Balkrishna's Hunger for Growth
To start with a pinch of comic irony, Balkrishna dipped a 7.21% to Rs. 1262 a piece on Janmashtami.
What is Balkrishna Industries
Balkrishna Industries evolved from a rubber plantation company to one of the worlds largest off high way and agricultural tyre makers in the world, currently with a global market share of over 6%.
Seen the huge JCB earth moving vehicles, Balkrishna Industries (here on referred to as BKT) is an OEM (original Equipment Manufacturer) for that and many more such companies.
BKT operates in a niché market, implying less competition, less players, higher volumes and awesome margins.
BKT has no net debt and short term debt of close to 825 Cr with Reserves of over 4000 Cr.
BKT has OPM margins of over 25% more than that of MRF and Apollo Tyre combined ;).
For those of you who haven't seen BKT tyres on the roads, well in terms of Market Capitalisation BKT is the 2nd Largest only after MRF but exports over 85%.
Why the sudden dip
While most people saw today as a dip we saw it as a buying opportunity, okay but why did it fall?
So the board of BKT on September the 1st announced a 1000Cr INR + $100MN = Rs. 1700 Cr expansion, which was seen as a "solid -ve" by the analysts resulting in downgrades and "HOLD / SELL Recommendations". So we decided to lift the veil and let our audience decide what to do.
"Mayank Mehra, advisory, related party and Family members all hold stock in the company"
Part 1: of expansion (USA)
BKT sold 30k MT in the Americas so decided to make a $ 100 MN Greenfield expansion in the USA via parent company funding and local debt. This expansion would allow BKT to supply 66% more and sell 50k MT in the USA.
The analysts believe this expansion would take away the low cost edge of the company (of cheaper labour from India) and would plunge the company into debt.
We however believe this expansion would create more cost synergies than debt crisis and help BKT expand market share putting it in a better position to command over its markets.
However, no outflow has happened yet nor have they even decided what debt/ equity mix to use nor have they even decided where to do it.
Part 2 : WALUJ
BKT has decided to spend UPTO Rs. 500 Cr in a Greenfield expansion on 22 Acres of land which the company already owns within 5 kms of it current facility at WALUJ, without disrupting its current operations in order to increase operational efficiencies.
Which we believe would be a great step considering the previous major expansions the company took (which happens once every 5 year) also if BKT takes on expansions to increase efficiency we strongly believe the advantage to the margins and costs have already been taken into account by the management.
But then again maybe a few analysts on the street actually can understand the workings of a company better than a management which took it from being a small rubber player to being one of the world's largest tyre makers.
Part 3: Bhuj
BKT earlier last year commissioned a Carbon Black Plant in the Bhuj facility of 60,000 MT Capacity to begin end of FY 19, but earlier this year the board decided to expand that expansion from 60k MT to 140k MT, however the 80k MT plant will begin by FY21 without adversely impacting the Phase 1 expansion.
Well, now for those of you don't know- CARBON BLACK is actually the chemical that literally makes the TYRES BLACK, this makes up of over 30% of the cost.
Remember the crazy outperformance in stock returns of HEG, Graphite Ind, Phillips Carbon etc, that happened because they make this chemical and an anti dumping duty on China made them the sole suppliers shooting the prices up by at least 20%.
Imagine a 20% drop in 30% raw materials ~ well obviously that won't convert mathematically but thats what is also known as SYNERGY, after BKT will sell the remainder of that chemical to other tyre makers for that massive margins.
Now, BKT has decided to spend INR 500 Cr on setting up a new line of 5,000 MT p.a. for layers of All Steel Radial OTR Tires and additional Mixing line in Bhuj.
Well but our analysts think BKT should not have spend so much on expansions. To quote company official who chose to be anonymous, " The Company can't stop expanding and go stagnant to impress analysts, had that been the case the company would have never grown to its current size"
Well, thats the expansion BKT has in mind. Only has in mind, no cash out flow has happened yet.
The Math around the expansion
BKT has no net debt and a short-term debt of INR 867 Cr while the net Free Reserves as at March' 2018 stood at 4.66 times that at Rs. 4045 Cr which is also 2.37 times of the maximum cash out lay for the current expansion plan of Rs. 1700 Cr.
I would want to bore you with technical and valuation metrics and calculations, but considering the Rate of Return in Indian Banks (FD) are at least 7% PA and you can borrow in the USA at close to 4% PA I would not look at the Local Debt usage for the USA expansion as a bad thing.
While the analysts on the street think, BKT will become debt ridden and loose Net Cash Flows and that it might actually take away productions to USA and loose the cheap labour edge.
We thank them for this decline in prices giving us a valuation comfort.
At Rs. 1267/share BKT is at 24.5X, FY19 expected earnings with net OPMargins of 25.92.
To put this in context,
MRF is trading at 25X FY 18 earnings with an OPM of 17.14%
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No part of this document shall be misunderstood as a buy recommendation. This company is in the portfolios of the author and related parties.