An automobile tyre passes final checking at a plant. (Photographer: Akos Stiller/Bloomberg)

Balkrishna Industries’ Unexpected Capex Plans Spook Street

Shares of Balkrishna Industries Ltd. fell the most in three months after the off-road tyremaker announced a surprise capital expenditure plan of Rs 1,700 crore.

The board of India’s second-largest tyre company by market value, at its meeting on Sept. 1, approved a capex plan of $100 million (about Rs 700 crore) to set up a new plant in the U.S., according to its exchange filing. It will also spend up to Rs 1,000 crore on its India operations. The entire capital outlay, funded by a mix of debt and internal accruals, will be completed in 30 months, the filing said. This, according to the board, is in addition to the current capex underway at the carbon black plant.

“Balkrishna Industries has been going overboard with capex, starting with plans to set up a carbon black plant at Bhuj,” Joseph George, analyst at IIFL, said in a note. “The company recently increased its planned capacity beyond captive needs to enable sales to third parties.” The tyremaker, George said, would need to start a brownfield expansion at Bhuj in FY21. “Thus, free cash flow for the firm would be low or negative for the next three to four years.”

The company has negligible long-term debt. It has a short-term debt of close to Rs 870 crore and a debt-to-equity ratio of 0.2 times, which is expected to increase after the capex.

“We find the decision to set up capacity in the U.S. a little surprising as India’s low labour cost lends Balkrishna Industries its main competitive edge over global peers, leading to the company’s higher profitability and return ratios,” Nishit Jalan, analyst at Kotak Institutional Equities, wrote in a note.

Also read: Here’s Why Balkrishna Industries Sees Tough Road Ahead

Here are the details of the capex plan in India and the U.S.

U.S. Capex

The company’s board approved setting up of a new plant with a capacity of 20,000 metric tonnes per annum. The capital outlay of $100 million will be funded through investments by its parent and local debt, according to the exchange filing. The current sales volume is around 30,000 metric tonnes in the Americas and the management expects it to grow over the next few years, the release said.

“While the currently announced capacity in the U.S. is relatively small, if Balkrishna Industries adopts the strategy of setting up more capacity overseas to gain market share, then its return ratios could come down significantly leading to a de-rating of the stock,” Jalan said.

Capex For Waluj

A new plant, including a co-generation unit and in-house warehousing facilities for raw materials and finished goods, will be set up with a capex of Rs 500 crore, the release said. This unit will be set up within the 5-kilometre radius of the current location where production takes place. The existing plant will continue to operate till the new plant becomes operational. There would be no change in the capacity, the release said.

Capex For Bhuj

Looking at the overall demand for higher-diameter segment, the board approved a capex of up to Rs 500 crore to set up a new line of 5,000 metric tonnes per annum for layers of all steel radial off-the-road tyres and additional mixing line in Bhuj.

Brokerage firm IIFL downgraded Balkrishna Industries to ‘Reduce’ after the capex plan and cut its target to Rs 1,160 from Rs 1,400 apiece. It also lowered the earnings-per-share estimates for the financial years 2019-21 by 3-11 percent, saying the capex will lower the return on capital employed and the free cash flow.

Setting up a plant in the U.S., according to IIFL, is not consistent with the business model of low-cost production in India. Returns on this investment will be low, it said, adding incremental returns from the Rs 1000-crore capex in India remains unclear.

Shares of the company fell as much as 7.4 percent intra-day to Rs 1,259.65 apiece.