Balkrishna Industries: Demand worries in Europe to impact margins

The Balkrishna Industries stock slipped about 12 per cent, its worst single day fall in four years, owing to a muted September quarter performance and downward revision of the volume guidance by the management. Drought conditions in Europe and the currency volatility due to the ongoing trade war has led the company to give a revised volume guidance of 0.21-0.22 million tonnes (mt) for FY19. 

While this is 15 per cent higher than FY18, it is over a third lower than the 0.25-0.30 mt the company had guided for at the end of the June quarter. Ironically, the company had revised its guidance upwards at the end of June, and has had to revise it downwards now, given various headwinds. 

The biggest hurdle is the European business, which accounts for half of the overall volumes of the company. The firm indicated that drought conditions would impact the volumes in the December quarter, especially in the agricultural segment that accounts for about 30 per cent of the company’s volumes. 

The other worry is the trade war. This is impacting demand from other (non-agri) sectors given uncertain tariff structures and currency volatility in countries (that are in the midst of the trade tussle). The company, however, indicated that demand in other sectors could improve if the currency situation stabilises. 

The worry for the Street, given the lower volumes, is the impact on profitability. Margins for the quarter were down 430 basis points year-on-year to 27.7 per cent. Higher crude oil prices were expected to make synthetic rubber and other crude oil derivatives expensive. Synthetic and natural rubber account for 65 per cent of raw material costs. 

The rise in promotional expenses is also expected to weigh on profitability, which may worsen as the company may not be able to pass on the entire pricing pressure to customers. However despite the challenges, the company has stuck to its FY19 margin band of 28-30 per cent. 

Finally, a Rs 20 billion modernisation and expansion plan across locations is expected to weigh on returns ratios, especially till FY21, given the ramp-up and shifting of production from old to new plants. The near term, could thus be tough for Balkrishna on the volume growth, profitability, and expansion fronts.