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BALKRISHNA INDUSTRIES Business Analysis and Valuation Jan 2011

BALKRISHNA

INDUSTRIES

BALKRISHNA INDUSTRIES Business Analysis and Valuation Jan 2011

Business Analysis and Valuation

BALKRISHNA INDUSTRIES Business Analysis and Valuation Jan 2011

Jan 2011

BALKRISHNA INDUSTRIES Business Analysis and Valuation Jan 2011
BALKRISHNA INDUSTRIES Business Analysis and Valuation Jan 2011

BALKRISHNA INDUSTRIES

BALKRISHNA

INDUSTRIES

Investment Thesis

[GLOSSARY]

Balkrishna Industries Ltd (BALKIND) is India’s leading manufacturer and exporter of Off-Highway Tires (OHT) with presence in 120 countries around the world. The OHT segment is predominantly a

“wide product portfolio and low volume” business that is labor and

capital intensive making it unattractive to major and small players alike.

BKT has thrived in this segment mainly due to the low labor costs, proximity to the “rubber” belt, large number of SKUs (1900) and good management. It has achieved an astounding growth of 26% annually, EBITDA margins averaging 22% and a return on equity nearing 27% during the past five year period. Yet in the same timeframe, BKT has increased its market share from 1.5% to a whopping3% worldwide.

The management has earmarked 1200 Crores (INR) to expand the production capacity by 75% in later half of 2013. This has doubled the debt to equity ratio but the prodigious cash flows from current operations should suffice to service the debt.

INR Indian Rupee

1

USD ~ 45 INR

1

Crore 10 million

10 Lakh 1 million MTPA Metric tons per annum OHT Off Highway Tires

OTR Off the Road

The market has recognized the company’s heady growth that has seen the stock price rise from March 2009 lows of Rs 120 to Rs 800 in Nov 2010, yet there is plenty of room to run.

The management announced a five to one stock split in December and the stock trades at Rs 120 per share. BKT currently trades at 9.5 times five-year average earnings and 6.0 times FY10 earnings providing an opportunity for investors to buy a growing company at a less than fair price.

Disclosure: Long BALKIND

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BALKRISHNA INDUSTRIES

SNAPSHOT

Sector

Manufacturer of Off-Highway Tires (OTH)

Market Capitalization (INR)

1158 Crores

Outstanding Shares (Crores)

9.65

Scrip Code (BSE)

502355

EV/EBITDA

(2000/364*) ~ 5.5

Shareholding Pattern

Promoters : 54%, Institutions: 16%, FII: 15.5%

52-Week Share Price Range

Rs 100 160.6

Reward Potential

>100% in 3 years

Website

http://www.bkt-tires.com

*Estimated FY2011

Amitabh Singhi of Surefin Investments presented Balkrishna Industries as one of his picks during

the Value Investing Congress presentation in Oct 2010. This excellent session titled “The Emerging Indian Investing Landscape” is available at

The author highly recommends the slides as it is quite revealing about the structure of Indian equity markets (40% of companies listed are small cap and ignored by analysts!) and in part depicts the reality with hilarious pictures.

INDUSTRY

The entire tire industry is a 130B USD market worldwide and the OHT segment makes up 10% of this market with a growth rate of 3-4% annually. The OHT market can be segmented into

 

Agricultural Tractors, Farm Equipment, Forestry

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Off the Road (OTR) Industrial, Construction, Earth Movers, Mining

 

Consumer utility vehicles like golf carts, All Terrain Vehicles

It is largely dominated by premier players like Bridgestone, Michelin, Goodyear with a market share of >60% but with very low turnover and margins due to high capital costs and competitive pricing. Goodyear sold its farm tire business in Europe/America to Titan to focus more on the lucrative commercial tire and OTR market. Titan (USA), MITAS (Czech), Alliance (Israel) and BKT are the few pure play OHT manufacturers.

Natural Rubber (32%) and Synthetic Rubber are the key raw materials and accounts for 60% of the total manufacturing costs. Thailand, Indonesia and Malaysia are the top three producing nations (70% of global supply, India is the fourth largest). South-east Asian Monsoons in 2010 have wreaked havoc in rubber supply adding to already increasing rubber prices. Natural Rubber prices have escalated to $5000 per metric ton in 2011, up about 240% from Feb 2009 due to tight global supply. Synthetic Rubber prices have also increased substantially to $3500 per metric ton owing to the rise in crude oil prices.

This has caused significant headwinds in the tire industry and all the manufacturers have increased their prices by 11-14% in 2010 to partially offset the costs. The natural rubber shortage is expected to prolong till end of 2011 with no ease in prices. Further price increase in 2011 have been announced by Michelin, BKT and few other players.

BALKRISHNA INDUSTRIES
BALKRISHNA INDUSTRIES

Source: BKT Tires Investor Presentation, Nov 2010

The farm tire industry has recovered to former levels from the 2009 recession while the construction industry is still affected by housing, infrastructure and government spending in Europe and America. Infrastructure and Agriculture sectors are booming in India and China unveiling new opportunities for growth in the industry.

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BALKRISHNA INDUSTRIES

COMPANY

Balkrishna Industries (BKT) is the flagship company of Siyaram-Poddar Group (SPG) with consolidated revenues of Rs 1564 Crores in Fiscal Year 2010. While the primary focus is on the manufacture and export of OHT (88% of revenues), Balkrishna Industries owns the following subsidiaries:

Name of the subsidiary company

% Ownership either directly or through subsidiary

Balkrishna Paper Mills Ltd (India)

100%

Balkrishna Synthetics Ltd (India)

100%

BKT Exim Ltd (India)

100%

BKT Tyres Ltd (India)

80%

The Paper Mills and Synthetics subsidiaries are in a mature state and are expected to add INR 200 Crores in sales with a 8% margin in FY 2011. No further information is available on these subsidiaries apart from consolidated accounts reported in the annual reports.

BKT Tyres owns three state of the art tire manufacturing plants (two in Rajasthan and one in Maharashtra) with an installed capacity of 160K MTPA (production capacity is 75%). OHT is a niche segment and BKT revenue breakdown across markets is:

Agriculture (70%), Off the Road (26%) and Others (4%)

Replacement market yields a majority (75%) of BKT revenues, OEMs (Volvo, Deere, CNH etc) contribute 15% while off-take (supplier to majors to sell under their own brand) the remaining 10% of the sales.

With a wide product portfolio (1900 SKU) and presence in 120 countries (>200 distributors), BKT has diversified worldwide to reduce geographical dependencies and it is also gaining market share locally (~11%).

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BALKRISHNA INDUSTRIES

BALKRISHNA INDUSTRIES NORTH AMERICA The North American OHT tire market is a 1B USD market: Titan,http://www.moderntiredealer.com/Channel/Suppliers/News/Story/2009/10/MTD-exclusive-BKT- discusses-2010-plans.aspx http://www.tirebusiness.com/subscriber/headlines2.phtml?cat=1&id=1253124523 5 http://bkt-tires.com/pdf/investers/BKTInvestorPresentationNov10.pdf (Slide 10) " id="pdf-obj-5-4" src="pdf-obj-5-4.jpg">

NORTH AMERICA

The North American OHT tire market is a 1B USD market: Titan, Firestone, Michelin and Yokohama command the lion share (90%). BKT has made significant inroads and has quickly grabbed a 3% market share in NA with an annual turnover of 60m USD in 2010 up from 52m in

  • 2008. 1

EUROPE

Goodyear (now Titan) and Michelin dominate Europe OHT market. Whopping 51% (160m USD)

of the company’s revenues came from Europe in 2010, down from 64% (68m USD) in 2006.

ASIA

Currently 11% of revenues are from India OTR segment and it is expected to grow rapidly as India continues to spend on infrastructure and construction equipment. The company’s estimate is that the Earthmoving and Construction Equipment industry will grow five-fold by 2015 creating significant opportunities for growth. In addition, BKT is also focusing on China and Russia markets.

1 Modern Tire Dealer -

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BALKRISHNA INDUSTRIES

COMPETITIVE ADVANTAGES

Low costs BKT enjoys a significant cost advantage when compared to its global peers (Michelin, Titan). Total cost of production is at Rs 134/kg vs 194/kg for competitors, Labor costs are also 1/5 th that of global companies and proximity to rubber producing countries lowers costs. Since BKT relies on its distributor network to sell, it does not have warehouse and sales costs. BKT prices its products at a 30% discount compared to premium brands due to these lower costs.

Entry Barriers With majors focusing on the more profitable auto segment, very few players concentrate wholly on the OHT market. Low volume, higher variety products, high labor costs and capital expenditures, distributor network setup with good incentives make it difficult for new entrants.

R&D - BKT is able to produce a wide variety of tires in a short period (3 to 4 days for changing mould vs 30 to 45 days in the industry, how ?) of time. It rolls out close to 150 new size tires every year and has a claim ratio of 0.5% vs 1% the industry norm. It is the first in Indian industry to setup and manufacture a full range of radial tires and will benefit from the transition to radial tires globally.

Increasing Brand Awareness the BKT brand is being recognized in the markets and will allow the company some leeway in terms of pricing. Management goal is to increase the market share to 6-7% by 2015 from current 3%.

Management The management has aggressively entered new markets and executed well to achieve a 30% growth rate over the past five years. The ability to finance the expansion plans at low interest rates (3.5%), Hedging foreign currency exposure and entering into six month forward contracts for natural rubber (3500 USD per ton) shows their business acumen. The compensation does not include stock options and is reasonable and the management has significant skin in the game with a 46% ownership.

EXPANSION PLANS

The management has reserved an expenditure of 200 Crores (90 Crores already utilized) for

upgrading and debottlenecking in the existing plants to increase the production to 130K MTPA in

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2012.

To realize its goal of 1 billion USD revenues by 2015, BKT has commenced the setup of a new Greenfield plant in Gujarat state to increase the production capacity by 70% to 220K MTPA by FY

2014.

This expansion will cost 1200 Crores staggered over three years (100, 700 and 400 Crores

in 2011, 2012 and 2013 respectively) and will be funded by debt (Foreign Exchange Convertible Bonds at 3.5% interest rate) and partially from cash flows.

BALKRISHNA INDUSTRIES

VALUATION

BKT Tyres Financial Statements from 2003-2010 is captured in the spreadsheet below

BKT currently trades at 9.5 times five year average earnings and 6 times FY10 earnings astoundingly cheap considering the phenomenal track record and discounting any future growth. The author believes that a PE multiple of 12-15 (2010 earnings) would be appropriate for BKT taking into account the growth rate and profit margins. This would imply an intrinsic value between INR 252 to 315 per share. The current market price offers greater than 100% margin of safety for investors with a long time horizon.

Any future projections must consider the following while evaluating BKT:

1)

Sales Growth With debottlenecking and plant upgrade, the production capacity is expected to grow by 10% to 110K mtpa in 2011. In addition, expansion plans will increase capacity by 75% when the Gujarat plant goes online in 2013.

Management has set an ambitious goal to increase sales to INR 4500 Crores (1B USD) by 2015 implying a CAGR of 26% over the next five years. Setting a conservative annual growth rate of 15%, revenues are projected to be INR 3260 Crores. With profit margins of 9%, the 2015 EPS will be Rs 29.3 (post-split) implying 4x 2015 earnings multiple.

2)

EBITDA margins and Earnings Growth Earnings have grown at 20% over the past five years and management is comfortable with meeting 22-23% EBITDA margins in the future. The author has assumed a conservative 9% profit margin while in reality this may increase with pricing leverage via brand awareness and increasing market share.

3)

Return on Invested Capital Management has been astute in deploying capital at >20% returns over the past five years. Historic returns on invested capital is tabled below

Year

2006

2007

2008

2009

2010

 

Capital Invested

540

785

992

999

1149

(Crores)*

Pre-tax

140.03

177.6

217.35

196.99

369.76

Operating

Income (Crores)

Pre-tax ROIC (%)

26

22.5

21.8

19.6

32

7

*Total Assets Cash Non-interest bearing current liabilities

 

BALKRISHNA INDUSTRIES

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RELATIVE VALUATION: GLOBAL BKT vs Titan International

                 

Nine

Relative Metrics

2003

2004

 

2005

 

2006

2007

2008

 

2009

months

       

2010

Revenue

Titan

18.61

25.02

 

19.32

 

27.44

24.5

30.03

 

20.63

 

18.3

per share

       

(USD)

 

BKT

6.8

9.02

 

7.29

 

10.36

11.55

14.5

 

16.08

16.1*

Operating

Titan

-3.3

8.1

 

6.8

 

4.5

3.7

7.1

 

-1

 

6.1

Margin

       

(%)

 

BKT

17.8

22.36

 

22.1

 

19.74

21.65

15.62

 

26.45

19.42*

EBITDA

Titan

-3.2

8.1

 

6.8

 

4.6

3.7

2.22

 

7

 

NA

(%)

 

BKT

18.79

23.41

 

23.05

 

20.73

 
  • 23.1 19.59*

16.01

28.34

 
 

Titan

-1.39

  • 0.54 0.45

   

0.21

-0.21

0.39

 

-0.7

 

0.3

EPS (USD)

BKT

0.54

  • 0.75 0.81

   

0.935

1.19

0.824

 

2.34

1.609*

 

*Extrapolated from six months (April-Sep 2010)

 
   

Valuation

 

Titan

BKT

Bridgestone

Goodyear

 

Michelin

 
 

P/E

  • 30.7 6

   
  • 12.6 9.3

20.5

   
 

P/CF

 

6

  • 30.9 3.0

3.6

   

3.8

 
 

EV/EBITDA

 

10

5.5

 

5.1

 

5.1

5.1

 

RELATIVE VALUATION: LOCAL

 
   

Company

Sales (Rs)

 

5 Years

   

P/E

EV/EBITDA

 

RoC (%)

 

Growth (%)

   

Apollo Tyres

  • 5036 16%

Crores

     

8.7

5.8

 

32

 

BKT

  • 1564 22%

Crores

     

5

5.5

 

32

 

JK Tyres

  • 3677 14%

Crores

     

6.8

5.7

 

12.9

BALKRISHNA INDUSTRIES

RISKS

Natural Rubber prices have escalated to 5000 USD per ton in 2011 and there is no sign of respite till 2012. Although BKT has hedged the commodity with forward contracts (USD 3500 per ton) till March 2011 and has increased prices twice in 2010, it remains to be seen how it affects the sales in FY 2012. Will the company be able to pass the raise in costs to customers or will need to absorb it internally leading to lower margins?

Foreign currency exposure is another concern significant appreciation of Indian Rupee against Euro or the USD will affect the company drastically. Currently, BKT also enjoys no import duty costs of natural rubber as it is a net exporter of tires.

Any failure or delay in execution on the capacity expansion could prolong the company’s

objectives and will lead to ceding market share to other players

JK Tyres owns 45% market share in Indian OTR market. CEAT, Apollo, MRF are the other major players in India and they have large capital and economies of scale to capitalize

on the oncoming Indian market growth. This may stall BKT’s growth in Indian markets.

DISCLOSURE LONG BKT.

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