A bumpy ride awaits Balkrishna Industries

What gives? To begin with, sales volumes were a sore point at 66,480 tonnes, down 5.5% year-on-year (y-o-y) and around 16% sequentially. True, looming fears of recession in its key market of Europe meant volumes were expected to remain under pressure last quarter. That said, management commentary was gloomy too, pointing to a weakness in near-term offtake as well.

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In the earnings call, the management said channel inventory clearance in end markets impacted its volumes in Q3. It said its distribution channel across the globe had excess inventory not only in off-highway tires , but for other tire segments as well. Inventory at the dealer level is currently at two-and-half months versus nearly three months in Q2. The management aims to reduce this to two months. While the situation is improving month-on-month, it continues to face challenges of de-stocking in Q4, the management said. Sequential volume growth in Q4 is expected to be in low-single digits.

Coming to Q3, profit performance was nothing to write home about. Balkrishna posted Ebitda (earnings before interest, tax, depreciation and amortization) margin of 19.1%, about 530 basis points lower from a year ago. One basis point is 0.01%. Furthermore, it reported an unrealized forex loss of ₹166 crore driven by a sharp rise in the rate of euro. Besides, elevated interest expenses dragged net profit down by about 70% y-o-y to almost ₹100 crore, missing analysts’ estimates.

While raw material prices have corrected, Balkrishna has not been able to fully reap the benefits due to availability of high-cost raw material inventory, the management said. This has offset the positive impact of easing freight costs. Further, the company passed on surcharge of freight cost to customers, which led to average selling price falling by around 6% sequentially.

The management hopes that benefits of lower freight costs will start reflecting from Q4 onward. Overall, it expects to see at least 300 basis points Ebitda margin recovery in FY24.

In Q3, Balkrishna did not take any pricing actions. But the worry is that with raw material prices easing further, competitors may opt for price cuts. Against this backdrop, unless volumes catch up adequately, Balkrishna may not be able to cope. “We see pricing pressures emanating for Balkrishna from hereon as competitors/industry begin to take price cuts to pass-on the benefits of easing raw material prices,” said Varun Baxi, analyst at Nirmal Bang Institutional Equities.

As things stand, the company is poised to see severe earnings downgrades. “There is not much clarity on volume recovery. The management commentary on margin is conservative; we feel reclaiming margins of over 25% would be a very gradual process. For FY23 and FY24, we expect consensus to downgrade the company’s earnings per share estimates meaningfully,” an analyst requesting anonymity said.

Meanwhile, so far in 2023, the stock has declined by nearly 4%. The shares trade at FY24 price-to-earnings multiple of about 22 times, showed Bloomberg data. While valuations have moderated, given the challenging business conditions, the room for expansion appears limited.

“The overall stock outlook for Balkrishna Industries is quite weak. We see more downside risk to the stock. Relatively higher exposure to Europe than peers and excess inventory issue in the off-highway tires segment, makes Balkrishna comparatively less attractive,” added Baxi.