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Better realizations drive revenue beat

Uncertainty in the EU leads to retraction of volume guidance

* BIL’s 2QFY23 performance was led by strong ASPs driving revenue and profits. However, due to geopolitical tensions the outlook for BIL’s biggest market – Europe – has turned uncertain leading to retraction of volume guidance by the management. Though, margin visibility has improved.

* We raise our FY23E EPS by 3% to factor in ASP strength, but maintain our FY24E EPS. Maintain Neutral with a TP of INR2,075.

Better mix and favorable currency boost performance

* BIL’s revenue grew 35% YoY to INR28.1b (v/s est. INR26.3b) while EBITDA/ adj. PAT remained flat YoY at INR5.5b/INR4b (v/s est. INR5.25b /INR3.3b), respectively. For 1HFY23, BIL’s revenue improved 42% YoY, EBITDA was flat and adj. PAT declined 4% YoY.

* The company’s volumes grew 8% YoY to 78.9k tons (v/s est. 79.3k tons). Volumes in Europe declined 3% YoY/6% QoQ, whereas America stood at +32%YoY/+2% QoQ and India was at +28% YoY/-17% QoQ.

* Realizations improved 24.5% YoY (+8.5% QoQ) to INR355.8k/unit (v/s est. INR331.1k) benefiting from: a) better product mix due to higher tech tyres, b) USDINR, c) higher contribution from North America (use of large dia and higher OTR than agri) and d) increased contribution of external sales of carbon black to 5% (from 3% earlier).

* Gross margin contracted 4.2pp YoY (-2.2pp QoQ) to 51.2% (v/s est. 54%), adversely impacted by RM cost inflation.

* EBIDTA margin declined 7pp YoY to 19.5% (v/s est. 20%). Further, higher other income and lower tax boosted adj. PAT.

* CFO declined 5% YoY to INR4.5b leading to an FCFF outflow of INR4.4b (v/s outflow of INR3b in 1HFY22). Capex for 1HFY23 stood at INR8.9b (v/s INR7.9b in 1HFY22).

* The Board has declared a second interim dividend of INR4/share for FY23 (FY23YTD = INR8/share).

Highlights from the management commentary

* Geopolitical challenges in Europe (over 50% of volumes) and continued channel inventory destocking (due to reduction in shipping times and weak demand) have led the management withdraw its FY23E volume guidance of 320-330k tons. However, North America and India are faring relatively better.

* Corrections in RM cost and freight cost will support margins from early 4QFY23. Natural rubber should reduce to ~INR150/Kg from ~INR157/Kg and Synthetic rubber to reduce from ~INR178/Kg to INR145-150/Kg. Similarly, logistic cost can reduce by 20-22%.

* BIL has revived its modernization plan of old Waluj plant (replacing old plant with a modern one) at a capex of INR3.5b. This project would be completed in 1HFY24E and would lead to temporary reduction in capacity by 25k tons. Eventually, the total capacity will be restored to 360k tons.

* Capex for 2HFY23 is likely to be INR3-4b (v/s INR9b in 1H) as the major capex has already been undertaken.

Valuation and view

* Near-term challenges notwithstanding, we expect BIL’s outperformance v/s the Specialty Tyre industry to continue, driven by expansion of its product portfolio and ramp-up in the OTR segment. There will be further scope to strengthen its competitive positioning.

* Current valuations fairly reflect its industry-leading margin, FCF, and capital efficiencies. It currently trades at a P/E multiple of 25.7x/22.2x FY23E/FY24E EPS. Maintain Neutral.

Highlights from the management commentary

* Geo-political related challenges in Europe (over 50% of volumes) and continued channel inventory destocking (due to reduction in shipping times and weak demand) has led to the management withdrawing its FY23 volume guidance of 320-330k tons. However, North America and India are doing relatively better.

* Correction in RM cost and freight cost will support margins from early 4QFY23. Natural rubber should reduce from ~INR157/Kg to ~INR150/Kg and Synthetic rubber to reduce from ~INR178/Kg to INR145-150/Kg. Similarly, logistic cost can reduce by 20-2%.

* EBITDA in 2Q was impacted by higher RM cost (200bp QoQ), due to impact of a) weak INR on imports, and b) high cost inventory.

* Realizations increased QoQ by 8.5% due to a) better product mix due to higher tech tyres, b) USDINR, c) higher contribution from North America (use of large dia and higher OTR than agri) and d) increased contribution of external sale of carbon black to 5% (from 3% earlier).

* EURINR was 85 for 2Q and is hedged at 85 for 2HFY23. USDINR for 2QFY23 was 81 (v/s 76 in 2Q) and is not hedged as there is natural hedge on imports.

* It has revived its modernization plan of old Waluj plant, which will led to replacing old plant with new modern plant at capex of INR3.5b. This project would be completed in 1HFY24 and would led to temporary reduction in capacity in capacity by 25k tons. Eventually, total capacity will get restored to 360k tons.

* Capex for 2HFY23 is expected to be INR3-4b (v/s INR9b in 1H) as major capex is done.

Valuation and view

Huge opportunity size, strong competitive positioning

* Profitable market share gains to continue: We expect BIL’s outperformance to the industry to continue, with scope to strengthen its competitive positioning. BIL has a well-established competitive advantage, which has enabled consistent market share gains. Its competitive advantage is driven by: a) competitive cost and pricing, b) consistent product portfolio expansion, and c) expanding reach. With a current market share of ~6% in the USD15b global Specialty Tyre segment, BIL aspires to increase this to 10% over the next four-to-five years by: a) ramping-up in the OTR segment, which is much larger than Agri Tyres, b) strengthening its presence in North America and RoW markets, and c) gaining share with OEMs. We estimate ~8%/~13% volume/revenue CAGR over FY22- 25E.

* Investing to improve its competitiveness: The management has invested over ~INR30b over the next last year towards expanding capacity in tyres as well as carbon black and modernization & automation. On completion of the ongoing capex, capacity would increase to 360kt by 1HFY24. As a percentage of sales, capex intensity would be start moderating from 2HFY23 to <9% of sales (v/s last 5 years average of 15%), driving improvement in FCF generation.

* Earnings growth to pick-up: We estimate EBITDA/PAT for BIL to grow at 13%/9.5% over FY22-25E. We expect a decline in EBITDA margin over FY22-25E to ~25.3%, led by cost pressures. With lower capex intensity, we expect FCF generation to improve resulting in FCF conversion (% of PAT) to 70% (<20% for last 5 years).

* Valuations factor in a focused strong business model: We raised our FY23E EPS by 3% to factor in for ASP strength, but maintained FY24E EPS. BIL ranks highest among domestic peers in terms of cost competitiveness and financial strength. In terms of valuation, it trades at a substantial premium to its mainstream peers. Premium valuations fairly reflect its industry leading margin, FCF, and capital efficiencies. It currently trades at P/E multiple of 25.7x FY23E/22.2x FY24E EPS. Valuing BIL at 22x Sep’24E EPS (in line to its five/10-year average P/E), we arrive at our TP of INR2,075. We maintain our Neutral rating.

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