We had expected a moderation in AIA Engineering’s gross margins in Q4FY19 due to more new volumes, but the fall was much more. We had previously highlighted that the 65% gross margin in Q3FY19 was not sustainable as volumes from new customers (which we estimate had discounted prices) were lower. The drop in gross margins to 57% was significantly higher than our expectation of 62%. However, the management highlighted that the cause was due to a mix effect (presumably higher discounted volumes of 7-8 kilo tonne (kt) and currency impacts flowing in from previous quarters.
The management highlighted that Ebitda margins are probably near their bottoms, but finished goods inventory stood at 64 days vs 57 days at FY18 end. Thus, we expect excess inventory likely to be from newer discounted volumes to be sold off in Q1 where gross margins may improve slightly from Q4 levels. With normalised inventory levels, we expect gross margins to improve from Q2FY20F.
AIAE recorded volumes of 80 kt in 4Q (+21% y-o-y), led primarily by mining (+34% y-o-y), which was 9 kt ahead of our estimate of 71 kt. This highlights that the story of mining-driven volume growth remains intact. AIAE was `12.27 billion net cash at the end of FY19. This highlights that incurring further `5.8-6.0 billion (of which `2.5 billion on mill liners, `2.75 billion on grinding media capacity and `0.5-0.75 billion in land and others) in capex over the next two years will not face any funding constraints. The management expects overall volumes of 300-305 kt or 35-40 kt of volume growth in FY20. This volume growth will be driven by mining.
Product mix may change in a positive direction with rise in share of mill liners whose Ebitda margins are higher. Realisations on mill liners can range from `150-300 a kg while that
of grinding media can range around `110-115 a kg, according to management. However, the impact is likely to be limited in FY20 as the 50-kt mill liner capacity gets operational only in FY21F. The management guides for `5.8-6.0 billion in capex over FY20/21F driven by `2.5 billion for 50 kt mill liner capacity, `2.75 billion for 50 kt grinding media capacity and `0.50-0.75 billion for land and others.