CEAT posted a strong growth in net revenue and operating profitability. Its margin also improved on the back of falling RM prices. The company is poised to gain from an increase in market share in passenger vehicle (PV) segment and capacity expansion in selected pockets.
Tyre companies have posted a healthy set of earnings for the first quarter of FY19, if the numbers from CEAT are any indication. Low base of last year due to Goods & Services Tax rollout, falling raw material (RM) prices and strong demand accruing from automobile manufacturers have all been supportive.
The company posted strong growth in net revenue and profitability. Margin too improved on the back of falling RM prices. The company is poised to gain from increase in market share in the passenger vehicle (PV) segment and capacity expansion in selected pockets.Quarterly at a glance
In terms of quarterly result, CEAT posted a 17 percent year-on-year (YoY) growth in Q1 revenue, led by volume growth of 18.5 percent. The latter came in from both original equipment manufacturers (OEM) and export demand, the volumes of which grew over 20 percent. Realisation, however, witnessed a YoY decline of 1.5 percent on the back of an unfavourable mix.
Earnings before interest, tax, depreciation and amortisation (EBITDA) witnessed an increase of 209.7 percent on the back of a fall in RM prices and other expenses. This also led to an expansion of 659 bps in EBITDA margin.Factors to watch out for
Raw material price trend
Tyre companies have, historically, been unable to pass on the full rise in the raw material (RM) prices to customers, leading to huge margin pressures. Though prices have come off from their highs, the management has guided to a 2-3 percent sequential increase in RM prices, which would put pressure on EBITDA margin. It has undertaken a 1.5-2 percent price hikes in Q1 FY19 across all segments to pass on the rise in RM prices.Impact of a change in axle norms
In light of the change in axle norms, the management said this would temper short term tyre demand from commercial vehicle (CV) segment, with demand shifting to bigger tyres. Manufacturing of those tyres would take around 3-6 months due to changes required in existing moulds.Management focusing on select areas; lower dependence on trucks
CEAT has identified growth areas. It includes two-wheeler, PV and over-the-road (truck/off-road) tyres to be its focus area as these have the ability to boost margin and reduce its dependence on the truck segment. In light of this, the management has been scaling up operations in these areas.Capex to drive growth
It has earmarked Rs 4,000 crore as capex over FY17-21 to increase capacity by 50 percent. This would be done across segments to attain strategic product mix and improve revenue contribution from focus areas. The management said this huge capex is expected to be funded through internal accruals and debt. For the current fiscal, it has guided to a capital expenditure of Rs 1,500-1,700 crore.ValuationsThe recent correction in the midcap space has led to the stock correcting 35 percent from its 52-week high, which has led to a significant drop in valuations. CEAT is currently trading at 15.7 times and 12.3 times FY19 and FY20 projected earnings, respectively, considering the likely increase in interest expense and depreciation owing to its big capex plans.
We take comfort from the management’s strategy. Valuation are also reasonable. We advise investors to buy this business for the long-term.
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