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Replacement demand growth to be tepid in H2

CEAT’s Q2FY22 performance was below consensus expectations and profitability suffered (down ~79% YoY) mainly due to gross margin compression (down 975 bps YoY). CEAT has witnessed market share gains in PVs as growth momentum continues to be led by new PV order wins (e.g. Nissan Magnite, Renault Kiger, Mahindra Thar). Replacement demand has high base effect in H2FY22, thus growth is likely to remain <5%. RM basket for CEAT is likely to witness ~4% QoQ inflation in 3QFY22; however, Oct’21 has already witnessed ~2% price increase. Margins are likely to improve in H2FY22 as operating leverage and price hikes would likely act as tailwind. Maintain ADD.

Key takeaways from earnings call:

* Overall volumes in Q2FY22 were up 9% YoY/ 23% QoQ with replacement demand down 3% YoY/ up 23% QoQ while OEM volumes were up 17% YoY/ 35% QoQ. Exports were up 50% YoY/ 10% QoQ.

* CEAT has 8-9% market share in TBR and 15% in PVs (higher share in UVs). The PV market share is similar across both OEM and replacement segment.

* RM cost was up 6.5% QoQ due to higher crude prices and elevated freight costs and is likely to increase another 3-4% in Q3FY22. The company has undertaken ~4-5% price increase across segments (in Q1FY22) and has initiated another 2-3% hike in Oct’21 (2.5% in 2W, 1-2% in PV, 3% in farm segment). Post these hikes, CEAT would need another ~1-1.5% price hike to mitigate the current RM inflation.

* Consolidated debt was up by ~Rs2.2bn due to higher project capex of Rs1.5bn and is expected to rise another Rs2bn in H2FY22. Capex for FY22 is likely at Rs10bn in project capex and Rs1.5-1.75bn in maintenance capex. Management expects higher debt levels to continue due to capex spends.

* Company reported higher D&A expense due to reclassification of Right to Use asset aggregating Rs0.61bn and Rs205mn in one-time impact and additional Rs100mn in recurring impact. This does not have any impact on PBT as the expense item is adjusted against other expenses to D&A. D&A for FY23 is expected to be Rs1-2bn higher compared to FY22.

* Capacity utilisation for PVs was ~80-85% with Halol facility being fully utilised. Utilisation for TBB was lower while TBR is ramping up; 2W utilisation ~85% capacity.

* Profitability in 2W was hit due to lower price hike amidst weak demand. Demand for CV replacement segment has been low due to weak truck bias demand (high base effect).

* Marketing spend in Q2 was up 70% QoQ; further IPL spends will accrue in Q3FY22.

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