The stock of off-highway tyre maker Balkrishna Industries has gained 77% in the past three months, outperforming the 45% return of the S&P BSE Auto index. While investors have rewarded the company for its resilient volume growth in challenging times, its current valuation looks stretched. In addition, given the slower expected volume growth for the current fiscal and dwindling demand from its overseas industrial clients, the upside for the stock looks to be limited.

Mumbai headquartered Balakrishna caters to the agriculture, and industrial sectors including mining. The company’s volume grew by 5% in the March 2020 quarter thanks to a steady replacement demand from the overseas market. The demand for the agricultural tyres in the US and the European markets was able to offset lacklustre volumes from the industrial sectors.

The demand for agricultural tyres, which form two-third of the total volume, grew by 8% year-on-year to 37,678 tonnes in the March quarter. On the other hand, the tyre volume from the industrial and mining operations fell by 2.7%. The company’s volume grew by 9% annually between FY10 and FY20 to 2,01,760 tonnes. But, the pace is likely to slow down.

The demand from the industrial segment will be most affected due to slower ramping in mining activities and lower capital expenditure by global companies. The company expects FY21 volume trend to be similar to the previous year when the volume dropped by 4.5%. In addition, the revenue trajectory of global peers such as Trelleborg Wheel and Titan International has not been encouraging. The deceleration in volume from the historical average and a hazy demand visibility may impact the company’s stock valuation.

On the flip side, a backward integration to produce carbon black, a key raw material, may support operating margin to some extent. Analysts expect a margin of 30% for the current and the next fiscal compared with 28.5% in the previous fiscal.

Balkrishna has so far enjoyed a steep premium valuation over the conventional tyre makers due to superior margins and a higher market share led by a strong labour arbitrage. At Tuesday’s closing price of Rs 1,242, the stock was traded at 25 times one-year forward earnings. This was at a 45% premium to its five-year average, according to Bloomberg. The extent of the premium valuation may compress due to slow volume growth and muted global demand.

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