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Operating de-leverage impacts performance

Price increases to pass on cost inflation happening gradually

* MRF’s 1QFY22 operating performance was impacted by operating deleverage and RM cost inflation. The industry is taking gradual price increases to dilute the impact of severe cost inflation.

* We cut our FY22E/FY23E EPS by ~11%/3%, factoring in the RM cost inflation. Maintain Neutral.

Revenue decline in-line v/s peers; price hike dilutes cost impact

* Revenue/EBITDA/PAT declined 13%/35%/49% QoQ to INR41.3b/INR4.9b/INR1.6b.

* 1QFY22 revenue was down 13% QoQ (+70% YoY) to INR41.3b. The decline was largely in line with peers [CEAT: 17% QoQ and APTY (S/A): 11% QoQ].

* The decline in gross margin was restricted to 60bps QoQ (205bps YoY) at 37.9%. The decline of just 60bps QoQ is largely on account of a sharp change in finished goods inventory. The gross margin decline was higher in peers (CEAT: -310bps QoQ and Apollo S/A: -440bps QoQ) due to 10–12% commodity cost inflation during the quarter.

* EBITDA was down 35% QoQ (+47% YoY) to INR4.9b. The EBITDA margin declined 390bps QoQ (180bps YoY) to 11.8%. This margin decline was better than that in APTY (S/A) (-500bps QoQ / -40bps YoY), but worse than that in CEAT (-270bps QoQ / -40bps YoY).

* High other income and lower interest cost restricted PAT decline to 49% QoQ (+846% YoY) at INR1.6b.

Valuation and view

* Cyclical recovery in both OEMs and replacement would enable the faster absorption of new capacities (Gujarat plant) and drive the benefit of operating leverage.

* The industry pricing environment seems to be stable, with all players taking price increases to pass on the substantial cost inflation. While there is likely to be a transitory impact of the cost inflation in 2QFY22, we expect margins to begin recovering from 2HFY22 (assuming stable commodity prices).

* MRF’s competitive positioning within the sectors has weakened over the past few years, further reflected in the dilution of pricing power in the PCR and TBR segments. This, coupled with the impact of capex over the last three years, has resulted in substantial dilution in its superior return ratios.

* Current valuations at 27.2x/20.7x FY22E/FY23E EPS fairly capture the changing competitive dynamics for MRF. We maintain a Neutral rating, valuing it at 20x Sep’23E EPS (v/s 21.5x/14.5x its five-/10-year average P/E) to arrive at our TP of INR83,730.

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