SKF India Ltd Q3 FY2025 Concall Summary

Key Takeaways

• Volume-led 15% revenue growth, but margins fell sharply: Revenue grew 15% YoY driven entirely by volume, while gross margin contracted ~4.5% YoY as traded product margins rationalized from double-digit to mid-single digits.
• Industrial segment surged 23%, automotive mixed: Industrial growth was broad-based across distribution, heavy, metals, renewables and general machinery; within automotive, 2-wheelers and passenger vehicles did well but commercial vehicles lagged.
• Demerger of auto and industrial is the defining strategic move: Management believes separation will create additional value for two fundamentally different businesses, with carve-out financials already submitted to SEBI.
• Margins have likely bottomed, recovery expected: Operating margins dropped to ~13-14% this year vs a 16-17% historical average, but management sees an uptick in the last two quarters and expects normalization back to the 14-15% range.
• What to watch next quarter: Whether the margin uptick continues into Q4, clarity on the plant separation plan for the demerger, and any announcements on new localization initiatives.

Demerger: Auto-Industrial Separation

• Rationale is structural, not financial: The two businesses have fundamentally different customers, manufacturing processes, and innovation needs; management has been operating them fairly independently and believes separation will unlock additional value.
• Carve-out financials show similar margins: Based on historical analysis submitted to SEBI, post-separation margins are very similar for both companies, reflecting different localization mixes: automotive is 95% localized while industrial is only 40% localized.
• Tractor and electricals reclassified: Post-separation, the tractor business currently reported under automotive will move to industrial, aligning with SKF's global classification where agriculture and electricals sit within industrial.
• Plant separation still under evaluation: Management is assessing multiple options, including transferring manufacturing assets to individual companies or having one company manufacture for the other; a decision is expected in the next couple of months.
• SKF Technology stays separate: The unlisted entity will continue to serve both listed entities independently post-demerger; no merger is under consideration.
• Trading arrangement unchanged: All sales of industrial bearings from SKF Ahmedabad and SKF Imports will continue to flow through the listed entity; no change is planned.

Mukund Vasudevan: "These are 2 fundamentally different businesses. We have been operating them fairly independently, but we believe by separating them into 2 separate companies, it will create additional value for everyone."

Margin Dynamics: The Traded Product Drag

• The core problem: Gross margin contracted ~4.5% YoY because traded product margins rationalized from double-digit levels in FY22-23 and FY23-24 to mid-single digits this year, while end-market pricing remained constant and no price increases were taken in FY25.
• The FEMA mechanism: In prior years, price increases from customers generated higher traded margins; under FEMA regulations, excess margins cannot be returned to foreign suppliers via debit or credit notes, so the company retained them. In FY25, margins are now in line with transfer pricing regulations.
• Further rationalization ahead: Management expects additional traded product cost rationalization as the company moves into Q4, with margins settling in line with transfer pricing practices, not close to double-digit.
• Localization as the structural fix: Long-term margin improvement is tied to localizing more industrial products; industrial currently has only 40% localization vs 95% in automotive, creating a clear runway as more products are made in India.
• Wind portfolio turned profitable: After continuous customer pruning, wind margins have become positive at mid to high-single digit, contributing 4-5% of full-year revenue.

Ashish Saraf: "If the margins are lower than the mid-single digits, then we would do a catch-up. But if the margins are higher, under the FEMA Regulations, we cannot go and recover that by issuing a debit note to a supplier."

Demand Environment & Segment Performance

• Industrial: broad-based strength, infrastructure-led: All industrial segments performed well including distribution, heavy, metals, and renewables; general machinery came back strongly. The 23% industrial growth was largely volume-driven, with ~19% from strong volume growth YoY.
• Automotive: two-wheelers and PVs lead, CVs lag: Market share gains were reported in 2-wheelers with key customers like Bajaj and Honda, plus the vehicle aftermarket and industrial distribution channels. Commercial vehicles did not perform as well.
• Capex cycle supports emerging industries: Metals (steel, aluminum) and infrastructure/cement capex is still ongoing; emerging industries like high-speed railways, wind, and EVs offer higher realizations and higher-margin products. Electronics manufacturing in India is still small but expected to emerge.
• Industrial outlook remains strong near-term: Driven primarily by infrastructure spending for the coming quarter; the longer-term picture is less clear due to changing economic conditions and global geopolitics.
• Market share gains underway: The company is onboarding new industrial part sellers and engaging new authorized industrial distributors, gaining share in distribution and aftermarket channels.

Margin Recovery Path

• Bottom likely reached: Management indicated margins have likely troughed, with an uptick visible in the last two quarters and a further uptick expected next quarter. Operating margins have dropped to ~13-14% in the current year vs a 16-17% average since 2018.
• Normalization target: 14-15%: Management expects margins to normalize back to this range, driven by traded product cost rationalization in the near term and localization gains over the long term.
• Portfolio rationalization is continuous: Where the company makes losses on a product, it either modifies it to be competitive, creates a unique value proposition, or prunes it; loss-making business is not tolerated.
• Capex steady at ₹120-130 cr: The company will continue investing in this range as communicated earlier, with no change to the plan.

Mukund Vasudevan: "We would hope so, right? I think you would continue as Ashish had also mentioned, we will see — even in the next quarter, you will see hopefully an uptick as it has come — even the last 2 quarters, you would have seen an uptick itself. So you'll continue to see that. We expect this to kind of normalize back to the 14% to 15% range."

Localization & Product Strategy

• Industrial localization is the margin lever: With industrial at only 40% localization vs 95% for automotive, management sees a clear path to margin normalization as more industrial products are manufactured in India.
• Korea plant capacity transfer in progress: Machinery transfer from Korea to India is still underway and will take a couple of quarters to start production, adding to local manufacturing capability.
• Product line expansion to accelerate post-separation: The demerger gives each entity the opportunity to innovate more and add products specific to the industries they serve.
• Emerging industries offer higher realizations: As electronics manufacturing emerges in India, the company expects to capture that opportunity with high-margin products.
• Services business moves to industrial: The services business, which is predominantly industrial, will transfer to the industrial entity post-demerger.

Mukund Vasudevan: "In India because of traded products being higher in industrial, it's a bit lower. But long term, as we localize more, we expect that to normalize."

Guidance & Commitments

Key Metrics