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High cost imports led to huge Gross margin erosion

SKF India reported subdued set of numbers for 2QFY24 on all fronts – Revenue growth, margins and PAT growth. The numbers were substantially lower than our and consensus estimates. The highlight of the results has been whopping 830 bps YoY erosion in the gross margin to 34% (Centrum – 36.2%), the lowest since 3QFY20. This has been attributed to the increase in the import costs. Revenue up by 4.4% YoY to Rs 11,252 mn (Centrum – Rs 11,645 mn / Consensus – Rs 12,060 mn). EBIDTA margin lowered by 910 bps to 10.8% (Centrum & Consensus- 18%). PAT registered a YoY decline of 42% to Rs 902 mn (Centrum – Rs 1,488 mn / Consensus – Rs 1,630 mn). Accordingly, we cut Revenue/PAT estimates for FY24 by 2.5%/9.7% and for FY25 by 2.4%/2.9% respectively. However, we believe SKF India’s Gross and EBIDTA margins to bounce back to near long range average in FY25E. Hence, we assign current FY25E earnings multiple of 40x (earlier 44x) to 1HFY26E EPS of Rs127 (earlier Rs 131) to arrive at a Target Price of Rs5,095 (earlier Rs 5,764) and recommend REDUCE (earlier ADD).

Revenue growth driven by growth in heavy industry and light vehicles

3QCY23 results presentation and transcript of SKF AB reveals revenue growth drivers for SKF India in 2QFY24. In the industrial segment, sales to heavy industries, off-highway, material handling and automation were significantly higher. Sales to high-speed machinery & electrical drives were higher while sales to other and agriculture, food & beverage were slightly higher. To industrial distribution, aerospace, railway and marine it was relatively unchanged while sales to renewable energy and traditional energy were significantly lower YoY. In the automotive segment, sales in the quarter were significantly higher compared to last year with significantly higher sales to light vehicles. To the vehicle aftermarket it was relatively unchanged while sales to commercial vehicles were slightly lower.

Gross margin remained volatile on the quarterly basis historically

A 17.7% YoY growth in the purchase of stock-in-trade led to 830 bps erosion in the gross margin to 34% vs 42.2% same period last fiscal. (Centrum – 39.8%). This has been the lowest gross margin since Dec 2019 quarter (34.4%). Traded stock as a percentage of net revenue has grown to 39.4% vs 35% YoY (Centrum – 36.2%). Industrial bearings are mostly traded and governed by transfer pricing mechanism. This causes a lot of volatility in the gross margin on quarterly basis for SKF India. Moreover, the management attributed gross margin erosion to higher import costs. On an annualized basis, gross margin has broadly remained in the range of 38-41% historically.

EBIDTA margin decline by 910 bps to 10.8% and PAT decline 42% YoY

An 830 bps YoY erosion in Gross margin coupled with 7% YoY growth in employee cost and 8.7% YoY increase in Other expenses transpired into 910 bps contraction in EBIDTA margin to 10.8%. Lower EBIDTA margin coupled with 14.5% YoY jump in depreciation and 117 bps increase in the tax rate led to whopping 42% YoY fall in the PAT.

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