Private Equity and Edtech - what do they have in common and why they need to be built for anti-scale?
by Naveen February 7, 2023
At Itus, we look out for businesses with cash flow growth and ability to generate return on incremental capital while ensuring that we don’t overpay to own the business. These principles are at core of Itus philosophy of picking businesses. Today, in this article, we will cover one such business which passes through our filters, named “Balkrishna Industries” and its evolution over the period. In this article we discuss about:
Let’s dive right in.
Focus is the very essence of success. Nobody has ever achieved greatness without focus. The same applies in the field of business too. Michael Porter, widely regarded as the father of modern strategy and management thinking famously put out “generic strategies”. These include “Cost Leadership”, “Differentiation” (creating uniquely desirable products and services) and “Focus” (offering a specialized service in a niche market). Balkrishna industries is as fully focused off-the-highway tyre manufacturer which differentiates itself through its cost leadership amongst its peers.
When Balkrishna industries was established in 1987, it started pre-dominantly as a two-wheeler tyre manufacturer which was supplying tyres to Bajaj Auto. In 1992, they had setup a plant to manufacture tyres for light commercial vehicles. But there was a problem. The tyre industry is a very commoditized business characterized by low margins and with very little or no pricing power. While the Poddar family owned the business, it was run by Mahansaria’s. So, at the turn of the century, Yogesh Mahansaria took control of the small tyre business setup in Aurangabad. Since there was huge competition in the domestic tyre market, Mahansaria started exploring the possibility of exporting the tyres from India. But, since two wheelers were not largely used in foreign countries and build of commercial vehicle tyres were different abroad, he could not find a suitable market. However, while exploring his options, Mahansaria realised that there was a demand for off-the-highway tyres abroad and no major player from India was focused on this segment. For the uninitiated, “off-the-highway segment consists of Agriculture, Industrial, Construction, Earthmoving, Mining, Port, Lawn and Garden and All-Terrain Vehicle (ATVs) Tires. Hence, Balkrishna Industries decided to cater this segment. But this was not a creamy ride. The company had to build relationships with OEM’s and setup a robust distribution network and business model in foreign territory. Since this a long gestation business, it took them about seven years to establish themselves in this niche segment. Between 1997 to 2002, their revenues from off-the-highway segment grew from roughly zero to about 50 odd crores. But the company saw that its cash and profits were burning up in the domestic business of two-wheeler and light commercial vehicles.
Now, we see how the power of focus plays out and transforms the fortunes of this company. In 2002, the company decided to close down its domestic two-wheeler and light commercial vehicle tyre business and become a fully focused player on off-the-highway segment in the export market. This turned out to be a stroke of genius. By focusing fully on the niche segment, the company’s topline between 2002 to 2007 grew by about 12x (from around 50crores dollars to roughly 600 crores) in the span of five years. And then in 2006 when it seemed like the humble tyre company was just about to take off, Yogesh Mahansaria, a man who had virtually transformed the company from being a loss-making entity to a 600crs global brand was abruptly asked to leave. The debateable move nonetheless ushered in a new era and it’s now on a quest to establish itself as the most dominant player in the sector globally.
Balkrishna industries has a worldwide distribution network ensuring extensive reach and penetration. The Company sells its tires in 160+ countries through its distribution network in the Americas, Europe, India & ROW. As of FY22, it receives 53.9% of its sales from Europe, followed by India (17.6%), America (17.3%) & the Rest of the World (13%). The company caters to both the OEM and replacement markets. As of FY22, replacement channel accounts for the majority of sales at 69%, followed by OEMs (28%) & the rest 3% of sales are contributed by other channels. The company’s client base includes OEMslike New Holland,John Deere, AGCO, CLASS, JCB, CAT, Sakai, Goldoni, TEREX, Turk Traktor, etc.
Since it gathers majority of its revenue by catering to the replacement market, it’s important to note that the average replacement cycle of agriculture tires is around 4-6 months, around 1-2 years for industrial tires and around 1.5-2.5 years for mining tires. So, what it effectively means is it’s an annuity and continuity business, which helps keep the revenue growth (last 5yr CAGR of 17.30%) and cashflows (last 5yr CAGR of OCF- 9.8%) steady and improving.
So, one may wonder how did Balkrishna grow and compete with established international tyre manufacturers in this segment, back in 2004, the giants of the tyre manufacturing industry Michelin, Trelleborg, Titan and Continental, dominated the competition catering to over half of the market. However, with the introduction of Asian manufacturers, they slowly began to cede market share and are currently down close to about 25-30%. Balkrishna Industries, on the other hand, continues to grow. From 3% in 2011 to 7% in 2021, they’ve consistently managed to add to their total market share by following a cost-effective model. When Balkrishna Industries started manufacturing Off-Highway tires, they had two distinct advantages — access to cheap labour and a growing talent pool. Their competition meanwhile is dealing with cost overruns and an expensive workforce. The below table highlights the same and shows the vast difference in the employee costs of the major players internationally compared against Balkrishna and how this provided them with a competitive edge.
So, when the company started selling tyres at a significant discount to most available alternatives, they found a niche market that they could tend to. This segment is highly technical, capital and labour intensive and known as “large varieties low volume segment” where any credible player needs to maintain large number of Stock Keeping Units (SKUs) to meet the diverse requirement of its customers worldwide. This meant it was not easy for any new manufacturer to enter the space. Also, interestingly Chinese players have largely stayed away from this segment. Reason being China is master of mass production but since this segment requires large SKU’s and customization, it was not really their forte which helped the cause of Balkrishna. As of 2022, the company has over 2800 SKU’s to serve the diverse requirements of its clients. Over the last decade, the company has not just shown growth in the topline but its volumes have gone up from 1,11,544 MTPA in 2010 to 2,88,975 MTPA in 2022.
While, the tire industry may seem cyclical and heavily dependent on the automobile sector and economic outlook, it’s interesting to note that the company has been able to its EBITDA margins above 24% over the last seven years (where we have observed periods of slump in mining activities, famine and floods in agriculture across Europe). The global peers, on the other hand in the segment have an average EBITDA margin around 13-15%. When we break down the unit economics of the company, we can observe that the company has been able to grow its EBITDA and sales despite fluctuations in raw material costs, which highlights the company may have little pricing power too.
Around 2017-18, the company was facing difficulty for sourcing carbon black, a key raw material used in the production of tyres. So, in 2018 the company setup a capex for backward integrating on the carbon black front. Company initially setup a capacity for 60,000 MTPA which they revised to 1,40,000 MTPA the following year. This capex helped the company source the key raw material for captive consumption and made them immune from the external raw material fluctuations and gives them better cost control measures and competitive edge which will help in growing the operational profit. Also, about 25% of black carbon produced is currently sold in open market after internal requirement. These can have margins up to 4-5% from the current 2-2.5% being sold. The company only put up capex for adding capacities and production of radial tyres, which we will discuss shortly.
The Company is continuously marching ahead to explore incremental opportunity in the form of developing “Ultra Large Earthmovers & Mining Radial Tires” markets and also taking advantage of the shift from Bias to Radial Tires, which is growing continuously. In order to take advantage of this opportunity, the Company had set up an Ultra Large size all-steel OTR Radial tire plant and have further added such capacities by setting up a Brown field tire plant at Bhuj to produce Ultra large size all steel OTR Radial Tires besides other categories of tires. In the Indian OTR sector, radialisation of tires is still in a nascent stage. Radial tires are better absorbers of heat compared to bias tyres, these tyres are generally larger in size and requires high technical capabilities to manufacture it. However, with the mining segment picking up and severe operational conditions in underground minds, radialisation can pick up significantly. We believe the Company’s move to produce “Ultra Large Earthmovers & Mining Radial Tires” to take advantage of the shift from Bias to Radial Tires, puts them in forefront of domestic peers. These radial tires generally have higher margins of around 33-35% compared to 22-25% in bias tires, which will further boost the profitability of the company.
The company is an asset heavy business with low asset turns, as one needs to constantly add capacities in order to grow and cater the demand. The 0.72x asset turnover as FY22 may not give a true picture, as the company has setup new capacities which are not yet fully utilised. Since 2011, their PAT margin which stood at 9.1% grew to 20.4% by 2021. The company’s debt/equity ratio stood at 0.36x as of FY22 with an interest coverage ratio of 213 times. The company’s topline has grown from 2,132crs in FY11 to Rs.8,295crs in FY22, implying a CAGR of 13% during the period. Volumes meanwhile during the same period has grown at 9.03% CAGR. The return on capital employed of the company over the last decade and throughout different cycles has largely been above the cost of capital and highlights the promoters ability to invest in the core business.
As Nassim Nicolas Taleb famously says, “Antifragility is beyond resilience or robustness. The resilient resists shocks and stays the same; the antifragile gets better.” During the last decade, despite several droughts in European region or fairly undermined mining industry, this company continued to show resilience and growth. The depressing business environment aided Balkrishna’s cause as opposed to choking its growth. As agriculture output and food prices began to decline, farmers started scouting for economical replacement tyres and found considerable value in the company’s product offering. Balkrishna Industries today is great example of how companies with humble beginnings with power of focus can establish themselves as the major player in the industry. In near term, the company may face headwinds from higher input and freight cost and a weak EUR:INR, but we believe BIL’s outperformance in the Specialty Tyre industry to continue, driven by expansion of its product portfolio, strong demand from agriculture in export markets and ramp-up in the OTR segment, with scope to strengthen its competitive positioning.
Itus Capital is a SEBI registered Portfolio Manager. The information provided in the News letter / blog does not constitute any investment advice and is for internal consumption and general information purposes only. The views expressed at or through this content are those of the individual authors of Itus Capital. The contents and information in this document may include inaccuracies or typographical errors and all liability with respect to actions taken or not taken based on the contents of this Newsletter are hereby expressly disclaimed.
No reader, user, or browser of this Newsletter / blog should act or refrain from acting on the basis of information contained in this Newsletter/blog without first seeking independent advice in that regard. Use of, and access to, this website or any of the links or resources contained within the site do not create a portfolio manager-client relationship between the reader, user, or browser and the authors, contributors or Itus Capital.