin Templeton Investment Funds||1.61|
|SBI Magnum Sector Funds - Emerging||1.19|
|HDFC Mid Cap||1.02|
|Public holders with > 1% stake||26.76||21.67|
Quite surprising is the exit by HDFC Bank. Seems like they picked this up from Chrys Capital sale (Copa cabana was the entity holding Balkrishna) during June 2012. And exited within a quarter ?
If anyone have more information on this, kindly share.
There are some pointers to think about this situation more clearly:
1). If you have noticed from back issues of Investor Presentations, Order Book has been sequentially coming down - roughly from 6m, 5m, 4m to 2.5 months
2). I had noticed this trend but was pretty sanguine about it till OrderBook was 4m+, but when it comes below a quarter, it indicates a completely different situation. The orderbook comes from advance orders placed by distributors who carry inventory to compensate for the shipping time for BKT vs just in time by Michelin, or Goodyear say in US.Current orderbook situation implies Distributors have de-stocked completely. As orders come in, they are placing orders on BKT. A changed game:(
3). The guidance between the 2 qrs is completely different. Q1 was positively bullish - indicating a 20% volume growth. That meant everything was on track. Q2 guidance - indicated a volume growth of just 5% at worst and 9% at best.
Kudos to BKT Management for being so transparent. Even as recent as 2010 and early 2011 only Institutional Investors like HDFC Bank would have been privy to developments such as these. My regard for the company goes up manifold. Small investors like us would have watched FY13 go by completely sanguine and may have woken up only after Q1 FY14 results!
That’s a very drastic change in outlook. And made worse by the 1000 Cr investment already done, and 800 Cr more lined up…these will all be unproductive if demand situation does not pick up. Higher depreciation and interest costs for completed Capex will make things worse.
Having said that, as and when demand situation turns, it will be a sweet spot to enter companies like BKT and OCCL who have completed some capex but have unutilised capacities. Then the ramp up is very fast.
It’s become easier for us to keep track of the demand situation in a few companies, so this should be a cinch. Again this is a pattern:) . Ayush has promised to write more about this pattern giving more examples - in the Success Patterns thread!
Rudra/Others - A request. Sometimes its better to talk about your allocation/reallocation/new purchases in the respective stock thread itself. By all means do update your Portfolio thread …it’s a great place for people following to get a consolidated view of your style/changes and learnings, etc. , but don’t ignore the main stock thread.
Will update my comments on OCCL - this is not the time to buy it - Reason why, in the OCCL thread.
My concern on this stock that while shift in European agri-replacement demand towards lower-cost suppliers like BKT is directionally a long-term trend supporting the company (and recessions often give low-cost suppliers to gain market share), the capacity expansion is a) debt-funded and is b) targeted towards mining replacement demand, which is experiencing softness (Caterpillar commentary, Australian economy etc). Any slip-ups in demand for their mining sector foray will simply mean an under-utilized capacity funded with (astronomical) debt, which carries the additional risk of being subject to currency swings.
So too much downside risk in the stock right now (not too different than paying fair price for a debt-funded commodity business, in my view). Would be keen to hear other views here.