Demand recovery, market share gains are critical; rising net debt/equity and low RoCEs make valuation dear; ‘Reduce’ maintained.
We met Ceat’s (CEAT IN, Reduce) management as a part of RPG Group’s annual investor conference. Based on our discussions, we feel that company is confident of its products and will continue to ramp up strongly in the passenger car radial (PCR) and truck and bus radial (TBR) segments. However, near-term demand remains challenging and market share gains in the highly competitive TBR/PCR replacement segment will be important to achieve our 10% volume CAGR over FY19-21F.
Also, while management targets to achieve sustainable Ebitda margins of 10-11% over the medium term, we expect near term to remain subdued on adverse product mix (higher TBR share); thus, we factor in flat Ebitda margins at 9.2% in FY20F. The company believes some capex from the Rs 13-15 bn planned in FY20F could be postponed if demand remains weak; we have partly factored this into our estimates (Rs 13/8 bn in FY20-21F).
Overall, we maintain that Ceat is expanding significantly in highly competitive segments over the next few years, which coupled with slowing demand and high capex spend, could impact earnings growth (only 6% CAGR over FY19-21F) and RoEs (10% over FY20-21F). The stock is currently trading at 7.1x FY21F EV-Ebitda which is expensive given low RoCEs and rising net debt/equity. We prefer Apollo Tyres (APTY IN, Buy) in the sector.
Demand recovery, market share gains critical for growth
Management acknowledged the weak (flat to marginal growth) replacement demand across segments in the near term and expects recovery from Sep-19. This is in line with our view of mid-teen volume growth in 2HFY20F led by original equipment (OE) recovery, TBR ramp-up and new PCR capacity coming on-stream.
TBR: With new capacities ramping up from Feb-19, we expect sharp 50% jump in volumes for this segment in FY20F. Management believes this will be largely driven by market share gains (4-5% currently) in the replacement segment as OE push is difficult in TBR. We note that a large part of FY20F growth for Ceat is led by TBR ramp-up. Execution by Ceat remains critical and would be watched closely.
PCR: A new plant will come onstream from 2HFY20F. The company remains confident of the offtake as it has got good visibility from OEs. However, higher OE share will impact margins in the near term in our view.
2W: The company’s market share remains stable in motorcycles and has increased in scooters.
Subdued margins in near term, operating leverage medium term catalyst
While the company does not plan to take price cuts to gain market share, execution will be important to maintain healthy utilisation levels. Management expects to achieve 10-11% Ebitda margins over the medium term, largely led by operating leverage benefit. It does not expect any cut-back on advertisement spend even if demand remains weak in the near term.
Commodity outlook remains stable and management does not see necessity to raise prices in the near term. In the off-highway tyre segment, utilisation levels are only at 50% now and the company expects to achieve full utilisation/positive Ebitda by Q4FY20F.