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Channel inventory de-stocking to continue in 4QFY23E

* Balkrishna Industries (BIL)’s 3QFY23 performance was hit by high channel inventory and lower realizations due to reduced surcharge to the end customers. Consequently, EBITDA margin came in lower at 19.1% (v/s est. 20%). Moreover, unrealized Fx loss of INR1.66b further impacted 3Q financials.

* We cut our FY23E/FY24E EPS by 26%/4%, respectively, to factor in the lower realizations and FX loss impact. Maintain Neutral with a TP of INR2,035.

* Inventory management and FX loss hit 3QFY23 performance

* BIL’s revenue grew 7% YoY to INR22.15b (v/s est. INR23.3b) while EBITDA/adj. PAT declined 17%/70% YoY to INR4.2b/INR996m (v/s est. INR4.7b/INR2.8b), respectively. Its 9MFY23 revenue grew 29% YoY while EBITDA / adj. PAT declined 4%/24% YoY, respectively. ? BIL’s volumes declined 5.5% YoY/16% QoQ to 66.5k tons (in line). Volumes in Europe/America/RoW declined 13%/9%/9% YoY, respectively, while India grew 21% YoY.

* Realizations improved 13% YoY (-6% QoQ) to INR333.2k/unit (v/s est. INR348.7k). BIL has reduced the surcharge to end customers due to freight correction that resulted in sequential decline in ASPs.

* Gross margin contracted 4.9pp YoY/ 2.6pp QoQ to 48.6% (v/s est. 53.5%). Due to high-cost RM inventory in the system, the company could not benefit from the falling RM costs.

* EBITDA margin contracted 530bp YoY/100bp QoQ to 19.1%, due to high RM costs, partially offset by declining freight costs (down 90bp YoY/480bp QoQ).

* Further, higher interest costs and depreciation costs combined with unrealized FX loss (INR1.66b), resulted in a decline in Adj. PAT to INR995m in 3Q (-70% YoY, est. INR2.8b).

* The Board has declared a third interim dividend of INR4 for FY23 with total FY23YTD dividend at INR12/share.

Highlights from the management commentary

* BIL’s 4QFY23 volumes are likely to grow on QoQ basis by low-single digit. Inventory destocking is expected to continue in 4Q, though the intensity is likely to reduce.

* The EU end retail demand is still holding up. North America declined YoY led by general market condition and not due to inventory correction.

* BIL expects further benefits, because of freight, to reflect in 4QFY23 and fully in 1QFY24. It expects lower RM cost benefit to partly reflect from 4QFY23 and fully from Apr’23. EBITDA margin should improve by a minimum of 300bp in FY24 due to lower RM/freight costs.

* Further, EUR hedge rate is also favorable with 4QFY23 being hedged at 89 (50% of the exposure) as against 85 for 3QFY23. For FY24, 50% of the exposure is hedged at 89.

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