Tyre sector outlook improving; MRF underperforms: IIFL Capital Services

9 Nov 2022 , 12:00 PM

Ceat surprises positively with margin expansion

Q2 revenue grew 18% YoY (4% beat), with 7% volume growth and 10% improvement in ASP. Gross margin (GM) expanded 80 basis points sequentially to 32.5% (estimated at 32.0%), as price hikes offset cost pressure. EBITDA margin improved 110 basis points sequentially to 7.0% (70 basis points beat). Absolute EBITDA came in 16% above IIFL Capital Services’ expectations, primarily driven by margin surprise.

Management guided to steady revenue growth in upcoming quarters, driven mainly by OE segment, as replacement growth has moderated. Starting Q3FY23, management expects flow-through of fall in input costs (Crude, Rubber) and also some lag benefit of price hikes. Analysts at IIFL Capital Services expect Ceat’s margins to improve from current 7% to a normalized 10-11% range by Q4FY23.

MRF’s margin continues to disappoint

MRF’s Q2 revenue grew 18% YoY, and came in 4% above IIFL Capital Services’ expectations. GM contracted 180 basis points sequentially to 29.7% (280 basis points miss), as price hikes fell short of rise in input costs. EBITDA margin contracted 40 basis points sequentially to 8.2% (230 basis points miss), due to GM pressure and higher employee cost. Absolute EBITDA came in 19% below IIFL Capital Services’ estimate. High depreciation magnified PAT miss to 38%.

Here again, margins are likely to improve in coming quarters. However, the starting point for MRF is much lower than its normalized levels; hence, it would be an uphill task.

Revenue outlook steady

Going by the 4% top-line beat by both Ceat and MRF, the revenue outlook for the industry is steady. With a combination of volume growth and price hikes, analysts at IIFL Capital Services expect the industry to clock over 20% revenue growth in FY23. On the volume side, OE segment is very strong, but aftermarket and exports are soft.

Margin and earnings outlook very positive

The margin outlook for the industry is very positive, with input costs (Rubber, Crude) softening sequentially and the benefit of price hikes coming with a lag. Ceat management guided to 2.5-3.0% sequential fall in input cost basket in Q3; further moderation is expected in Q4. This comes after 8 quarters of sequential input cost pressure.

MRF’s under-performance is a structural positive for the industry

Analysts at IIFL Capital Services, in their recent sector report, had highlighted three structural positives for the sector, one of which was MRF’s underperformance. MRF has lagged the industry on growth in recent years. Its margin lead versus peers has come off substantially, as further reinforced in Q2 results. As a result, the pricing discipline in the industry has improved substantially (reflected in 30% ASP improvement in 2-3 years). MRF’s low margin also lowers risk of price cuts when input costs fall.

Valuation and Recommendation

Analysts at IIFL Capital Services have upgraded Ceat’s FY23/FY24/FY25 estimated EPS by 79%/16%/6% respectively, following these results. They have largely maintained MRF’s estimates.

Apollo Tyres is IIFL Capital Services’ top pick in this space, followed by Ceat.