BALKIND - Balkrishna Industries (India)

[QLEAP]

Investment Thesis

 

Balkrishna Industries Ltd (BALKIND) is India’s leading manufacturer and exporter of Off-Highway Tires (OHT) with presence in 120 countries around the world. The OHT segment is predominantly a “wide product portfolio and low volume” business that is labor and capital intensive making it unattractive to major and small players alike.

 

BKT has thrived in this segment mainly due to the low labor costs, proximity to the “rubber” belt, large number of SKUs (1900) and good management. It has achieved an astounding growth of 26% annually, EBITDA margins averaging 22% and a return on equity nearing 27% during the past five year period. Yet in the same timeframe, BKT has increased its market share from 1.5% to a ‘whopping’ 3% worldwide.

 

The management has earmarked 1200 Crores (INR) to expand the production capacity by 75% in later half of 2013. This has doubled the debt to equity ratio but the prodigious cash flows from current operations should suffice to service the debt. The market has recognized the company’s heady growth that has seen the stock price rise from March 2009 lows of Rs 120 to Rs 800 in Nov 2010, yet there is plenty of room to run.

 

The management announced a five to one stock split in December and the stock trades at Rs 120 per share. BKT currently trades at 9.5 times five-year average earnings and 6.0 times FY10 earnings providing an opportunity for investors to buy a growing company at a less than fair price.

 

Disclosure: Long BALKIND

 

Detailed analysis available at http://www.scribd.com/doc/47369876/Balkrishna-Industries

 

Any feedback appreciated, thanks !

[shalab]

Which market does this trade in? Doesnt look like a north american investor can get into this?

 

[QLEAP]

Shalab,

 

Yes, this trades in the Indian Stock Exchanges (BSE and NSE). No ADR

 

 

[beerbaron]

Shalab,

 

Yes, this trades in the Indian Stock Exchanges (BSE and NSE). No ADR

 

 

 

Pink sheets?

 

 

[QLEAP]

Nope :)

[seshnath]

Qleap - looked at it.

 

Wondering why BKT is expanding mfg capacity.  According to 03/31/10 annual report, licensed/installed capacity is around 40 lakhs tyres while production currently is only about 19 lakhs.  Isn't better utilisation of production facilities the first choice in a scenario like this?  I don't get it.

[QLEAP]

Actually they have earmarked Rs 200 Crores in 2010-2011 to remove the bottlenecks to increase production from 120K to 130K mtpa (installed is 160K mtpa) in the existing plants - this increase should show up in 2011. This is apart from the new manufacturing plant to increase it to 220K mtpa.

 

They had covered the installed vs achievable capacity in one of their conference calls - the low volume, large product portfolio with mould changing restricts the optimal utilization vs installed capacity. This is different from the auto industry where I guess you just keep churning the same tyres..

 

Basudeb Banerjee: One is going by your annual reports historically, as per the installed capacity in terms of tyres, never had we seen a capacity utilization level beyond 55% in the last four years. Like for example, installed capacity being somewhere around 50 lakhs and production coming out around 19 lakhs, whereas the rubber in kg per tyre remaining in the same zone of around 35 kg. So where is the mismatch lying, the incremental CAPEX every year is coming from the cash accruals whereas the capacity utilization still remains at around 50%. So why is this thing happening?

 

Arvind Poddar: Yes, I do not know whether you have attended any of our con call. There is always an installed capacity based on a particular kind of product mix or production. Now the kind of tyres and number of SKUs what we are producing, our actual achievable capacity is around 75%. So what we are reporting in our Annual Report is our installed capacity based on a certain product mix, which gives 100%, but when you talk about achievable, that is why if you have gone through my current speech, that is I have mentioned about achievable, which is around 75%.

 

Basudeb Banerjee: But does that mean that the remaining 25% which is non-achievable, that’s absolute capacity?

 

Arvind Poddar: No, that’s not absolute. If I’m going to produce because our production model is that since we have about 1,800 to 1,900 SKUs and majority of them are live. So to produce all different, different SKUs, we have to change the mould very quickly. Like the other tyre industry, they change the mould maybe after 30 days to 45 days whereas we are changing our mould within two days to three days, which is our unique proposition to the market. So when you are changing so quickly and if you are producing a lot of varieties at a time, definitely your achievable will come down. In our case, it is about 75%. It’s not absolute.

[seshnath]

Thanks.  Makes sense.

[pilaniman]

most of the capacity expansion is being funded by debt. Too much investment in working capital. Not a good idea at current valuation levels IMHO!

[QLEAP]

Yes, the home loan rates in India have risen to 12% and the inflation is at a multi-year high. I really wonder where this is going to end up.

 

Re: BKT expansion, the debt has been financed using FCCB (foreign currency convertible bonds) at < 4% for 6.5 years.

 

 

thanks

Qleap

 

 

[shalab]

There are interesting similarities between India and China:

 

1. Both have capital controls - individuals can't convert their currency to dollars. Most companies can do the conversion though.

2. Both have pegged the currency against the dollar.

3. In India, a company can simply list; borrow dollars from the US at low rates and deposit it with the bank and earn the differential. It can't be done however because of the licensing/permitting problems.

4. Corruption is a problem in both places.

 

Differences:

 

1. China may be more open than India in some respects; e.g; starbucks/walmart can open shop there.

2. India is more open than China in many other areas especially concerning IP. ( e.g: software companies earn more from India than in China despite China being several times larger )

3. China has more central planning - can build cities or infrastructure without much problem, land is leased and not owned by private parties

4. India is run by oligarchs, where wealth is passed from one generation to the next with huge gaps between the very rich, rich and the poor

 

 

 

The policy of controlled economy has resulted in high inflation in India as wages are not fixed. In China, it seems most of the wages are fixed so it hasn't led to rampant inflation.

[Gopinath]

"I have heard that clothing, food and real estate in the big Indian cities cost more than big US cities. "

 

I'm in the same boat with you. I visited India(Chennai, Bangalore) last month..Prices of clothing, food and real estate are very expensive. I don't buy that 8-10% inflation in India.

 

Gopi

[seshnath]

There are interesting similarities between India and China:

 

1. Both have capital controls - individuals can't convert their currency to dollars. Most companies can do the conversion though.

2. Both have pegged the currency against the dollar.

3. In India, a company can simply list; borrow dollars from the US at low rates and deposit it with the bank and earn the differential. It can't be done however because of the licensing/permitting problems.

4. Corruption is a problem in both places.

 

Differences:

 

1. China may be more open than India in some respects; e.g; starbucks/walmart can open shop there.

2. India is more open than China in many other areas especially concerning IP. ( e.g: software companies earn more from India than in China despite China being several times larger )

3. China has more central planning - can build cities or infrastructure without much problem, land is leased and not owned by private parties

4. India is run by oligarchs, where wealth is passed from one generation to the next with huge gaps between the very rich, rich and the poor

 

 

 

The policy of controlled economy has resulted in high inflation in India as wages are not fixed. In China, it seems most of the wages are fixed so it hasn't led to rampant inflation.

Talking about India,

1. Capital Controls - limits are high to the point of being irrelevant.  Individuals can remit up to $200K per year.  If you have 200k in India in cash, you can live royally in most places (exclude metros).

http://www.rbi.org.in/scripts/BS_ViewBulletin.aspx?Id=10916

 

2. Currency peg - as far as i know there is no peg for the last 20 odd years.  RBI (the Central Bank) intervenes in the market through nationalised banks to correct demand-supply situations some times - I have come across such interventions fewer and fewer times in the past 5 years.  Rupee volatility is an evidence of it.

Section V of the following link talks about the policy:-

http://www.rbi.org.in/scripts/BS_ViewBulletin.aspx?Id=8555

 

3. You don't have to list to borrow dollars - I used to work for a private company which was an exporter - it used to borrow in USD all the time.  There are legal ways to do it.  I have come across companies which borrow in USD to invest locally - but rarely to just sit on a bank deposit of some kind.  Entrepreneurial mindset of the people prevents them from such carry trades, IMHO.

 

4. Corruption - agreed.  It was always there in India - I know with 99% confidence that my driving school paid to get my license in India.  The difference back then was that these stories never came out/were never prosecuted.  Now it is coming out in the open more often.  Presently discussions are on how to tackle this - one interesting suggestion is the following:-

http://blogs.wsj.com/indiarealtime/2011/03/30/kaushik-basu-says-make-bribe-giving-legal/?KEYWORDS=kaushik+basu

Another is the Lokpal bill - it brings ombudsman type official to just handle complaints on corruption.  There are also lot of other grass-root level organisations working towards similar goals.

 

Regarding starbucks/walmart - investment in retail is not permitted currently with foreign participation.  However, Walmart is already in India through some local chains - mostly advising on operations and such.

 

Regarding India being run by oligarchs - I just don't see it - a country of billion plus with trade unions and communist ideology being run by a handful of oligarchs - sounds absurd.    Wealth is passed from generation to another, true.  The gap between rich and poor is high, true.  That doesn't mean it is run by oligarchs. 

 

Problems/Challenges, IMHO:-

1. Caste system and its resultant status discrepancies - something like the financial status discrepancy between White-malesVs. African-American/Hispanic males in the US.  It is just a matter of time.  Also, unlike the US, religion/caste is part of the system.  Right from the school days, you have to have your caste/religion on your marklist/passport/ids.  You cannot fill a form without encountering this line.

2. Infrastructure/Planning - visit India, you can see what I mean everywhere.

3. Inflation - blame oil prices, for the most part.

 

 

[shalab]

Thanks for the info.

 

Currency peg/capital controls: - although freer than the Yuan, the peg has still been in place so it doesnt move radically one way or the other. For the record, even the Japanese central bank has been intervening in markets to shore up yen. For conversion to dollars, dont I need permission from some authority before I do anything?

 

 

Inflation:

It is not because of oil prices. The salaries in India for IT professionals has been growing at double digit rates pretty much every year with the exception of 2009 may be.

 

For India oligarchs, see this story in FT:

 

http://dollarsandsense.org/blog/2009/08/oligarchs-threat-to-indian-democracy.html

 

 

[shalab]

Sorry, the FT story is here:

 

http://www.ft.com/cms/s/2/3c5009ba-53f2-11e0-8bd7-00144feab49a.html

 

[Guest longinvestor]

 

...that does not mean Oligarchs are in control

 

 

Don't know if the correlation between Swiss bank accounts and Oligarchs in control are perfectly correlated but it surely reeks of it. I am hearing that something like 52% of the Swiss bank accts are Indian money. Even if I heard it wrong, there is an awful lot of Indian money in Swiss banks.

 

If the country was not in the hands of Oligarchs, sould'nt we expect a "bare it all" approach from the Indian govt, the socialists and the media? Enough money for over two decades of the country's budget, including infrastructure investments. Given the size of this problem, it is amazing it is not screaming headlines every day.

[QLEAP]

 

...that does not mean Oligarchs are in control

 

 

Don't know if the correlation between Swiss bank accounts and Oligarchs in control are perfectly correlated but it surely reeks of it. I am hearing that something like 52% of the Swiss bank accts are Indian money. Even if I heard it wrong, there is an awful lot of Indian money in Swiss banks.

 

If the country was not in the hands of Oligarchs, sould'nt we expect a "bare it all" approach from the Indian govt, the socialists and the media? Enough money for over two decades of the country's budget, including infrastructure investments. Given the size of this problem, it is amazing it is not screaming headlines every day.

 

Long, I think your argument is flawed. By your account, even USA is run by oligarchs ! India is making slow steps in unraveling the issue of black money and Swiss Bank accounts - I believe we will get there eventually albeit at a slow pace.

[turar]

Also, unlike the US, religion/caste is part of the system.  Right from the school days, you have to have your caste/religion on your marklist/passport/ids.  You cannot fill a form without encountering this line.

 

Wow, is this really true? Why can't they just take it off all the forms/passports/etc? What's the point of it?

[Guest longinvestor]

...that does not mean Oligarchs are in control

Long, I think your argument is flawed. By your account, even USA is run by oligarchs ! India is making slow steps in unraveling the issue of black money and Swiss Bank accounts - I believe we will get there eventually albeit at a slow pace.

Name the steps taken! Why "eventually albeit at a slow place"? I would stop all else and go after 28 years of budgetary outlays....won't happen because the Oligarchs are in control. Please keep the discussion focused on Indian Oligarchy to stay on topic.

THe FT article has it right, it is the Oligarchs spreading this pseudo-patriotic protectionism, keeping the capital flowing in freely. With multinationals, atleast some future taxes will flow into the state's coffers versus the Swiss banks. It is reported that entire sectors of the economy has paid no taxes ever.

[savant]

Also, unlike the US, religion/caste is part of the system.  Right from the school days, you have to have your caste/religion on your marklist/passport/ids.  You cannot fill a form without encountering this line.

 

Wow, is this really true? Why can't they just take it off all the forms/passports/etc? What's the point of it?

 

This is untrue. Passports don't have caste / religion. Don't think driving licenses or ID's have them either. Only place that do have them are marklists because if you fall under Scheduled Castes and Other-Backward Castes (SC / OBC) you get entitlements of getting into universities and colleges with lower grades ( i.e. affirmative action). As incentives often work, most people would love to be put under the SC / OBC bucket during admission time!

[finetrader]

What is the best way to play this carry trade( take US money and invest in India's bond) for an american citizen?

[savant]

 

3. You don't have to list to borrow dollars - I used to work for a private company which was an exporter - it used to borrow in USD all the time.  There are legal ways to do it.  I have come across companies which borrow in USD to invest locally - but rarely to just sit on a bank deposit of some kind.  Entrepreneurial mindset of the people prevents them from such carry trades, IMHO.

 

 

Sesnath - what was the longest maturity on this debt that this private company was able to borrow at? I'm guessing it really depends on your relationship with your bank but still curious to know how much $ denominated debt can be raised by a private indian co.

[QLEAP]

...that does not mean Oligarchs are in control

Long, I think your argument is flawed. By your account, even USA is run by oligarchs ! India is making slow steps in unraveling the issue of black money and Swiss Bank accounts - I believe we will get there eventually albeit at a slow pace.

Name the steps taken! Why "eventually albeit at a slow place"? I would stop all else and go after 28 years of budgetary outlays....won't happen because the Oligarchs are in control. Please keep the discussion focused on Indian Oligarchy to stay on topic.

THe FT article has it right, it is the Oligarchs spreading this pseudo-patriotic protectionism, keeping the capital flowing in freely. With multinationals, atleast some future taxes will flow into the state's coffers versus the Swiss banks. It is reported that entire sectors of the economy has paid no taxes ever.

 

Here's one - http://in.finance.yahoo.com/news/Black-money-India-Switzerland-ians-3312104591.html

 

 

[seshnath]

Thanks for the info.

 

Currency peg/capital controls: - although freer than the Yuan, the peg has still been in place so it doesnt move radically one way or the other. For the record, even the Japanese central bank has been intervening in markets to shore up yen. For conversion to dollars, dont I need permission from some authority before I do anything?

 

 

Inflation:

It is not because of oil prices. The salaries in India for IT professionals has been growing at double digit rates pretty much every year with the exception of 2009 may be.

 

For India oligarchs, see this story in FT:

 

http://dollarsandsense.org/blog/2009/08/oligarchs-threat-to-indian-democracy.html

 

 

 

Currency conversion - there is a general permission in place since, may be, a decade now.  No specific permission is required.  If you are converting Rupee (local earnings, for instance) to $, your wire request/draft request form at the bank takes care of the information required for the RBI.  I believe it is a form called A2 - generally specifies the purpose for which you are transferring money.  Your bank/money changer takes care of the formalities.  Generally speaking an individual (say, 95% of the Indians) doesn't need permission.

 

Inflation - Salary increases are only part of the story.  Indians are super-savers, traditionally and super-bargainers.  (check out an interesting stand-up comedy by Russell Peters on youtube.)  Point is increases don't necessarily translate to spending.  It has affected places like Bangalore - where auto rickshaws (yellow cab equivalent) don't even stop for older people.  They know they can get better fare plus a tip from young techies without much bargaining.  Real estate prices are a reflection of this increase as well.  Initial increases may have triggered this spiral, but later on oil prices have aggravated this.

 

Corruption by itself doesn't translate to oligarchy.  Oligarchy by definition means power with small number of people.  It just isn't practical in India - especially with decentralized government with allocated budgets to the grass-root level.  As an anecdote, I have seen it work with my parents' local rep.  I happened to be visiting them and just saw how it works.  The local reps when I was growing up never visited/cared between the term of their elections (5 years) about local needs.  Now, they come in, at least, a month - visit to check about local affairs - easier access to government services through them etc. etc.  It is a c-change.  This kind of decentralization is a good guard against oligarchy.  The case in my anecdote, to be fair, is probably the top quartile due to educated voters and such.

 

Regarding passports and caste, I guess I mis-spoke.  When I filled the form - back in the 90s, I had to fill in my religion-caste etc.  It has changed - it is not there in my wife's passport from 2008.

 

 

[seshnath]

Also, unlike the US, religion/caste is part of the system.  Right from the school days, you have to have your caste/religion on your marklist/passport/ids.  You cannot fill a form without encountering this line.

 

Wow, is this really true? Why can't they just take it off all the forms/passports/etc? What's the point of it?

 

There is caste based positive affirmation in India - it is included in the constitution.  If I remember correctly, there was meant to be a term-limit on it, but after caste became a vote bank, it just kept getting extended.  Sad truth is real, deserving don't necessarily get the benefit of it.

 

The affirmation takes a lot of modes - quotas for backward classes (there are subclasses in there - SC/ST/OBC etc. etc. ) for education, lower threshold in marks, concessional fees, job quotas etc - mostly in government/public sector jobs.  The perverse incentive is that the upper class end up in business and private sector jobs, earning good pay and the deserving get stuck in government jobs.