Markets
Red Sea crisis punctures outlook for Balkrishna Industries
Summary
- Potential risks include weak retail demand in key markets and the struggle to increase market share in the global off-highway tyre market
Tyre maker Balkrishna Industries Ltd is set to be a casualty of the Red Sea crisis and the ongoing geopolitical tensions. With the likelihood of shipment delays and higher freight costs, the management has guided for a flat year-on-year and sequential volume growth for the March quarter (Q4FY24). This is disappointing, especially since volume growth had only recently improved after four consecutive quarters of decline, with a 9.4%year-on-year increase in Q3FY24 to 72,749 tonnes.
Inventory at dealer levels at 30-45 days is normal for the period, but will edge lower due to supply chain issues this quarter, the management has cautioned. Due to this uncertainty, Balkrishna has stayed away from providing volume guidance for FY25.
Muted volumes would have an adverse impact on margins. In Q3FY24, Ebitda margin rose to 25.3% from 24.4% in the September ended quarter, aided by operating leverage. In H2FY24, the management expects Ebitda margin at 23–25%. However, the Red Sea crisis could lead to an increase in logistics costs, which may act as a hurdle to meet this target and threaten the long-term target of a 26-28% Ebitda margin.
Currently, freight costs account for 3-4% of sales. If geopolitical issues persist, the company will pass on the elevated freight costs to customers, a process which usually takes a few quarters. Note that the company did not take any price hikes in Q3FY24 as demand has been picking up gradually. With crude oil prices softening but natural rubber prices rising, the management doesn't foresee significant impacts on gross margins.
Given these conditions, the cut in earnings estimates is not surprising. “We have fine-tuned our FY2420-26 Ebitda estimates and cut FY2024-25E earnings per share by 3% on higher freight costs and lower other income assumptions," said Kotak Institutional Equities. “We expect profitability trends to decline from current levels on account of a sharp uptick in freight costs in the near-term."
Meanwhile, retail demand in both India and European Union markets is stable and is expected to gradually improve. Balkrishna, with a 5-6% global market share, aims to reach 10% by focusing on the off-the-road (OTR) segment and adding stock keeping units (SKUs). Its market share in India is around 5%.
ICICI Securities has cautioned that weak retail demand in key markets would impact volume offtake for Balkrishna Industries in the coming quarters. This follows a period of weak sales volumes resulting from inventory destocking. Additionally, the firm faces potential risks due to its struggle to increase its market share in the global off-highway tyre market, which is highly competitive.
Little wonder then that investors are nervous, with the negatives taking a toll on Balkrishna’s share price. In the past two trading sessions, the stock has declined almost 8%. Plus, current valuation largely captures positives, leaving little room for an earnings disappointment. At FY25 price-to-earnings, the Balkrishna stock trades at a multiple of 33 times – a premium to listed peers, showed Bloomberg data.
According to Motilal Oswal Financial Services, the management has invested nearly ₹3,000 crore in the last three years to expand capacity. As a percentage of sales, capex intensity would start moderating in FY24-25 to 7-10% of sales versus the last five-year average of 16%, driving improvement in free cash flow generation. However, premium valuations fairly reflect its industry-leading margin, free cash flow, and capital efficiencies, it said.
