AIA Engineering's Q2FY18 results (Outperformer) - Lackluster quarter; Outlook remains robust

Q2FY18 result highlights

• PAT declined 23% yoy to Rs865mn: due to lower margins (-1000bps yoy to 20.1%) and other income (-19% yoy, lower yields, forex gain).
• Revenue growth muted at 5.6% yoy to Rs5.6bn: led by 5% growth in volumes (on 7% yoy growth in mining volumes). Realizations were flat yoy as higher commodity prices were not passed through as part of AIA’s entry pricing strategy to add new customers.
• Margins normalising – 20.1%: OPM fell 1000bps yoy due to sharp rise in RM costs on higher ferro chrome prices (+5-10% yoy), which is typically passed on with a lag of 3-6months. Margins are normalising as prior year saw favourable currency and RM price benefits. Also, AIA is adopting an aggressive pricing strategy to gain market share. Hence, EBITDA fell 29.5%yoy to Rs1.1bn.

Conference call highlights: (1) FY18 volume guidance at ~225-230kt (2) Incremental volumes growth in mining of 40-50kt each year FY19 onwards, primarily led by deeper penetration; (3) Won a long term order in mining segment from Barrick group for 18000 tons per annum, with likely more such long term volume contracts (4) Share of primary grinding media stands at >50% (5) Capex in H1FY18 at Rs610mn; FY18 capex estimated at ~Rs1.85bn (6) 100kt capacity expansion on track for total capacity of 440kt (50k in FY18, 50k in FY19)

Key positives: Significant long term order win

Key negatives: Margin contraction

Impact on financials: 11.3%/10.5% cut in FY18/19 EPS to Rs39.7/50.1

Valuation and view

AIA has seen market-share gains in 3m-tonne grinding media business in mining with its ‘total solutions’ approach. We expect the trend of market share gains to continue led by AIA’s value proposition and cost efficient offerings (we estimate 15% volume CAGR over FY17-FY19). As expected, margins are normalising (580bps drop to 22.5% over FY17-FY19E; high base) as volumes ramp up and AIA adopts an entry pricing strategy. AIA trades at 29x/22x FY19E/FY20E earnings. While near term earnings are weak, we believe the long term structural growth drivers are in place on continued penetration into mining (likely upside on volumes from foray into primary segment), oligopolistic nature of the industry and superior return ratios. Outperformer.