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Favourable mix and localisation efforts drives margin resilience

SKF India reported in line revenue/ EBITDA for 3QFY23, but higher tax rate drove net profit miss. Net sales were up 11% YoY to INR10.8bn, in line with JMFe, as we estimate 10-12% growth in domestic automotive segment and industrial segments, while exports would have recorded double digit growth due to low base, in our view. Gross margins largely sustained sequentially at 41.5% (+80bps QoQ, 35.6% in 3QFY22) led by price pass through and favourable mix. Given decent sales growth and sustained gross margins, EBITDA grew by 49.5% YoY, but was lower 14% QoQ to INR1.8bn (in line with JMFe) and margins came in at 17.1% (in line with JMFe). Net profit grew by 31% YoY, but was down 25% sequentially due to higher tax rate (35% vs 28%). On 3-year CAGR basis, sales/EBITDA/PAT growth was 15%/36%/32%. We expect SKF to clock sales/EPS CAGR of 14%/23% over FY22-25E as we expect a) ramp up in annual capex to increase localisation levels (at 57% currently) and improve margins, b) market share gains through participation in future freight wagon tenders (26,000 in FY24BE vs 21,000 in FY23RE), and c) higher share of aftermarket (45-50%) vs peers to provide resilience in margins. We maintain BUY with revised TP of INR 5,200, based on 35x FY25E EPS, lower vs peers Timken (45x) and Schaeffler (40x).

* Robust performance across segments: Net sales were up 11.4% YoY to INR10.8bn, as we estimate 10-12% growth in domestic automotive and industrial segments, while exports would have reported double digit due to low base, in our view. Recovery in industrial segment was possibly led by Indian Railways and metro rail, coupled with increased activities on core sectors, particularly in cement and steel. Further, pick up aftermarket sales and price hikes would have offset weak 2W/3W volumes.

* Favourable mix and price pass through drives margins: Gross margins expanded by 590bps YoY to 41.5% in 3QFY23 (42.5% in 2Q23). We attribute sustenance in margins to price pass through and robust mix with better sales mix (low 2W volumes). EBITDA grew by 50% YoY (inline with JMFe), as margins by 440bps to 17.7%, (19.9% in 2QFY23).

* Capex intensity maintained: The share of traded goods stands highest among peers at 41% of COGS and management has highlighted in past that in order to increase its localisation levels, the company is stepping up its annual capex intensity by 35-40% over next 3 years. Localised sales are likely to increase from 55% to more than 70% over a course of period and align its margin profile (17-18% currently vs 14-16% in past) with peers – SCHFL (19-20%) and Timken (22-25%).

* Maintain BUY with TP of INR5,200: We forecast 23% EPS CAGR over FY22-25E, as we expect company’s growth trajectory to improve on a) strong growth in railways and core industries to drive volumes and capacity utilisation, b) step up in capex to drive localisation to support margins and c) higher share of aftermarket sales to drive margin resilience. We maintain BUY with revised TP of INR5,200 (35x FY25E EPS), even as we assign a lower target PE vs peers – Timken (45x) and Schaeffler (40x)

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