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Temporary margin pressure; recovery ahead

Kirloskar Oil Engines (KOEL)’s 1QFY27 result came below our estimate due to a miss on EBITDA margin. Overall revenue growth stood healthy at 16% YoY and was led by powergen, industrial, and distribution segments, while exports were weak due to the impact of the West Asia crisis on exports to the Middle East. KOEL has managed gross margin well versus other peers during the quarter with staggered price hikes across ranges, which will also get reflected in upcoming quarters. Employee cost increased due to salary increments, ESOP cost, new hirings, etc., and we expect it to get absorbed better in coming quarters as revenue scales up. The company has also gained market share during the quarter and is investing across segments to capture powergen, industrial, and export demand. Going forward, we would keenly monitor

1) growth across segments

2) delivery schedule of the HyperNext order

3) operating leverage benefits for margin recovery. We cut our estimates by 7%/4%/2% for FY27/28/29 to bake in 1QFY27 performance on margins. We roll forward our valuations and reiterate our BUY rating with a revised SoTP-based TP of INR2,800 (vs. INR2,750), valuing the core business at 35x on two-year forward earnings.

In-line revenue; both margin and PAT below our estimates

KOEL’s 1QFY27 revenue was in line with our estimates. Gross margin did not witness any major impact (-70bp YoY on a LTL comparison). However, employee costs as % of sales increased 120bp YoY, and other expenses as % of sales rose 40bp YoY, which led to a lower EBITDA margin for 1QFY27. During the quarter, employee cost increases were mainly due to wage increases, ESOP costs, and new headcount additions to incorporate new capabilities across segments. The company expects these costs to be absorbed well in the coming quarters as revenue increases. Revenues grew 16% YoY to INR14.7b, broadly in line. Gross margin stood at ~34.3%, vs. our expectation of 34.0%. Absolute EBITDA declined 4% YoY to INR1.7b, vs. our estimate of INR1.9b, while the margin contracted YoY to 11.2% vs. our estimate of 12.5%. Adj. PAT declined 9% YoY to INR993m vs. our estimate of INR1.2b

Powergen segment boosted by pricing and market share gains

Powergen segment revenues grew by 18% YoY for 1QFY27. This growth was supported by volume and pricing gains across genset ranges – below 750kVA as well as for higher ranges. To pass on higher RM costs, the company has taken staggered price hikes during the quarter across ranges, which also aided revenue growth partially. The full impact of price increases will start getting reflected from 2Q/3QFY27. The company has also been able to improve its market share versus last year. We expect the powergen segment to continue to benefit from demand in low-to-mid kVA ranges as well as improved traction of HHP products of KOEL across user segments. KOEL’s Optiprime product continues to gain acceptance across data centers as well as mission-critical projects. The company is targeting the genset delivery of the large-sized HyperNext order by 4QFY27 and the service portion over the next 5-6 years. During the next two years, we expect the powergen segment to benefit from upcoming capacity expansion as well as delivery of the HyperNext data center order. We expect powergen revenue to clock a 33% CAGR over FY26-29

Financial outlook

We cut our estimates by 7%/4%/2% for FY27/28/29 to bake in 1QFY27 performance on margins. We thus expect a revenue CAGR of 27% over FY26-29, driven by 33%/27%/18%/14% CAGR in powergen/industrial/ distribution/exports. Over FY26- 29E, we bake in a 190bp improvement in margins to build in better product mix and operating leverage benefits. We expect an EBITDA/PAT CAGR of 22%/37% over the same period.

Valuation and recommendation

The stock is currently trading at 52.7x/35.5x/26.4x P/E on FY27/28/29E earnings. Adjusted for subsidiary valuation, KOEL is trading at 48.6x/32.7x/24.3x 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 INR2,800 (vs. INR2,750), valuing the core business at 35x on two-year forward earnings.

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