Nitin Agrawal Moneycontrol Research
Highlights: - Tyre companies posted a subdued set of Q3 earnings - Raw material price continue to be a big concern, falling crude oil prices to aid margin - Domestic automobile industry outlook is sluggish in the near term, positive for the long term - Prefer Apollo Tyres and CEAT --------------------------------------------------
Tyre companies posted a disappointing set of Q3 FY19 earnings. Subdued topline growth and rising raw material prices marred operating profitability of companies in this space. Concerns over demand from original equipment manufacturers (OEMs) and margin pressure kept sentiment subdued for tyre companies. This soft patch, however, is expected to provide an appropriate opportunity to accumulate fundamentally strong businesses for the long-term.
Raw material prices – respite to come from crude oil prices Natural rubber and crude derivatives constitute a major portion of the raw material basket for tyre companies. Natural rubber prices have been flat at Rs 125 per kg as compared to average price of Rs 126/kg recorded in Q3 FY19. What could act as a big respite for tyre companies is a significant fall in the crude oil prices, leading to reduction in crude derivatives used in tyre manufacturing. The impact of this is expected to be felt in the operating profitability of tyre companies in Q4 FY19.
End-market demand outlook – sluggish in the near term; long-term positive Multiple macroeconomic challenges such as liquidity crunch, compulsory long-term third-party insurance, new axle load norms and tepid economic activity ahead of general elections have dampened demand for passenger vehicles (PVs), two-wheelers (2W) and commercial vehicle (CV) segments. Market conditions are expected to remain sluggish in the near term, but the long-term outlook for all segments continues to remain positive on the back of robust economic growth, rising income levels, lower penetration, government’s thrust on increasing rural income and focus towards infrastructure and construction.
CEAT: Muted volume growth & operating cost weigh on profitability CEAT posted an 8.9 percent year-on-year (YoY) growth in net revenue from operations, driven by price hike taken by the management to pass on RM price increases. Volume growth stood at two percent due to tapering demand from original equipment manufacturers (OEM) and replacement market. Exports declined significantly as well.
In terms of operating profitability, earnings before interest, tax, depreciation and amortisation (EBITDA) witnessed a significant decline of 23.7 percent (YoY) on the back of significant increase in operating expenses (higher advertising expenses) and inventory build-up. This led to significant (356 bps) YoY contraction in EBITDA margin.
Though there is pressure in terms of demand outlook, the company is expected to grow on the back of its focus towards increasing market share in PVs, 2W and three-wheeler segments and expanding capacity in select pockets.
MRF – witnesses challenges The company posted subdued (6.2 percent) growth in net revenue in Q3. Growth was much lower than its peers, indicating loss of market share for the company due to under penetration in truck bus radial (TBR) tyres and increase in competitive intensity in the 2W segment.
EBITDA margin continues to remain under pressure owing to significant rise in RM prices and negative operating leverage. Its EBITDA margin witnessed a contraction of 483 bps.
Apollo Tyres – strong volume growth Apollo Tyres posted a 16.5 percent YoY growth in net sales on the back of performance across regions. Asia Pacific, Middle East, Africa (APMEA) grew 17 percent and Europe 16 percent driven by strong volume and rich product mix.
With around 60 percent contribution from replacement market in domestic sales, Apollo Tyres has been the least impacted from the slowdown accruing from original equipment manufacturers (OEMs). The company witnesses a volume growth of 11 percent in the domestic market.
EBITDA margin contracted 108 bps YoY, although it showed a 20 bps expansion on quarter-on-quarter (QoQ) basis. EBITDA margin was marred by significant rise in RM prices, which was partially offset by reduction in operating expenses.
The management maintained its capital expenditure guidance at Rs 6,500 crore over the next three years. On the capacity expansion front, it is on track to ramp-up capacity at its Chennai plant to 12,000 tyres per day (TPD) from 10,000 TPD at present.
New plant construction in Andhra Pradesh for CVs and PVs has also started, which is expected to be online in Q4 FY20. Hungary plant’s capacity is expected to touch 16,000 TPD by FY19-end. Moreover, the plant is expected to be ramped up to 12,000 TPD by FY20-end and would act as another leg of volume growth for the company.
Valuations: Apollo and CEAT are at reasonable levels Amid market volatility, sluggish industry demand outlook and significant rise in RM prices, the share price of tyre companies have fallen significantly from their 52-week high (MRF: 29 percent, Apollo Tyres: 28 percent and CEAT: 32 percent).
We avoid MRF as the company has been continuously losing market share to its peers and under-penetration in the TBR segment. We advise long-term investors to accumulate Apollo Tyres and CEAT ahead of expected margin expansion in the upcoming quarter.
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Disclaimer: Moneycontrol Research analysts do not hold positions in the companies discussed here
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