While tyres may feature quite low down the totem pole of interesting and engaging manufacturing businesses, Balkrishna Industries has done enough to make Dalal Street sit up and take notice. Founded in 1961, Balkrishna ventured into the off-highway tyre (OHT) market in 1995 and today boasts of a product range featuring more than 2,000 tyre varieties, with a presence in over 130 countries.
Accounting for around 10% of the overall tyre industry, the global OHT market is valued at around $9 billion and Balkrishna gets 90% of its revenue from exports (see: Continent hopper). That investors are solidly sold on Balkrishna’s growth story can be seen from its skyrocketing share price, which has increased at a 77% CAGR over FY09-FY14, compared with an 18% growth in the Sensex over the same period. Over the past year, the stock price nearly tripled to ₹840 from ₹285 before correcting recently to ₹600 on the back of Q2FY15 results, which fell short of analyst expectations.
Europe accounts for more than half of Balkrishna's revenue
With the expected commissioning of Balkrishna’s new facility in Bhuj by the end of FY16, the company will continue to hold on to its status of India’s premier player in the niche OHT segment, that is, tyres for off-road usage in agricultural, construction and forestry equipment, etc. However, it is important to remember that the company’s growth will be tempered by the vagaries of the global economy.
Balkrishna undoubtedly has the first-mover advantage in the domestic OHT space. The company also has a sturdy competitive moat against encroachment by other leading Indian tyre manufacturers such as Apollo Tyres, MRF and Ceat, as its business model is primarily based on low volume and high variety.
The task of maintaining Balkrishna’s capex-intensive range of 2,000 varieties of tyres acts as a natural entry barrier for domestic competition, helped along by the fact that it is quite difficult for other companies to convert idle radial tyre capacity for OHT use. “This is particularly difficult for domestic conventional tyre makers, who are accustomed to high volumes of standardised passenger car and commercial vehicle tyres,” says an Ambit Capital report authored by Ashvin Shetty and Ritu Modi.
The only major competition Balkrishna faces in India is from the Alliance Tire Group (ATG), founded by the Mahansaria family, which also co-founded Balkrishna and is related by marriage to Balkrishna’s promoters, the Poddar family. ATG has witnessed meteoric growth so far and draws revenue comparable with Balkrishna’s ₹3,500 crore. In one of the largest PE deals in India, Kohlberg Kravis Roberts (KKR) Equity acquired a controlling stake in ATG in April 2013 for a reported figure of $450 million.
With such influential backers, there can hardly be any doubt about ATG’s growth trajectory, enough to etch furrows in the foreheads of Balkrishna’s promoters. But analysts are of the opinion that there is enough space to grow, considering Indian players hold less than 10% of the global market in spite of a strong cost advantage.
Balkrishna also enjoys other advantages because of its business model. Surjit Arora, analyst with Prabhudas Lilladher, says, “Balkrishna enjoys zero import duties on rubber because of the export orientation of its business. Hence, compared with other domestic tyre companies, which mostly manufacture for domestic use, its margins are much higher.
Also, Indian manufacturers are split between passenger vehicles, commercial vehicles and OHT, of which OHT makes up just 6-7% of their revenue. So, given that the commercial vehicle segment is expected to grow at a heady pace there is no reason for other manufacturers to shift to OHT, reducing competitive threat for Balkrishna.” In addition, the company pays zero excise duty on its exports, further boosting its margins.
Given all these factors, there is the possibility of Balkrishna gaining from an expansion in the domestic OHT industry. While the OHT segment in India is miniscule today at around 10% of the entire tyre market, an AT Kearney report says the earthmoving and construction equipment industry is estimated to more than double from $3 billion in 2012 to $7-8 billion in 2016, following the widely expected uptick in capital expenditure in India.
And thanks to rising rural wages and the need to enhance productivity, agriculture might also slowly shift to mechanised farming to feed a growing population. As Balkrishna derives almost two-thirds of its revenue from agriculture equipment, catering to the highly mechanised farms in Europe and America, the management expects agricultural demand to boost the company’s revenues in the coming quarters once the American winter is over. It helps that the need for variety inherent in the OHT business discourages competition from Chinese manufacturers.
“The Chinese advantage comes from mass production of standardised products. The high variety, low volume nature of OHT has prevented Chinese companies from becoming dominant players in the business,” notes the earlier mentioned Ambit report.
Another major advantage Balkrishna has over global competitors such as Bridgestone, Michelin and Titan International is the availability of low-cost manufacturing facilities in India compared with the geographies — Europe and America — the multinational giants operate in. Balkrishna’s employee costs work out to a meagre 5-6% of its sales, significantly lower than Michelin, which spends around a quarter of its sales revenue on employee costs (see: Cost warrior).
Low labour cost is a huge advantage for the company
“Despite selling at a 30% discount to the industry leader, Balkrishna enjoys strong margins as its products are competitive due to lower labour costs in India, compared with significantly higher wage and benefits/entitlement structures present at European facilities,” says an ICICI Securities report authored by Nishant Vass.
Balkrishna holds only 4.5% of the global market share, which means it has plenty of room to expand. Balkrishna presently has plants at Aurangabad in Maharashtra and at Bhiwadi and Chopanki in Rajasthan. Once the fourth plant at Bhuj is fully commissioned, it is expected to double Balkrishna’s capacity to 300,000 metric tonne from 156,000 metric tonne in FY12. The proximity of the plant to various ports on the Gujarat coast will also bring down transportation costs.
The Bhuj plant is also expected to expand capacity in the non-agricultural off-the-road (OTR) tyre segment, that is, the construction and mining tyre space, which constitutes two-thirds of the global OHT market. Restricted by capacity constraints, Balkrishna holds less than 2% market share in this segment and derived only 33% of its revenue from it in FY14. The Bhuj plant, which will focus on manufacturing large-diametre tyres catering to the OTR segment, should help rectify this.
This expansion comes at an appropriate time for Balkrishna, given that an uptick in demand in the OHT segment is foreseen in India, and the company’s global peers are turning away from this segment. “While global giants such as Michelin, Bridgestone, Pirelli and Trelleborg dominate the OHT industry, the contribution from OHT to their overall revenue is just about 10-12%. While margins are high in the OHT space, the segment faces its own set of challenges in the form of high degree of customisation, relatively high labour costs (particularly in developed economies) and relatively higher capital requirements,” notes the Ambit report.
Between FY09 and FY14, Balkrishna’s revenue has grown at a CAGR of 24%, compared with the 6% growth in Michelin’s OHT revenue and the 2% increase in Trelleborg’s OHT sales, indicating a rise in market share. Balkrishna is also set to gain from expansion into newer geographies such as Russia, CIS countries and Latin America, aided by capacity addition in the OTR segment from the Bhuj plant. As of FY14, Balkrishna derives 53% of its sales volume from Europe, 19% from America, 11% from India, 6% from the rest of Asia and 12% from New Zealand, Australia, West Asia and Africa combined.
According to Modern Tire Dealer, in the US market, Balkrishna holds nearly 20% market share in the radial rear farm tyre replacement segment and 40% in the bias rear farm replacement tyre segment, which indicates growing customer acceptance of the brand. A report by Dolat Capital also corroborates this observation: “We expect the replacement market to continue to be the growth driver as it is a relatively higher margin business, compared to the OEMs. Our assumption is supported by the fact that globally, the OEM business is witnessing some turbulent times, thereby giving a fillip to replacement demand. With its focus on replacement markets, and with new capacity coming on stream, Balkrishna is well placed to cater to this demand with faster execution, thereby gaining market share.” According to industry sources, margins in the replacement tyre business are typically twice that for OEMs.
Balkrishna has scope to exploit the high global demand for OTRs
Incidentally, the share of OEMs in Balkrishna’s business has increased in FY14, supplying 19% of the company’s volumes as compared with 14% in FY13. The company highlighted this fact and identified known brands such as JCB, Greaves and Ferrari as customers in its 2014 investor presentation.
“It is important for the company to make inroads into the OEM market even if it happens to be a low-margin business. If they have a good product, this market will help get replacement orders; that’s how a company builds its profile. Also, if a company’s tyre is visible on a reputed OEM’s equipment, it helps build its brand internationally,” explains Arora. As the company management expects the share of OEMs revenue to increase to 30% in the next three to four years, there could be some visible margin compression.
Mark to market
Given that rubber constituted 48% of Balkrishna’s raw material costs in FY14, the global fall in rubber prices, which have declined from an average price of ₹208 per kg in FY12 to an average of ₹166 per kg in 2014, has helped the company achieve tremendous margin expansion. Operating margin has increased from 16% in Q4FY12 to 18% in Q2FY15 in sync with global rubber prices. Hence, one of the key threats the company faces is a possible upswing in rubber prices, which could severely affect its operating margin.
“The main reason behind the rise in Balkrishna’s stock price during the last year is that rubber prices have fallen sharply. To understand the trend, you need to look at all the tyre companies – Apollo, CEAT, JK and MRF – in tandem; all of them have gone up strongly. Of the rise in Balkrishna’s share price, 70-80% was contributed by the fall in rubber prices,” says Arora. However, this fall in price has not been passed on to consumers yet, which has enabled most tyre companies, including Balkrishna, to command hefty margins.
Hence, a surge in rubber prices could mean a correction for Balkrishna, whose fortunes have so far moved with rubber prices. (see: Moving in sync) There is a ray of hope, though, as rubber prices are expected to remain benign for the next couple of quarters. “I don’t see rubber prices rising for the next six months or so. Global supply from Indonesia and Malaysia is improving, while demand hasn’t picked up because of slow growth in India and China. At the same time, the leather industry is not doing well,” says Arora.
Moving in sync
Falling rubber prices have reflected in a rising operating margin
nother potential threat is rupee depreciation as most of its long-term debt is dollar denominated, in the form of external commercial borrowings used to fund the Bhuj plant. As of September 2014, the company had long-term borrowings of ₹1,338 crore. However, Balkrishna’s forex exposure is naturally hedged as it imports most of its raw material. Other risks include an increase in labour costs, which would take away Balkrishna’s key advantage of a low-cost manufacturing centre, and the slim possibility of duties imposed in the European Union.
However, muted global demand has taken its toll on Balkrishna’s top line in Q2FY15, which fell short of analyst expectations, leading to a sharp 26% re-rating of the stock from ₹838 to ₹618. In addition, competitors have started taking price cuts, an indicator that demand will remain sluggish in the next couple of quarters. Balkrishna reported a growth of 5% in its top line at #880 crore despite a higher than expected 12.5% volume growth. This was mainly led by a 6.7% year-on-year decline in net realisation.
Also, the management has lowered its volume guidance from 160,000 metric tonne to 155,000 metric tonne due to discouraging demand and price cuts by competitors. “The outlook in the mining sector isn’t very good. China and Europe are slowing down and the mining industry can’t pick up unless the overall economy picks up, given the extensive capital expenditure required. Hence, there are no new orders. Also, the replacement cycle is getting elongated since usage has come down. In my opinion, this situation will continue for the next six months or so if we look at mining and construction equipment as a lead indicator,” says Arora.
The six months estimated by Arora could also be the time the stock takes to stabilise from the current pounding. In spite of intermittent setbacks due to its exposure to the global economy, Balkrishna remains a good play with a competent management focused on a niche segment, unlike its global peers who are spreading themselves too thin. It is positioned to take advantage of the impending revival of the Indian industry and increase its share in the global market due to its huge cost advantage and understanding of OHT demand.