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Current weakness transitory; growth drivers intact

Kirloskar Oil Engines’ (KOEL) 2QFY24 PAT declined 19%YoY to INR 586mn and was below our estimate of INR 840mn led by weak power genset sales and lower margins. 1QFY24 had seen robust pre-buying activity in power gensets and hence 2Q was expected to be softer (Power gensets 1HFY24 Rev growth healthy at 23% YoY). EBITDA came in at INR986mn; down 15% YoY and EBITDA margin stood at 9% (JMFe: 11%, -210bps YoY) on account of poor absorption of overheads and provision of INR 100mn towards doubtful receivables. Management expects pickup in demand from 2H as demand for CPCB4+ compliant gensets should progressively pick-up. Further, with entry into HHP market (1500-3000KVA) with Optiprime range also increases the addressable market. Push on exports continues with an OEM supply chain partner being appointed for GCC countries. We expect revenue/EPS CAGR of 17%/23% over FY23-26E and maintain Buy with revised price target of INR 630.

* Pre-buying in 1Q negatively impacted revenue growth: Standalone net sales grew by a modest 5% YoY to INR 10.6bn due to 8%YoY decline in power gen sales at INR 3.6bn – impacted by pre-buying in 1Q (1HFY24 growth at 23%YoY). Aftermarket segment grew 23% YoY to INR1.8bn, industrial segment grew 5%YoY to INR 2.4bn and exports grew 11% YoY to INR1.3bn. Overall B2B segment grew 19% YoY to INR9.0bn. B2C segment grew 19% YoY to INR1.4bn led by water management (+21%) and farm mechanisation (+13%). LGM reported revenue of INR 5.5bn in 1HFY24 (down c14% YoY).

* Poor fixed cost coverage and provisions lead to lower margins: On a standalone basis, EBITDA was down by 15% YoY/36% QoQ, as EBITDA margin came in at 9.3% (-210bps YoY; JMFe: 11.4%). The margin contraction was driven by poor fixed cost coverage on account of lower sales volume even as RM costs remained almost flat YoY at 66.9% of sales (down 160bp QoQ). EBITDA margin was also impacted by provision of INR 105mn for doubtful receivables (100bp impact). B2B segment reported EBIT margin of 8.2% vs 10.4% in PY, while B2C segment reported EBIT of 2.4% vs -0.5% in 2QFY23. Hence, adj standalone net profit was down by 19% YoY to INR586mn.

* New launches to target HHP market: KOEL reiterated its growth strategy of growing revenue by 2x to INR 65bn in 3 years (starting FY23). This would be supported by entry to HHP market which previously remained untapped for the company and would aid in gaining market share with expansion in margins. The company has introduced gensets in the range of 1500-3000 KVA with name of OptiPrime which is patented technology which would aid company to cater to niche segments like Datacentre, construction etc.

* Maintain BUY with revised TP of INR630: We estimate revenue/EPS CAGR of at 17%/23% CAGR over FY23-26 led by sustained growth in power gen and industrial segments and push towards exports. KOEL’s balance sheet remains strong with high RoIC of 45%+. We arrive at an SOTP based price target of INR 630 valuing the standalone business at 16x Sept’25E EPS (16x FY25E EPS earlier) and cash and investments (including Arka Fincap stake) at 1x BV. Maintain Buy.

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