AIA Engineering's Q1FY20 results (Outperformer) - Volume miss

Q1FY20 result highlights

• Adj. PAT grew +34% yoy to Rs1.4bn: on higher margins, strong other income (+91% yoy on Rs137mn forex gains) and lower tax rate. 
• Volume muted: Revenue growth was sluggish at 2.5% yoy to Rs8.33bn led by 1% yoy decline in volumes to 63,618 tons (mining +2% yoy). Volumes were muted as its iron ore client in Brazil saw zero volumes in the quarter due to its mine shut down (typically 15k/ year). However, realizations improved 4% yoy to Rs112/kg led by improved product mix.
• Margins expanded 125bps yoy to 23%: led by improved revenue mix and higher realisations. Hence, EBITDA grew +8.4% yoy to Rs1.68bn.

50ktpa capacity commissioned: AIAE has commenced the 2^nd phase of its greenfield project at GIDC Kerala with an annual capacity of 50ktpa. This increases total annual capacity from 340,000 MT to 390,000 MT.

First trial of mill lining complete: AIAE (in collaboration with EEMS, US) has successfully completed its 1^st trial of Mill Liners at a gold mine in Africa which opens up several opportunities in the primary grinding in mines worldwide. AIA has developed this improved solution and design of mill internals in combination with patented energy efficient pulp lifter system to improve throughput (higher by ~20%) and energy efficiency of SAG mills. We believe this is a critical step towards faster penetration into the mining segment (~300k tons mkt) and improves customer stickiness.

Conf call highlights: (1) AIAE cut its volume guidance by 15,000 tons (~290k tons) due to challenges faced by its client in Brazil (2) RM prices have corrected in Jun/jul-19 and should remain stable driving better margins (3) Working capital has expanded on increased inventories to reach more clients (4) Capacity expansion: 50k grinding media and 50k mining liner by Dec-20; FY20 capex of Rs2.5bn (Rs350m in 1Q20)

Impact on financials: FY20/21E EPS cut by 4/2% to Rs60/71

Valuation and view

While the cut in Brazil’s volumes impacts near term volumes, we believe this is likely to be transient in nature and see an uptick once the clients’ mines restart over the next 12-18 months. On the other hand, AIA’s success of its trial run with EEMS collaboration is likely to strengthen its competitive strength and drive faster conversion & customer stickiness driving market share gains. Accordingly, we estimate 14% earnings CAGR over FY19-FY21E on sustained volume growth. We believe valuations are attractive at 23x FY21E earnings considering the long term structural growth drivers (likely upside on volumes, margins). Outperformer.