Growth momentum continues to be led by organic growth in CV and PV segments coupled with new PV order wins (e.g. Nissan Magnite, Renault Kiger, Mahindra Thar).
CEAT’s Q2FY22 performance was below consensus expectations and profitability suffered (down ~79% YoY) mainly due to gross margin compression (down 975 bps YoY). Growth momentum continues to be led by organic growth in CV and PV segments coupled with new PV order wins (e.g. Nissan Magnite, Renault Kiger, Mahindra Thar). Outlook for H2FY22 remains mixed due to worries on potential demand slowdown caused by OEM production cuts on account of chip shortages.
However, margins are likely to improve in H2 as price hikes are more amenable while inputs costs have softened a bit (Bangkok rubber prices down ~23% since Q1FY22). On balance sheet side, consolidated debt rose to ~₹20bn (FY21:~ ₹14.2bn). CEAT’s capex intensity is likely to peak in FY22; we expect FCF generation to improve in FY23E (~₹2bn/~4% FCF yield). Maintain ADD.
Key highlights of the quarter: Revenue rose ~24% YoY to ~₹24bn led by faster growth in OEM segment (revenue share rose 200bps YoY in H1FY21). Gross margin declined 975bps YoY at 36.9% due to higher raw materials costs. EBITDA margin fall was curtailed to 8.9% (down 589bps YoY) due to lower employee costs (down 110bps YoY) and lower other expenses by 276bps due to tighter cost control and potentially lower ad spends. Adjusted PAT was down ~79% YoY to ₹363mn on account of higher fixed-cost absorption (D&A) expense (up ~44% YoY).
Focus on industry leading growth: Management continues to focus on achieving above industry growth, led by a) higher share in high growth compact SUV segment in PVs driven by the new Halol capacity; b) new product innovations (i.e. SecuraDrive) are likely to drive market share gains in existing OEMs (e.g. Hero Motocorp, Mahindra); and c) strong capex push for FY22E-23E is likely to be ~₹18-19bn (FY21: ₹6.4bn); expansion of high volume TBR capacity would be the key driver for market share gains in CV segment.
Maintain ADD: We like CEAT’s plan to drive growth via market share gains (product innovations, new customer additions) while focusing on margins; however, sustained capex intensity and lower industry pricing power are likely to curtail FCF generation and increase leverage (FY23E: ~₹22bn). RoCE improvement is unlikely to surpass 15% in FY24E, thus curtailing potential valuation expansion. We cut our earnings for FY22E/ FY23E by ~34/11%, respectively due to steep increase in below EBITDA fixed costs (e.g. depreciation expenses). The stock has modest FCF yield (~4%) on FY23E basis. We introduce FY24 and rollover to Sep’23E and we cut target multiple for India business to 13x FY23E EPS (earlier: 14x) of ₹112. We maintain our ADD rating with a revised target price of ₹1,480 (earlier: ₹1,487).