‘Buy’ Balkrishna Industries: Industry export growth a good augury

The stock remains attractive at ~7.5% FY22e FCF yield.

Balkrishna Industries (BIL) has been – and continues to be – one of our highest-conviction ideas in the automobile space. We believe the company provides an attractive risk-reward proxy for investors keen on playing the global cyclical recovery theme as trade tariff worries ease. The latest monthly industry export data indicates the fastest combined growth since Aug’18 for the Agri (Ag) and Off-the-Road (OTR) tyre segments at 12% y-o-y.

Investor concerns today revolve around the sustainability of the demand recovery. We believe the improving industry growth curve (grew ~5% in Oct’19) reinforces our hypothesis that the demand bottom is behind us and that a recovery cycle is in store for CY20. We believe BIL’s earnings are poised to grow at ~19% CAGR over FY19-FY22e. The stock remains attractive at ~7.5% FY22e FCF yield. We maintain our Buy rating.

Industry exports grow across regions and product categories: Agri (Ag) and OTR segments combined grew fastest in Nov’19 at 12% y-o-y since Aug’18. On a regional basis, the US grew fastest at ~ 16% while EU grew at ~7%. On an end-product basis, sharp growth acceleration (~16% y-o-y) was witnessed in the Ag segment. On the OTR side, growth momentum continued at a slightly better pace in Nov’19 vis-a-vis Oct’18 at ~6%. Continued growth in exports could reinforce investor confidence.

Distributor restocking cycle could support growth: Over the past couple of quarters, BIL witnessed its distributors across key markets, i.e. EU/US, aggressively destock their own channel inventories to much below normal levels. We believe CY20 could mark the resumption of restocking with the waning of the negative impact of US-China trade tariff dispute in CY19. Mathematically, even two weeks’ restocking could add ~4-5% to BIL’s growth.

Domestic Ag demand too is likely to remain strong: Domestic Ag market is also expected to have a healthy CY20 supported by higher reservoir levels vis-à-vis the long-period average across the country and rising mandi prices to aid farmer profitability. BIL is likely to benefit from the same as its products have witnessed favourable customer acceptance – more of which is expected in CY20.

Maintain Buy: We believe tyre businesses need to be evaluated on through-cycle FCF basis. BIL has transitioned from a difficult phase of negative operating leverage and higher capex/brand investments with relative ease (unlike peers). Its capex phase is nearing its end (FY21/FY22 estimates: ~Rs 5.5/2bn), hence we expect it to generate FCF of Rs 8.2/13.7 bn (4.5/7.6% FCF yield) during the same period. The stock trades at 14.1x and 8.7x FY22e PE/Ebitda and EV/Ebitda respectively. We find the current FCF yield attractive. We continue to value the stock at 20x Sep’21 EPS with an unchanged TP of Rs 1,220.