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Inflationary pressure continued in 2QFY27

Kirloskar Oil Engines (KOEL)’s 2QFY27 result came in below our estimate due to a miss on EBITDA margin. Revenue growth came in better than our estimates on sharp scaleup seen in distribution and exports. Lower gross margin and lack of operating leverage benefits resulted in a miss in EBITDA margin. KOEL has gained market share in MHP and select segments of HHP in powergen and plans to grow HHP segment at a faster pace. We cut our estimates by 13%/8%/8% for FY27/28/29 to factor in lower margin and expect revenue/EBITDA/PAT CAGR of 27%/30%/33% over FY26-29. The stock has corrected sharply in the recent past, but we believe that underlying thesis remains strong and inflationary pressure is hitting performance over the last few quarters. We expect price hikes and plateauing of RM prices to aid margin recovery going forward. We maintain BUY with a revised TP of INR2,600 (INR2,800 earlier), valuing the core business at 35x two-year forward earnings.

Beat on revenue; margin and PAT miss our estimates

KOEL’s 2QFY27 revenue increased 19% YoY to INR17.4b (vs. our est. of INR16.6b), driven by better-than-expected growth in exports and distribution segments. Gross margin contracted 150bp YoY to 33.9%. Other expenses as % of sales increased 100bp YoY to 16.3%. These factors led to EBITDA margin contraction of 300bp YoY to 11% (vs. est. of 13%), while absolute EBITDA declined 6% YoY to INR1.9b. Led by lower-than-expected margin, higher-thanexpected non-operating expenses and lower other income, PAT of INR1.2b (- 14% YoY) came in below estimates. For 1HFY27, revenue increased 18% YoY, while EBITDA/PAT declined 5%/12% YoY, and margin contracted 270bp YoY to 11.1%. For 1HFY27, OCF declined 83% YoY to INR398m, mainly due to lower profitability and higher working capital requirements, while it reported a free cash outflow of INR1.6b (vs. an inflow of INR966m last year).

Powergen segment growth remained healthy

Powergen segment registered a growth of 17% YoY, led by volume growth, price increase and ramp-up across HHP segment. Demand for powergen has remained strong from data centre, hospitality, realty, etc., and the company has gained market share in MHP segment and has crossed more than 30% market share in 1,010kVA category in HHP. KOEL is taking calculated price increases due to inflationary pressure and we expect further price hikes if current inflationary trends worsen. Going ahead, we expect powergen segment to continue to benefit from 1) demand and pricing growth, 2) further ramp-up in HHP segment, and 3) scale-up in execution of Hypernext DC order from FY28. First phase of ongoing capex for powergen will be commissioned by next fiscal and second phase by FY29, which will also aid powergen segment growth. We expect powergen segment revenue to clock 33% CAGR over FY26-29.

Financial outlook

We cut our estimates by 13%/8%/8% for FY27/28/29 to factor in lower margin. We thus expect a revenue CAGR of 27% over FY26-29, driven by 33%/25%/20%/17% CAGR in powergen/industrial/ distribution/exports. We expect an EBITDA/PAT CAGR of 30%/33% over the same period.

Valuation and recommendation

The stock is currently trading at 45x/29x/21x P/E on FY27/28/29E earnings. Adjusted for subsidiary valuation, KOEL is trading at 40x/26x/19x P/E on FY27/FY28/29E earnings, which is still at a significant discount to the market leader. We reiterate our BUY rating with a revised SoTP-based TP of INR2,600 (vs. INR2,800), valuing the core business at 35x on two-year forward earnings.

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