Balkrishna Industries Management Q&A: July, 2012

Management Q&A

1. POST-EXPANSION PRODUCTION CAPACITY OF 276,000 BY FY2015. SINCE WE TALKED LAST TIME IN JULY 2011, BKT’S AMBITIONS HAVE GROWN MULTI-FOLD. THERE IS FURTHER CAPACITY EXPANSION OF 30,000 MT WITH AN OUTLAY OF 400 CR. THERE IS A NEW MIXING PLANT FOR 100 CR, AND A TOWNSHIP ~ANOTHER 100 CR. 600 CR OUTLAY IN ADDITIONAL PLANS IN A YEARS TIME.

You seem to be in a hurry to consolidate your position. It looks like your FY12 performance and developments/feedback from the Market has fired more ambition for BKT. Is this a sign of a more confident/more aggressive Management?

It’s been a natural normal advancement in our plans. You know that we were making small quantities of OTR Radial in FY12 from existing plants. We received very encouraging feedback from the OEMs. That led us to fast-tracking some of the plans on that front. We also saw that the Captive Power plant which we were putting up at Bhuj could now have full utilisation with this additional plant (in earlier case, we would have had to sell spare power to the Grid).

The other important aspect we were dealing with was about attracting and retaining talent. The plant is 30 Km away from Bhuj City – with no good educational facilities, etc. We realised an Integrated Township will go a long way in help addressing these.

What are the risks according to you?

Unforeseen demand crash! That’s the only risk so far as we can see.

2. FUNDING FOR ADDITIONAL CAPEX OUTLAY OF 600 CR. ON 31ST MAR FY12, LONG TERM DEBT POSITION STOOD AT ~900 CR. YOU HAVE MENTIONED ANOTHER $100 MN FUNDING TIED UP AT LIBOR+320 BPS.

You must be looking to draw this soon. Long-Term Debt to Equity would cross 1.4x, probably for the first time. There is also Short Term borrowings of ~750 Cr. Is the company comfortable with these figures?

Yes the new 500 Cr Loan will take the total debt to about 2100 Cr. If you take out the Working Capital borrowings, long term debt would still be at ~1.3x. We are comfortable with that, even if that figure goes up to 1.4x we are okay.

In FY13 you will be spending ~800 Cr in Capex. Do you envisage a consolidation phase in FY14 and FY15, or further capex/borrowings are pretty much the order?

There will be 600-700 Cr capex in FY13 and the balance 500-600 Cr in FY14. Any fresh Capex will not be needed before FY16.

Also you should note that we have about 280 acres of land in Bhuj. Currently we have utilised only about 125 acres. Further Capex will be at lower levels.

3. SIGNS OF A SLOWDOWN IN KEY EUROPEAN MARKETS. YOU HAVE MENTIONED SEEING A SLOWDOWN IN EU REGION IN THE FIRST 2 MONTHS. YOU HAVE ALSO MENTIONED SLUGGISH OEM DEMAND.

How are you factoring this in? To maintain its position in the EU market, BKT may have to further reduce its price advantage of 20%?

That was a general statement acknowledging the state of the economy. We are growing. We have a good visibility.

Paring prices at this stage will be an aggressive move, and not warranted. We have no such plans. We would rather be conservative.

While Rupee depreciation effect on RM may be neutralised by US$ sales, this must be queering the pitch for Euro zone sales booked in Euros. Your RM import bill is probably 15-20% higher vis-a-vis major competitors in EU. Isn’t the competitive advantage degrading fast for your comfort?

Actually no such thing. All our imports are in US$. The competitors also have to import in US$. As far as the Euro is concerned we had average realisations of Rs 63-64 to the Euro. In FY13, the average realisation is ~Rs 70 to the Euro, so we are in a better position.

All our pricing is in US$ or the Euro. Rupee has nothing to do. If we managed very well when Rupee was at 39 to the dollar, we should be able to manage much better at current levels.

We have a natural competitive hedge in Europe. With a falling Euro their imports starts going up; becomes uncompetitive for the bigger players. Yes if Euro-US$ PARITY, if that happens, we might face problems with a falling Euro as realisations will be going down. But that doesn’t seem to be happening at the moment. US $ remains strong with $ at 0.81 Euro.

In FY12 we had 40% revenue growth. 20% of this was driven by volume growth. We had taken a 6-7% price hike, so the balance is all from currency growth.

How are you looking to mitigate these effects? You have mentioned the US market making up for some of the loss from EU. Will we see a major drive to increase penetration in the US market and RoW markets?

See in 2007 we had US Sales of $15 Mn. That contributed 6-7% of our sales. In 5 years we are at 100Mn in US sales which is now ~25% of Sales. This is a natural progression. As we have more capacities, we will penetrate more markets.

4. GUIDANCE FOR FY13 AT 160,000-165,000 MT. THIS IS AGAIN BASICALLY A 20% GROWTH IN VOLUME TERMS, SIMILAR TO FY12. HOWEVER THE COMPANY HAD REGISTERED A 40% GROWTH IN SALES IN FY12 BY VIRTUE OF PRICE HIKES AND A BETTER PRODUCT MIX.

FY13 may turn out to be very different? Rubber prices have corrected by some 20% in last 6 months and are expected to correct even further as mentioned by you.

Yes we may have to pass on some price reduction benefits later in the year, depending on the competitive activity. So far we have not seen any such moves. There is also the lag effect. Earlier Inventory was of 4-5 months. So this may become relevant only in subsequent quarters.

We remain confident of a revenue growth of 38-40% depending on the currency.

Where do you see price realisations stabilising in FY13? Is it correct to assume that price hikes are less likely? Better product mix may drive up realisations a bit? By how much?

Yes Price hikes are not on in the current scenario. Better realisations from Product Mix will start reflecting from next financial year. This year the new plant will only contribute probably 10-15000 MT of OTR radials and some from our existing plants – which may not be significant.

5. MARGINS & PROFITABILITY

Where do you see Operating margins stabilising for the next 2-3 years?

We are pretty comfortably placed for FY13. In the coming years too we should be able to operate within our historical range 18-21% EBITDA levels.

In a depreciating rupee scenario, do you foresee the revised Schedule VI norms for Forex accounting taking a further toll on margins?

No it works to our advantage. We are a net Forex earner.

The currency fluctuations occur because we book Sales at the Customs rate when goods go out of the factory, and realisations happen at the forward contract rate. This difference was earlier attributable to Sales but now need to be recognised as Forex gains/loss in Other Income (as per Schedule VI norms).

On the other hand, the Mixing Plant at Bhuj is supposed to bring in efficiencies and savings on transportation & logistics costs. There is also a co-generation plant contributing to power savings. What order of savings is this likely to bring in?

There should be a differential of 2-3%.

Interest cost capitalisation benefits for this phase of Capex may be over soon? That will see a spurt in interest costs and exert further pressure on Net margins. Where do you see Net Margins stabilising at?

Today we have access to funds at pretty low costs. Our net cost of borrowing was only 3%. Working Capital borrowings are at 2%. We also take advantage of buyers credit.

The next tranche of loan is also at low cost 3.2 +3m Libor which is 0.45, so 3.65% or so. In FY13, the interest costs will be applicable only for half year. In FY14, interest costs for the full year will be ~60-70 Cr.

We should be able to main PAT at 9-10% levels.

Could you explain 3m/6m Libor terms?

Basically refers to the interest payment cycles. 6 month Libor would mean interest payments are due every 6 months, which are at 0.75%. 3 month Libor is at 0.45% with interest payments due every quarter.

This seems like a big advantage. Not many companies are able to manage finance costs at these levels, are they?

Actually everyone should be able to access funds at 3.5%+ Libor. So that translates to 4.25% to atmost 5% costs.

But yes, smaller loan amounts probably come at a higher cost.

6. 30,000 METRIC TONNES OF LARGE AND ULTRA-LARGE SPECIALTY OTR TYRES

Kindly tell us a little more on what this means for the company in the coming years? Are you looking at expanding the presence in this segment in a big way?

OTR -all steel radial is a technology advancement. Just like it moved from cross-ply to normal radials (Nylon cords), now the technology has moved to all steel radials.

The total demand is ~$13-14 Bn globally, growing at 4-5%. Of this $4Bn is Agri demand. The balance $8-10 Bn is non-Agri – mostly Industrial, Mining, Construction – what we call OTR (Off the Road) And these require large and ultra-large specialty OTR tyres.

As you are aware our current mix is 33% OTR, 63% Agri. So this is very big incremental opportunity for us. The results of our initial attempts have been very encouraging. We should be able to encash on that.

We had a 3.5% market share 5 yrs back. We are at 5-6% market share currently. We should get to a 10% market share by 2020 or before.

This will start contributing from FY14? What kind of realisations are possible in this segment?

These will start contributing from FY15. 30000 MT should get us a topline of 750 Cr, or [email protected]

What is the total size of the land available at Bhuj facility? And how much of this will have been utilised by the new plant, mixing facility and Township?

as mentioned before, total area is 280 Cr. We are using up only 125 acres for all above.

In the interim, Agri segment remains the biggest segment for BKT. How is BKT’s Agri business affected by recession, monsoons?

Recession affects the OEM segment first. As you are aware our business model caters mainly to the Replacement market. In recession people stop buying new equipment, but they continue operating old equipment – for that they need replacement tyres!

Also Agri/Food business is recession proof. It is evergreen whether it is US, EU or rest of the globe. Someone has to produce, right? Certain countries like Israel are not monsoon dependent. Drip-Irrigation is very advanced.

We are not dependent on the Indian market for Agri segment.

7. ORDER BOOK POSITION. FOR THE LAST FEW QUARTERS WE HAVE BEEN NOTICING THE COMPANY MAINTAINING AN ORDER BOOK POSITION OF ~65000 MT OR ABOUT 5-6 MONTHS OF SALES AT THE CURRENT RUN RATE OF 12000 MT A MONTH.

Do you see this changing in the coming years in view of overall demand slow-down and capacities being ramped up at the same time?

It is a good thing if we can serve the customers in time. Order book may come down in future form the 4-5 months order book levels currently, as customers look to pare their inventory levels.

But there is a basic 45-60 days shipment time for EU/US as it goes by Sea. So customers have to book atleast 3 months in Advance taking into account the transit time.

Only someone like Michelin attempts Just-in-Time delivery models with company owned warehouses.

Why can’t BKT adopt similar models?

We have chosen to go the distributor route. In our case the Distributors play that role of warehousing.

We can chose to knock of a 15% expense difference that is attributable to the distributor-led sales model. We can also set up just in time, with company owned warehouses, but then we will end up competing with our distributors. We find no incremental gains in doing so.

8. OUTLOOK FOR RUBBER PRICES IN FY13. LAST YEAR WHEN WE TALKED ABOUT THE SPIRALING RUBBER PRICES, YOU HAD ATTRIBUTED SPECULATIVE INTEREST AS THE MAIN REASON DRIVING UP PRICES, AND NOT DEMAND-SUPPLY GAPS.

What are the reasons for the downtrend this year? Is it true that there is surplus production of rubber in Thailand?

The surplus production is actually across the globe. 2004-05 had seen lots of new rubber plantations coming up. It takes 6-7 years for these to mature. This has now come into the market only from this year.

Prices are expected to fall lower. We have cut our inventory levels down to 2 months (from earlier 5 months).

9. FOREX MANAGEMENT

US Sales currently act as a natural hedge for the raw material imports. You have guided for a 20% volume growth in FY13. Do you expect US Sales increase, say from 25% of Sales to 30% of Sales to be able to compensate?

It is not only US sales. Anywhere other than EU, it is US$ Sales for us.

Or this will need hedging on the US $ front too, apart from hedging the Euro?

Not necessary for Sales. We might require some hedging, only to the extent of the loan repayments.

The ECB repayments are starting in FY15, that will need to be factored in? What is the repayment period?

If Rupee depreciates significantly from here, we might need to hedge on this front.

10. SUSTAINABILITY OF COMPETITIVE EDGE. THE LARGE VARIETIES-LOW VOLUME NATURE OF THE OHT MARKET MAKE IT UNATTRACTIVE FOR NEW PLAYERS TO ENTER THIS MARKET, INCLUDING MAINSTREAM TYRE MAJORS.

When we talked about players like Alliance with similar cost advantages as BKT, you had clearly identified the ability to maintain a large no SKUs as BKT’s competitive edge. That Alliance is the closest and they will take atleast 5 years to catch up to offer any serious challenge to BKT. Has this position changed, or are you still sanguine on this front?

Alliance has a 45000 MTPA facility in Israel. They also have 30-35000 MTPA production in Chennai. Further progress in Chennai is reportedly halted due to labour problems. They have acquired some land in Jagedia near Bharuch. Israel is a high cost location so they dont get much advantage from there. So they are still 4-5 years away from catching up.

They acquired GPX which gets produce from China. The GPX acquiaition gives them the distribution access. But it’s not really a marketing challenge, it is still a manufacturing challenge. Getting to the right no of SKUs is key.

Price differential of 30-35% in FY09 with OHT majors in US and EU markets is eroding steadily. In FY11 this was down to 25%. And in FY12 we hear this is down to only a 20% differential. Will this be sustainable beyond FY15, and Why?

Well the price differential is still in the range of 25-30%. BKT is now a brand in its own right. It may come down to 20-25% in the next 5-7 years. The erosion cannot be more than 4-5%.

Promotional expenses would be up then, on the flip side?

Yes, but that’s only incremental in nature.

11. MAJOR CHALLENGES BEFORE THE COMPANY. RM AND FOREX FLUCTUATIONS ARE DYNAMIC CHALLENGES THAT BKT HAS TO FACE UP TO AND IS DOING A VERY COMMENDABLE JOB.

Is it correct to say Resources, Labour and Training are the bigger challenges before the company?

Resources – not an issue anymore. We have access to easily available funding at very good terms.

Labour and Training are issues. The ramp up happens slowly. That is the main reason our production capacity can only be ramped up to 30000 MT in a year or so. We have very good long term agreements signed with the labour force.

What is the size of the Labour force needed for the Bhuj facility? And how are you coping with these challenges?

Ultimately we will be needing about 3000 strong workforce there. We are building that up gradually in tune with the demand situation.

When you say long term agreements, kindly explain?

We have long term settlement agreements at all 3 locations. They are of 4-5 years duration.

12. CHRYS CAPITAL EXIT

Chrys Capital off-loaded its entire stke of 9.59% in BKT recently. It is surprising that a long-standing investor in BKT chose to exit at a time like this. Would you please comment on the circumstances and timing of this exit?

Chrys Capital invested in us from 2005. It is already 7 years. The fund that invested had a term of 5 years and it had already taken 2 extensions. Under its terms it could not get a 3rd extension, hence the exit.

Why would they choose to exit, just when the benefits of the expansions are about to kick in?

Also you may know Ashish Dhawan is exiting Chrys Capital to set up his own. He offered the investment to be liquidated rather than being taken over by new team which they accepted under the conditions.

You are also aware that bulk of it was taken up by 3 fund houses. Franklin Templeton, HDFC and BNP. Franklin Templeton took up the biggest chunk.


Disclosure(s)

Ayush Mittal: No Holdings in the Company; ;
Donald Francis: No Holdings in the Company; ;
: ; ;
: ; ;

Balkrishna Industries Management Q&A: July, 2011

Management Q&A

Balkrishna Industries operates in the specialty tyres segment – Off-Highway Tyres. Pneumatic tyres for special applications for agriculture, construction, earthmoving industry, material handling, forestry, lawn and garden, and All-Terrain-Vehicles (ATV). It has an amazing run and track record in the last 10 years – as it built up a global brand, exports 90% of its produce and enjoys a 4% global market share. In the last 10 years sales have grown at a ~28% CAGR while EPS has grown at over 41% CAGR!

Read this Balkrishna Industries stock story to know why it made it easily to our shortlist of promising mid-cap stocks – that our in-depth process for hand-picked stock-picks throws up.

There are a few questions that came up during our detailed analysis on Balkrishna Industries, its prospects, and risks as we see it. (of course that is entirely based on published sources and without the benefit of a meeting/interview with Management).

We put forward these questions to Balkrishna Industries Management with a request for a meeting/visit to its premises. We met the CFO Mr B K Bansal and spent more than 2 hours with him trying to understand the business opportunities and challenges ahead.


Questions for Balkrishna Industries Management

1.     POST-EXPANSION ACHIEVABLE PRODUCTION CAPACITY OF ~230,000 MTPA. AGRICULTURAL TIRES (65%), OTR TIRES (29%), OTHERS (6%).

Please explain to us the current demand-supply situation in Agricultural Tires, and OTR Tires segments. Is demand running far ahead of supplies? What makes for this aggressive expansion of over 80% from current levels? How have you planned for increasing Sales in tandem, or is that a given? What are the risks according to you?

Let me first set the context. The Off-highway Tires business is about $11 Bn globally which is growing at 4-5% annually. We have been growing sales at 25-30% annually for the last 10 years. So obviously we are taking away market share from the more established players. Our current global market share is ~4%.

We have grown sales in FY11 over 40%. If we had the capacities we could have sold much more. There are no doubts in our mind that we can increase sales in tandem with increase in capacities. We have invested in increasing our distribution reach and penetrating deeper in existing markets. We don’t think there are any risks on that front.

2.     PREMIUM PRODUCTS. AGRI RADIAL AND OTR RADIALS. BKT IS THE LARGEST MANUFACTURER OF FULL RANGE OF RADIAL TRACTOR TIRES FROM ASIA.

How much of the post-expansion capacity is planned for premium products like Agri Radials and OTR Radials? What is the revenue contribution from Premium products currently and is there going to be increasing focus on premium segments?

Radial/Non-radial products is roughly 30:70 in our Sales mix today and is likely to go upto 40:60 with increased capacities being available. There is little higher contribution from Radials segment but not by very much.

3.     OFF-TAKE FROM GLOBAL MAJORS LIKE MICHELIN AND VREDESTEIN CURRENTLY FORMS 6% OF TOTAL SALES.

With large capacities available from BKT especially in premium segments, do you foresee greater interest from Global majors in increasing off-takes from BKT. We know that OEM market margins are lower than the Replacement market, but how are the margins in the Off-take segment?

There is lot of interest from global majors to increase off-takes from players like Vredestein, Trelleborg, Nokian. The margins are also better. However we are not very interested in pursuing that as we believe BKT is a good brand we would rather invest in increasing our market share. We have had offers for a JV from Vredestein too – the enticement is access to more markets through their network and better technology. We have not taken these up as we feel we can handle Technology and we know how to market our products from the experience gained in the last 10 years.

We maintain a certain level of engagement with these players as there are a few things that we do learn form them from time to time. The engagement levels will remain same at some 5-6% of total sales, unlikely to touch something like 10-12% levels.

4.     INDIAN MARKET SHARE CURRENTLY FORMS 11% OF SALES AND MOST OF IT COMES FROM OTR SALES. THE INDIAN EARTHMOVING AND CONSTRUCTION EQUIPMENT INDUSTRY IS MEANWHILE EXPECTED TO GROW FIVE FOLD FROM USD 2.3 BILLION TO USD 12 –13 BILLION BY 2015.

Would we see an increasing focus on the Indian OTR tires segment once you do not have any constraints on the capacity front? Who are the existing players in this market –same Michelin, Titan, or there are others? What are their market shares, and how far behind is BKT.

In the Indian market we have chosen to concentrate mainly on the OTR Earthmoving and construction equipment segment. We are not present in the Agri-Tires segment and unlikely to pursue it.

You see in India agricultural tractor use is usually of less than 50 HP. In the developed markets tractors use go as high as 200 HP. They use different equipment for different seasons, even different crops. The Agri tires mix is pretty diverse.

The OTR segment in India comprises some 11% of our Sales. Yes there will be a higher focus from us on this segment and OTR segment sales in India should go up to 20% levels from here with the increased capacities. We do not face international competition here, but its mostly MRF and Apollo.

5.     GLOBAL COMPETITION. MICHELIN. TITAN. OTHER PLAYERS LIKE ALLIANCE FROM DEVELOPING MARKETS HAVING SIMILAR ADVANTAGES AS BKT HAVE EMERGED ON THE SCENE TOO.

Michelin 2008 Investor Presentation listed BKT as serious competition in Europe and showed BKT’s share as 3%. Kindly explain what has changed in the last few years. Do you still enjoy the 30% price differential? If there is a demand-supply mismatch situation, the bigger players also must have invested in creating larger capacities?

In Europe BKT has grown much stronger in the last few years and commands 9-10% market share. Price differential has narrowed to something like 25%.

Mehensarias (Alliance Tires) have a strong technical background, they have the Capital backing them up, the benefit of the BKT experience till 2005/6, and have lined up substantial capacities by now, and may well replicate most of the advantages that BKT today enjoys. How closely do you track local competition? Any changes in tactics/plans to tackle this emerging threat.

Yes they are strong players. And yes they should be able to replicate most of the advantanges that we enjoy, eventually.

They invested in a 30000 MTPA capacity in Chennai for Phase I. There were some issues and a strike, and they have deferred the deciaion ton invest for the planned Phase II expansion of another 30000 MTPA. they are looking for a new location. Their Israel facility has ~40000 MTPA capacity.

They way we look at this is simple. It has taken us 10 years to reach where were today. Anyone striving to reach our levels has to go through the same process, they may be able to do it faster but it will still take them 8-10 years. It takes atleast 3 years to stabilise production and reach peak capacity utilisation levels. The 90,000 MTPA capacity we have coming onstream next year will still take us 3 years to reach peak levels, or roughly 30000 MTPA each year. There is no magic formula or shortcuts.

From ground zero, it will take anyone 5 years to reach peak utilisation levels from a 90000 MTPA capacity installation!

So, BKT will have a unchallenged run for the next 5 years, atleast?

That’s right the next 5 years should see an unchallenged run, at the least. And other than Alliance we aren’t aware of any other player wanting to take on this complex niche, which has seen exits from several big players.

The new entrants in a bid to capture greater market share faster may resort to undercutting? Is that not a real threat?

That risk is probably very remote. The market is big and there is enough room for new players to sprout and thrive without resorting to undercutting other small players. Its only when BKT gets to the size of say 25% market share that perhaps this may become a real threat for us.

If it’s possible, kindly share why Mahensarias (who now run Alliance Tires) had to split from the Poddars in 2006. They were actually running the show in BKT till then. To the Poddars’ credit though, BKT has done exceedingly well in the last 5 years since the split.

Well the MD’s brother-in-law was Mr Mahensaria. Mahensaria held 5% in the company and 10% through Promoter Holdings. The Poddars didn’t have a second generation to run the company and thus Mahensarias played the Executive role. To be fair the strong foundation for BKT’s success today was laid by the Mahensarias when they ran this company till 2006, and they had done a very good job. Then the Poddar 3rd generation came along and were ready, naturally they wanted to take back control. The Mahensarias understood and accepted this situation graciously. The parting was perfectly amicable. Today Mr Arvind Poddar is assisted by his son and nephew in running the show at BKT.

There was no non-compete agreement as it was made clear by the Mahensarias that this is the only business that they knew how to run, and it was made clear that they will be attempting to start building a business from scratch.

Its good that they now have secured funding. Both sides are still on very good terms. There is no reason for under-cutting and killing each other, when the market is ripe and low hanging fruits are still available.

6.     EUROPE AND AMERICAN MARKETS. FAST GROWING ECONOMIES SUCH AS BRAZIL, ARGENTINA, COLOMBIA, COSTA RICA

Tell us a little more on the penetration that you are making in your fastest growing markets, especially the Americas. Which of these markets will provide you most of the sales growth? Are you able to get similar margins form the South American growing markets?

BKT had initially focused on European markets and is gradually increasing its presence in Americas, which is our fastest growing market, and that is mostly the US. South American markets are also seeing increasing presence but they are smaller markets. Margins are more or less the same.

7.     IN FY11 BKT REGISTERED AN IMPRESSIVE 40% PLUS GROWTH IN SALES, BUT SUFFERED AN 11% DEGROWTH ON PAT FRONT DUE TO THE REVERSAL IN RAW MATERIALS PRICING.

How do you see FY12 panning out? You mentioned order booking of 5 months in the last Conference call. Are you protected on the margins front in booked orders?  At what levels 18-20%? What is a sustainable level for the full year?

Yes on the booked orders we are protected on the margins front at 18-20% OPM levels.We have seen Price peaks at $6400/tonne, then it corrected somewhat to $5100 levels. Since the last 2 months prices are stabilising at $3500-4000 range. Our understanding is that it will settle lower at $3000+ levels.

How do you do this forecasting or reach an understanding on what levels are likely? Is it that demand supply gaps have narrowed with increased production this year?

Well no such thing as demand supply gap. If that was the reason we should have seen at least some people complaining that rubber is not available the quantity they want. In this whole hullabaloo we did not come across a single situation like that – it was always available at a certain price. It was purely speculative plays!

So far as we can make out and understand from those who track these markets well, rubber prices are expected to stabilise at lower levels this year.

If prices are expected to soften in coming months, how are you booking your current orders?

Well we have not seen anyone rolling back prices since the last time hikes were announced. Neither have we.

8.     FINANCIAL STRENGTH. BKT HAS ALWAYS MAINTAINED PRUDENT DEBT LEVELS IN THE RANGE OF 0.7X TO 1.3X. CAPEX FOR FY12 OF ~700 CR IS GOING TO BE A BIGGER BURDEN ON THE BALANCE SHEET THIS YEAR.

We may see Debt-to-Equity levels touching 1.5x or so. Please tell us a little more on the financing costs. Working Capital/ Sales has risen to over 32% of Sales, and is likely to go further up as inventory levels go higher. Is Working Capital also financed in foreign currency? What will be the overall financing cost? Will it be lower than your traditional 4-5%?

The current debt is about 600 Cr. Of the 700 Cr we will be spending about 500 Cr this year and 200 Cr will be used in FY13. So I think we will still be within D/E levels of 1.3x. Yes Working Capital finance is also in foreign currency now. Our overall financing cost will be around 2%

9.     EUROPEAN ECONOMY IS TROUBLED. THE CURRENT BAILOUT TO GREECE MAY NOT BE ENOUGH AND THERE ARE FEARS THIS MAY LEAD TO MORE SUCH BAILOUTS FOR GREECE AND THE OTHER COUNTRIES LIKE IRELAND, SPAIN TOO. THE EURO AS A CURRENCY IS UNDER TREMENDOUS PRESSURE. BKT DERIVES ~47% OF REVENUES FROM EUROPE.

What are BKT’s views on the risks from this front and what are its plans to mitigate these risks?

Well these fears have been around for last 3 years or so. we hear them all the time but from customers on the ground we have heard no such fears -they expect business as usual. If there is some turmoil, the Agri-Tires situation (65%) will probably be okay because farming & food business will still carry on. The OTR segment may see some pressures.

The Euro currency front is a cause for concern say if it corrects to being equivalent to dollar levels. We can’t do much on that except the simple 1 year forward contracts that we take to hedge for upto a year ahead.

10.EXPORTS ACCOUNT FOR ~90% OF SALES. MORE THAN 70% EXPORTS ARE TO DEVELOPED  MARKETS.

How soon will emerging economies together account for something like 40-50% of Sales? What are BKTs views on entering the Chinese market?

In the post expansion situation of 230,000 MTPA capacity the export dependence on developed markets will continue. The mix may change – Europe may come down to 40% levels from 47% and US market may increase to 30% from 23% currently. Some Other markets may inch up to 4-5%.

Post the 2015 expansion, there may be a higher tilt to emerging economies. Chinese market has established players -but they operate solely within China. We have no plans of entering that market.

11.SUSTAINABLE COMPETITIVE ADVANTAGE. WE HAVE SEEN BKT HOLDING ITS ADVANTAGE THROUGH THE LAST 10 YEARS AND GROWING MORE THAN 10X IN THE SAME TIME IN SIZE.

What are the reasons you have continued to enjoy competitive advantages and have not faced serious threats from emerging or bigger players?

As you know our niche is known by its characteristics as a low volume-large varieties market. The approach needed for production and servicing this niche is completely different from the mainstream high volume commercial tire production market. It needs completely different processes, a completely different factory and a different set of people.

The business is very SKU driven. The larger the number of SKUs that you can manage the larger business you can attract. The reason is because our customer businesses need to run a very tight ship because of the low volumes and large varieties. They will always prefer to deal with a vendor who can support all their requirement sunder one roof, rather than deal with multiple vendors.

For the bigger players, the OHT segment is very small, less than 10% of their business. But if they have to grow this smaller segment profitably, they would have to shift a considerable focus away from their main commercial tire business. Many big players with OHT presence have chosen to exit from the niche.

If we look at tractor tyres in India we see mostly MRF or Goodyear. Why has MRF for example not found it profitable to compete with you in exports for Agricultural tires? It’s not that MRF or Apollo or any of the tire biggies in India aren’t aware that BKT operates at something like 2x their margins and returns!

True, these players have been making some noises from time to time but they have all been running small OHT operations, and the size continues to remain small. For them to scale up the OHT segment would mean a considerable shift of focus from their main bread & butter business, for reasons as explained before. They have been unable/unwilling to take those steps.

Why has no one from the mainstream tire industry ventured out in off-highway tires in a big way despite clearly seeing a decade long growth story unfolding before them?

Exactly the same reasons.

And for the first time there is hint of serious competition coming from players like Alliance who seem to be capable of replicating the same advantages as BKT. Why do you think you will retain sustainable competitive advantages for the next 5 years?

The number of SKUs that we have built and are managing. Its not that you can turn on a switch and you have a set. Each SKU takes its own process and time, endurance testing and the like which varies from product to product. It will take anyone atleast 8-10 years to reach here.

Like most businesses isn’t it true of your business too that 80% of the business comes from 20% of the products? So what prevents a competitor from fast-tracking on the most important SKUs and Alliance for example could be well are of those characteristics.

Well no such luck! Our business is spread more or less evenly across the whole SKU range. The more the number of SKUs we have, the more business we can attract.

In other words, is it fair to surmise that having large number of SKUs is your actual moat – or main competitive advantage today?

It is!

12.MANUFACTURING PLANTS & AUTOMATION

The modern automated plant at Chopanki (60000 MTPA) is reportedly delivering 110 TPD at 75-80% utilization. Both the plants are functioning on three shifts per day on a 7 day week. But your Bhiwadi plant (60000 MTPA) is over 18 years old and reportedly still delivers about 135-140 TPD close to 100% achievable capacity. Is this true??

 Actually the Bhiwadi plant was acquired from Govind Rubber a subsidiary -which makes bicycle tires in 2001. They had 2 plants one of which was lying idle. That plant was acquired by us and the whole set up was revamped. So its like a 10 yr old plant today. Our Walud plant is the oldest.

This is an amazing record and speaks well of Management’s ability to maintain its plants and progressive de-bottlenecking. It also indicates maneuverability and the expertise of the company to implement a complex manufacturing process and switching it flexibily to accommodate client specific requests.

Both Bhiwadi and Chopanki plants are exactly similar. They have similar levels of automation or manual interventions. The Chopanki plant is new and as mentioned before will need progressive de-bottlenecking to reach peak utilisation levels.

13. MOULD DIVISION MERGER. BKT REPORTEDLY HAS 500-600 MOULDS USED FOR VARIOUS APPLICATIONS IN VARYING SIZES AND DESIGNS LAID IN THESE TWO PLANTS, ALL MANUFACTURED AT BKT’S MOULD MANUFACTURING PLANT AT DOMBIVALI, MAHARASHTRA. THIS DIVISION IS NOW BEING MERGED WITH BKT?

Kindly tell us a bit more on the advantages of having your own mould manufacturing plant. And why this decision now to merge it with BKT?

We had acquired a plant that basically had land. We thought this land could be best used for expanding our mould making facility in BKT moulds which was adjacent. Thus BKT Moulds was merged with BKT. 

14.DIVIDEND POLICY. BKT USED TO BE PAYING ABOVE 20% OF EARNINGS AS DIVIDEND TO SHAREHOLDERS. THIS HAS BEEN GRADUALLY COMING DOWN AND HAS SEEN DRASTIC CUTS IN THE LAST 2 YEARS. FY10 DIVIDEND PAYOUT WAS AT 6.48% AND FY11 IS EVEN LOWER

Can you please clarify the Managements thinking on this front? What kind of dividends can we expect in the future?

We do not have a Dividend policy written down. But we are clear that we will pay dividends – we must maintain our uninterrupted dividend paying record. The quantum of dividends paid got reduced yes, during the last credit squeeze, liquidity was very tight. We reckoned that we could better utilise the proceeds by paying lesser dividends and consequent taxes, which otherwise we would have had to raise from the market.

We have taken into consideration views on Dividends from several Investor groups, and in happier times we will try and restore some balance there.

15. $1 BN IN SALES?

What are the important milestones on the way? With a Sales target of 130000- 135000 MTPA for FY12 we are probably doing ~2300-2400 Cr in Sales?

No actually we should do better at some 2700 Crs. We have locked in orders booked at higher realisations.

With 230,000 MTPA achievable capacity from 2HFY13, what kind of Sales is probable in FY13? 3000-3500 Crs?

FY13 would probably see ~30,000 MTPA additional capacity coming onstream. So yes Sales could be in that range.

What kind of market share will this transalate to for BKT? When will we see BKT claiming a 10% market share in the global off-highway tires market?

$ 1 Bn will happen by 2015. The global market by then would be close to $12 Bn by then and a 10% market share will translate to over a Bn$ sales.

16. CHALLENGES AHEAD. WE HAVE TRIED TO COVER THE ISSUES BEFORE THE COMPANY AS WE SEE IT FROM OUR LIMITED UNDERSTANDING OF BKT AND THE INDUSTRY.

Please elaborate on the main challenges before the company as it is scaling up in a big way and trying to address the huge opportunities before it.

Well we see the Challenges mainly on 3 fronts.

First Execution Challenges – and this includes resources, labour, training, handling multi-locational issues while executing on-time. Second challenge is handling the RM situation well, and lastly there are challenges on the Currency front like we discussed before.

So Marketing is not a challenge?

No, Marketing is NOT a challenge!


Disclosure(s)

Nagabrahma: No Holdings in the Company; ;
Donald Francis: No Holdings in the Company; ;
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Balkrishna Industries

Background

Balkrishna Industries is one of the world’s leading manufacturers of “OFF-HIGHWAY tires”. BKT has the widest product range with more than 2000 SKU’s (Stock Keeping Units) and is “One Stop Shop” for all off-highway tyre solutions.

The success story of BKT begun in 1995, when it entered into production of cross ply off-highway tires. Product received instant acceptance in European & North American market. With the help of persistent & intensive market research coupled with ever expanding production capabilities, today BKT has made its mark in the specialty segments like Agricultural, Construction, Industrial, Earthmover, Port, ATV (All Terrain Vehicle) and Turf care applications in both cross ply & radial construction.

More than 90% of tyre production is exported to more than 120 countries across all five continents, in all the major markets of Europe, North & South America, Africa, Asia & Middle East.


Main Products/Segments

Balkrishna Industries operates in the specialty tyres segment – Off-Highway Tyres. Pneumatic tyres for special applications for agriculture, construction, earthmoving industry, material handling, forestry, lawn and garden, and All-Terrain-Vehicles (ATV).


Main Markets/Customers

  • Agriculture sector is the mainstay, contributing ~65% of the Sales. Industrial and Mining sector are other key sectors
  • Exports contribute ~90% of Sales. Europe contributes ~55%, US ~16-18%, and Rest of the World (ROW) 15-17%; Domestic sales contribute ~9-10%
  • OEM Sales contribute ~12%, rest comes from Replacement market sales: Replacement market margins tend to be higher

Bullish Viewpoints

  • Impressive Track record – Balkrishna Industries has significantly expanded its presence in the niche off-highway tyres segment in the last 9 years. From about Rs. 166 Cr in FY 2001, Balkrishna Industries Revenues crossed Rs.1386 Cr in FY10. The focus being on export-led growth, Balkrishna Industries now derives over 90% of its revenues from exports –primarily to Europe and other countries.
  • Industry leading margins & returns – Balkrishna boasts of industry leading margins (FY10 OPM ~21%) and returns besting bigger international competition like Mitas (FY09 OPM 14%), and Michelin (FY09 OPM 8%). It has concentrated on increasing its presence in the replacement market, which tends to be somewhat less cyclical than the OEM market. The replacement market also offers the potential for higher profit margins and is larger in most markets.
  • Aggressive Capex Plans – Already operating at 100% of achievable capacity, it has announced big capacity expansion plans. Rs. 120 Cr capacity expansion at Aurangabad facility , 25 Cr for mould shop expansion and another 10 Cr for warehouse expansion for FY11. Another Rs. 1000 Cr is planned over the next 2 years for a new factory at Bhuj. 275 acres of land has already been acquired and ground levelling is being done. This will add another ~90,000 MTPA to existing capacity of 132000 MTPA. As per the company, the demand for BKT brand is strong and it is only supply constraints that’s holding back further growth.
  • Strong Balance Sheet – Current debt-equity stands at 0.25. There is enough headroom for leveraging the balance sheet for funding expansion plans through debt and internal accruals. The company has announced plans of taking a $175 Mn debt to fund this and the balance from internal accruals.
  • Valuation – the stock is valued at general tyre industry valuations despite having much better operating margins and ROCE as compared to the industry. Balkrishna has margins & ROCE almost double the industry average yet stock is available currently at a PE of less than 7.

Bearish Viewpoints

  • Depreciation of the Euro – Since exports to Europe constitute 55% of Sales, depreciation of the Euro can pose a serious drag on the margins and ability to compete. Major competition like Michelin and Bridgestone continue to manufacture in Europe, US & Japan and they need to import the raw material (35% natural rubber, 15% synthetic rubber) in dollars; for them raw material imports neutralises the benefit of Euro depreciation. As per the company, there hasn’t been a major impact. The company has hedged the Euro at Rs. 63/64
  • The tyre industry is raw material intensive. The main raw materials for tyre are rubber (natural or synthetic or mixture of both), carbon black, nylon tyre cord and rubber chemicals. Except natural rubber, the costs of all the other raw materials in tyre production are related to crude oil prices. Natural rubber has seen huge price-volatility in recent times.
  • There is an outstanding 4.5% FCCB aggregating to US$ 22 million with premium of 1.5% p.a. payable on cumulative basis on redemption date (Dec 31st, 2010). The bonds are convertible at a price of Rs. 1,375 at a pre-determined exchange rate of Rs. 45.66 per US$. The current stock price situation suggests the FCCBs may not convert on the maturity date and redemptions will have to be met through internal accruals. That may pose an additional burden.
  • Huge Capex plans – The 150 Cr Capex plan for FY11 and another Rs. 1000 Cr for the Bhuj factory will be funded out of $175 Mn debt and rest from internal accruals. While operational leverage takes time to kick in, there is a possibility of increased interest and depreciation costs, and lower capacity utilisations having a negative impact on bottomline. Execution risks remain significant as the company looks to almost double capacity in the next 2 years. To be fair it must be mentioned, the track record so far has been impeccable.

Barriers to entry

  • The off-highway tyre business is fragmented, with low-volumes, and is labor-intensive. In India, employee cost is around 3%-5% of net sales, whereas in overseas countries it accounts for 12%-15%, pressurising operating margins. Some tyre majors including Continental and Goodyear exited the OTR and farm-tyre market in the US in 2005-06 as labour costs began eating into profitability.
  • The specialty tyres segment in which Balkrishna Industries operates is predominantly represented by large varieties and low volumes. It is geared up to take advantage of the peculiarities of this segment and has developed more than 1800 Stock Keeping Units (SKU) to meet the diverse needs and applications. For any new competitor to match up, this is a huge and complex task. The wide product range covering nearly all segments of off-highway tyres is the company’s main strength.

Interesting Viewpoints

  • BKT Tyres are currently priced 30-35% lower from that of international tyre brands like Michelin and Bridgestone. Earlier this was about 45% lower. This indicates two things. One, that BKT brand is slowly finding more acceptance; Two, there is headroom to pass on price increases in case of raw material price rise. In the current year, Balkrishna has passed on price increases of 10% in two trenches, while the majors have hiked price by 3-5%.
  • As per the company, demand for BKT brand is very high. People have come to appreciate that BKT Tyres match performance of the higher-priced international brands. The current sales contribution from US is 16-18%, it can easily go over 25% if the company did not face capacity constraints.
  • In order to minimize raw material price-volatility risks, the Company not only enters into medium-term contracts but also adopts the policy of “Buy and Stock” large quantities during lean periods. The company plans on increasing warehouse capacity with an additional investment of 10 Cr in FY11.

Disclosure(s)

Donald Francis: No Holdings in the Company;