SKF India Ltd Q3 FY2023 Concall Summary

Key Takeaways

• Profitable growth pivot is the core story: Management made a deliberate strategic shift in 2022 to prioritize profitable growth, pruning loss-making customers and pushing back on pricing in challenged segments like wind and railways.
• Gross margins hit life-highs of 40–41%: Price corrections taken throughout CY22, combined with a lag effect on traded product transfer prices, drove gross margins to record levels; management believes the level is sustainable.
• Industrial is structurally outpacing automotive: The mix has already shifted from 50:50 to roughly 50% industrial, 42% automotive, 8% exports, with industrial expected to keep gaining share toward a 60:40 split over time.
• Traded margin tailwind will fade: A portion of the margin uplift came from selling traded products at market prices above their older, lower transfer prices; as the group adjusts transfer prices prospectively, that uplift normalizes.
• What to watch next quarter: Whether the wind and railway profitability turnarounds show traction, the pace of traded margin normalization, and any demand recovery in two-wheelers by late calendar Q3.

The Profitable Growth Pivot

• Strategic shift in 2022: Management made a deliberate decision to drive profitable growth rather than pursue volume at any cost, a response to the inflationary environment and post-COVID supply chain disruption.
• Customer portfolio pruning: The company is reviewing each loss-making or non-profitable customer and negotiating better pricing; it will compromise growth rather than sign loss-making customers unless the relationship is very strategic.
• Cost measurement overhaul: The company moved from measuring performance based on standard costs to actual costs after COVID, supply chain disruption, and the Ukraine-Russia war; this fundamental change supports margin improvement.
• Cost reduction mandate: Management has a mandate to reduce costs every year; internally driving cost-savings projects and working with a consultant to identify areas to bring down manufacturing costs.
• Working capital release: Working capital improved from ~21% of sales in December 2021 to ~17%, releasing significant cash flow; around ₹200 crore of cash generated in the last year.

Saraf: "We will not sign up a customer unless it is very strategic. If it is a loss-making customer, we will probably not sign up with them. So we will be happy to compromise the growth if needed if not making money."

Margin Architecture: The Traded Product Effect

• Gross margin at life-highs: Gross margin reached 40–41%, partly due to price corrections taken throughout CY22 in response to significant cost pressure.
• The traded margin lag: Price increases taken in the market, combined with transfer prices set earlier at lower levels, resulted in higher realized margins on traded products; a two-month transit lag and the inability to retrospectively change transfer prices created a temporary uplift.
• Normalization ahead: If pricing stagnates, traded margins will stagnate and come down over time as the group adjusts transfer prices prospectively; no inventory loss is expected from this process.
• Offsetting tailwinds: Management believes the current gross margin level is sustainable; rationalization of the overall business portfolio will act as a tailwind that may offset some transfer pricing normalization.
• Margin range expectation: Management wants to be in the 17–20% range, though this is not formal guidance; some possibility of improvement exists but not a significant change, with quarterly blips possible.
• Cost pass-through dynamics: Overall, costs have been fairly passed on to customers; pass-through was much easier on the aftermarket side and relatively more difficult on the OE side, both industrial and automotive.

Saraf: "Now when you close the year, say, for example, I close the year, whatever has happened during the year has happened during the year, because these are imported products, I cannot go and change the pricing of the product at which I imported."

Segment-Level Profitability Challenges

Wind

• The problem is pricing, not demand: Wind has grown in 2022, but the market itself is slowing down and has not been paying good pricing; SKF has been doing business at a loss and is now focusing on driving profitable growth, not just growth.
• Turnaround underway: Most orders executed in 2022 came in 2021, so they could not be cancelled even though they were loss-making; incrementally, new orders are being taken only at positive margin.
• Hard line on pricing: The company is pushing back on customers for better pricing and will not sell at a loss, even if it means walking away from large orders.

Saraf: "We don't want to sell at a loss. That's where the focus on wind is not really on growth, but on making sure that we do profitable business."

Railways

• Structural margin pressure: Railways is a tender business governed by L1 (lowest bidder) decision-making, creating profitability challenges; price quoted is effective for the entire tender duration of 6–12 months, so input cost increases cannot be passed on during execution.
• Mostly traded product: From SKF India's perspective, railways is mostly a traded product manufactured out of the unlisted entity; only sales margins are booked, and a marketing margin is assured under transfer pricing norms even if selling at a loss.
• Internal cost projects: The company has internal projects to drive costs and is focused on turning railways around to improve margins; will pursue railway business only if it is profitable.

Saraf: "It's always L1, which is the lowest bidder. So it's all governed by that. So that is where we see challenges on profitability and that is where we are kind of having a lot of projects internally to drive costs."

Industrial vs Automotive: The Mix Shift

• Industrial growing faster: Industrial and automotive both grew at similar rates of 24–25% for nine months, but industrial is expected to grow at a faster pace going forward; the mix has already shifted from 50:50 to roughly 50% industrial, 42% automotive, 8% exports.
• Long-term target: Globally the mix is 70% industrial vs 30% automotive; India's industrial share is expected to continue increasing and may become 60:40 over time.
• Industrial growth drivers: The long-term India growth story is infrastructure-led; focus sectors are heavy industry, construction, and drives (pumps, motors, fluid power, textiles); railways, wind, distribution, and metals were big growers in the last nine months.
• Automotive aftermarket penetration: Market penetration improved from ~50% to 65–70% in terms of district presence, with distributors now in ~500 out of ~733 districts; the Udaan automated replenishment model is driving higher growth in areas where deployed.
• Two-wheeler softness: Two-wheeler is growing at a relatively lower pace due to export challenges from the global geopolitical situation and low domestic demand from petrol prices; it is only ~10% of total business, so impact is not significant.
• Passenger and commercial vehicles: Seeing strong growth, which should offset two-wheeler softness and drive growth in the OE space.

Localization and the Unlisted Entity

• Localization ambition: Focus is to increase localization from 58% toward 70–80%, though not 100%; some will be localized in SKF India, some in the unlisted entity SKF Engineering.
• Split by bearing size: SKF India (listed entity) handles smaller size bearings for automotive and small industrial applications; medium and large-size bearings (SRBs, TRBs, spherical) are being localized in the unlisted entity's Ahmedabad factory, which has different technical capability, steel grade, and supply chain requirements.
• Unlisted entity capex: Expectation of around ₹250 crore of investment in the unlisted entity over two to three years; a credit line of ₹250 crore at 9% interest was approved by shareholders last quarter, to be drawn only as and when capex investments happen.
• Listed entity capex: Expected somewhere between ₹100 crore to ₹150 crore; may not see a significant spike because its investments are predominantly for smaller size bearings.
• Unlisted entity profitability: The Ahmedabad factory is operating at relatively low utilization, impacting overall profitability; investments were originally made for wind and railway segments, which are not very profitable businesses.
• No merger on the table: As of now, management is not looking at merging the listed and unlisted entities.
• Traded share reduction: The 60% traded share will reduce over time due to localization, though not dramatically because medium and large size bearings will continue to be manufactured in the sister company.

Saraf: "For me to give you a number, it's very difficult because it's a journey, right, that we have started. It's not that I have given the entire and I have a clear roadmap of what all investments will make. It is a continuous evaluation process for small, small investments that we are going to make over a period of time to cater to the Indian market."

Competitive Positioning and Pricing

• Premium positioning intact: SKF always sells at a premium and accepts pricing differentiation; customers may buy local bearings for non-critical applications but prefer SKF for critical applications.
• First mover on price increases: SKF was first mover in taking price increases; now competition (Schaeffler, Timken) is following in, facing similar cost pressure; no demand pressure felt from price increases taken.
• Counterfeit challenge: Counterfeit and spurious bearings remain a challenge; customers have paid premiums for counterfeit bearings thinking they were genuine SKF; the company's focus is on creating strong penetration and reach rather than directly stopping counterfeits.
• Automotive aftermarket pricing pressure: Temporary pricing pressure observed, attributed to a larger competitor dumping high volumes into the aftermarket because they are not getting share in OEM; management views this as a temporary phenomenon.
• EV content per vehicle: The number of bearings required in an electric vehicle comes down, but from a cost or pricing perspective, that goes up; overall value proposition remains very similar.

Saraf: "One of the things that we always see with our customers that they might be okay buying a local bearing, but when it comes to critical applications, they always prefer SKF against competition."

Guidance & Commitments

Key Metrics