AIA Engineering's Q3FY18 results (Outperformer) - Margins stabilize; Outlook remains robust

Q3FY18 result highlights

• Adj. PAT fell 20% yoy to Rs967mn: due to lower margins (-710bps yoy to 22.2%; high base). Reported PAT at Rs1.16bn (-3.5% yoy; tax write back).
• Revenue fell 3% yoy to Rs5.7bn: led by 10% volume decline (high base, delays in client conversion). Realizations +7% yoy /+9% qoq led by pass through of higher commodity prices and improved product mix.
• Margins stabilise at 22.2%: OPM fell 710bps 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 27% yoy to Rs1.26bn.

Conference call highlights: (1) FY18 volume guidance reduced from ~225-230kt to 220kt largely led by elongated sales cycle (2) Confident of incremental 40-50kt/ year mining volumes in from FY19 onwards with possible upsides led by deeper penetration; (3) Brazil anti-dumping cost is being borne by the client and is unlikely to have an impact on volumes; (4) Ferro chrome prices have stabilised, but scrap prices are moving up and likely to be passed on with a lag; (5) While mgmt. did not give a margin guidance, it believes volumes ramp up would drive positive operating leverage; (6) 9M18 capex at Rs850m; FY18 capex at ~Rs1.3bn; FY19E at Rs2bn (7) 100kt capacity expansion to 440kt  capacity delayed by 3 months (50k in 1QFY19, 50k in 1QFY20).

Key positives: Steady margins over the past 3-4 quarters

Key negatives: Volume miss

Impact on financials: ~3% cut in FY18/19/20 EPS to Rs38.7/48.5/62.7

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 14% volume CAGR over FY17-FY20). As expected, margins are normalising (420bps drop to 24% over FY17-FY19E; high base) as volumes ramp up and AIA adopts an entry pricing strategy. AIA trades at 30x/23x 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. Outperformer.