LKP Securities has reiterated a "BUY" recommendation on AIA Engineering (AIAE) with a 12-month target price of Rs 4,455, indicating a potential upside of 16% from the current market price of Rs 3,853. Despite a notable decline in volumes and revenue due to slower client activity in the mining sector and increased freight costs, LKP remains optimistic about AIAE’s medium to long-term prospects. AIAE is actively pursuing significant contracts that could offset recent volume declines, backed by its continued investment in capacity expansion and strategic growth in overseas markets.

Q2FY25 Financial Highlights

Revenue Decline and Volume Impact:
AIAE’s Q2FY25 consolidated revenue fell by 19% YoY to Rs 10.4 billion, impacted by a 22% decline in total volumes, which reached 60,330 MT. Mining volumes saw a significant 23% YoY drop to 39,896 MT, while non-mining volumes fell 20% YoY to 20,434 MT. This slowdown is attributed to inventory de-stocking by large clients, systemic challenges in mining, and increased shipping costs.

Margins and Profitability:
While gross margins improved by 110 bps to 58.9% YoY, EBITDA margins declined by 310 bps, landing at 26.4%. This margin contraction was due to the impact of reduced volumes and rising operational costs. As a result, profit after tax decreased by 21% YoY to Rs 2.6 billion, falling short of market expectations.

Outlook for FY25 and Growth Prospects

Volume Decline Anticipated:
AIAE projects a full-year volume reduction of 25,000-30,000 MT for FY25 due to continued challenges within the mining sector. This shortfall has led LKP Securities to adjust its EPS estimates for FY25 and FY26 downward.

New Contract Opportunities:
Despite the near-term headwinds, AIAE is actively pursuing multiple large contracts across its operational regions, particularly in North and Latin America. These contracts, if secured, could significantly boost AIAE’s volumes, helping to mitigate the current decline and drive growth in the coming quarters.

Overseas Plant Expansion:
AIAE's board is evaluating the feasibility of setting up a new overseas facility to further support its international growth. The expansion is under active consideration and could enhance AIAE’s capacity to meet demand in key markets abroad.

Capital Expenditure and Strategic Investments

Capex Commitment:
The company’s FY25 capital expenditure plan remains on track with an allocation of Rs 2.5 billion. This includes a brownfield capacity expansion of 36,000 MT, expected to bolster production capabilities and support future growth.

Technological Edge in High Chrome Media:
AIAE’s expertise in high chrome grinding media, particularly for the mining sector, remains a strategic advantage. With only a 20% market penetration in high chrome grinding media, AIAE sees substantial untapped potential for growth. The company’s ongoing R&D efforts aim to increase market share in this high-margin segment.

Valuation and Investment Recommendation

Target Price and Valuation Metrics:
LKP’s target price of Rs 4,455 is derived from a forward valuation, reflecting a 16% upside. Key valuation ratios include:

P/E Ratio: Estimated at 32.6x for FY25, with an anticipated drop to 28.5x in FY26.
EV/EBITDA: Projected at 26.6x for FY25 and 23.2x for FY26.
Dividend Yield: Expected to remain steady at 0.4% for FY25 and FY26.
Revenue and Earnings Projections:

FY25E: Revenue of Rs 46.1 billion with EBITDA margins of 27.4%.
FY26E: Revenue projected to increase to Rs 50.7 billion, with EBITDA margin improving to 28%.

Key Risks and Challenges

Currency and Forex Exposure:
Approximately 73% of AIAE’s revenue comes from exports. A significant appreciation of the rupee could compress margins due to forex fluctuations. Any adverse currency movements would require close monitoring as AIAE has limited natural hedges in place.

Commodity Price Volatility:
Though AIAE has mechanisms to pass on raw material and freight cost increases, there is typically a lag of 3-6 months. Rapid changes in commodity prices could compress margins until AIAE adjusts pricing accordingly.

Protectionist Policies and Duties:
Trade protectionist policies, including anti-dumping duties in key markets like Canada, Brazil, and South Africa, have previously impacted AIAE’s volumes. Potential duties on imports from India, as petitioned by AIAE’s competitor Magotteaux to the U.S. Department of Commerce, could disrupt future sales volumes if imposed.

Strategic Initiatives and Market Positioning

Shift from Forged to High Chrome Grinding Media:
AIAE is progressively converting clients from forged to high chrome grinding media, a shift that offers efficiency benefits in mining operations. However, supply chain delays and shipping costs have slowed this transition, impacting AIAE’s competitive positioning in some markets.

Focus on Latin American and North American Markets:
AIAE continues to expand its footprint in North and Latin America, regions with substantial growth potential in mining. Recent contract acquisitions in Canada and exploratory projects in Latin America highlight AIAE’s commitment to strengthening its market presence in these high-growth areas.

Potential for New Mines and Six-Digit Opportunities:
The company’s expansion strategy includes targeting high-value mines, with six-digit metric ton potential, that could significantly drive long-term revenue growth. AIAE is positioned to benefit from these conversion opportunities as the global demand for mining resources recovers.