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Margins likely to improve gradually

Bosch’s (BOS) Q2FY22 operating performance was in-line with consensus estimates as adj. EBITDA margin was up just 63bps YoY to 12.3%. However, gross margin contraction of 343bps YoY to 37.2% was largely on account of higher RM inflation and elevated share of traded goods (~58% of RM cost). Automotive revenue grew ~15% YoY on the back of mobility division (up ~16% YoY) while non-automotive revenue rose ~41% on a low base. We expect growth tailwind of tractor segment to slow down in FY23 (high base effect) while lack of diesel growth in PVs and gradual market share loss in MHCV will further limit potential of above industry growth. Slower pace of localisation is likely to delay margin improvement as share of imports is likely to remain high while competitive intensity remains high in ICE products. High exposure towards ICE engine components remains key risk to premium valuations. Maintain SELL.

* Key highlights of the quarter: BOS’ mobility business was up 17% YoY. Powertrain solutions business was up 16% YoY while aftermarket division grew 27% YoY. Business beyond mobility rose 36% YoY mainly due to higher sales in power tools segment. Higher finished good inventory (~Rs3bn YoY) curtailed gross margin drop via better fixed cost absorption aiding EBITDA margin expansion of ~63bps at 12.3%. On a reported basis, employee costs and other expenses declined 377bps and 29bps, respectively. Adjusted PAT was up 32% YoY at ~Rs3bn largely due to one-time tax benefit of Rs765mn.

* Key takeaways from concall: a) Domestic sales were up 15% YoY as revenue from mobility business was higher from tractors and M&HCVs. Aftermarket segment was higher due to 66% YoY growth in exports to Rs3.5bn; b) traded goods portion of costs (read imports) is likely to remain elevated due to the emission related technology changes ; c) transfer pricing adjustments with parent company resulted in increase in RM costs and management indicated ~2.6% of net sales is one-time repricing impact; d) supply-chain issues on chip shortage are impacting production for BOS, and this situation is expected to continue till the end of FY22, albeit at lesser intensity; and e) BOS has made investment worth Rs133.5mn in Autozilla Solutions to strengthen its aftermarket division, with the company focussing on expansion of distribution reach through Bosch Car Service.

* Maintain SELL: We remain cautious on BOS due to multiple challenges: 1) margin headwinds due to delayed localisation of bought-out content in new programmes, 2) structural industry decline in diesel PV segment, 3) market share loss in M&HCV, and 4) likely moderation of key growth driver (tractors) due to high base effect. We introduce FY24E and upgrade our earnings by ~2.2%/2.3% for FY22E / FY23E on the back of better fixed cost management. We rollover to Sep’23E and retain our target multiple at 25x Sep’23E EPS of Rs551. Maintain SELL with revised target price of Rs13,774/share (earlier: Rs12,327/share).

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