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Margins recovery to continue

View and Valuation – Price hikes and ease in RM to drive margins  

CEAT 2QFY23 results were better than estimates as consol gross margins expansion of 80bp QoQ at 32.5% (est 31%) surprised positively. This was led by ~4% price hikes entirely covering RM inflation of ~4% QoQ in 2QFY23. On S/A basis while volumes remained flat QoQ, ASPs grew 3% QoQ. YoY basis large volume growth was led by OEMs (+20% YoY) while exports/replacement have been flattish while QoQ volume was flattish. We believe, with stability in key RM prices (such as NR and crude) and aggressive price hikes (management hinted at up to ~12% blended price hike likely in Nov v/s 4% in 2Q) to help margins expansion QoQ. Going forward, focus on high margin segments such as exports and OHT over TBR (being a low ROCE biz) to aid volumes and margins. CEAT has maintained the capex guidance of ~Rs9b for FY23E (similar to FY22 and 1HFY23 spends of Rs4.5b). However, we believe it would need capex even in FY24 as utilization of current TBR/PCR (7580% currently) would reach optimum level by end of FY23.  

Cyclical recovery in both OEMs and replacement will enable faster absorption of new capacities and drive operating leverage. This, coupled with gradual pass through of cost inflation, will drive margin recovery in 2HFY23E/FY24E. Further, with current capex plan, contribution from focus areas could scale up to 6062% over FY2425E, which would reflect positively on margins. We have raised FY23/24 EPS by ~18/8% to factor in for better gross margins and price hikes. We maintain ‘BUY’ on the stock with revised TP at Rs1,898 based on ~15x June24 EPS. Current valuation of 11.4x FY24 consol EPS (v/s 10yr LPA of 16x) is attractive.    

Result Highlights  Above Est led by better than expected gross margins

* Consol revenues grew 18% YoY (+2.4% QoQ) at Rs28.9b largely led by price hikes where volumes remained flattish QoQ.  

* Consol Gross margins expanded to 32.5% (+80bp QoQ/  440bp YoY, est 31%) leading to ~23% QoQ EBITDA growth at Rs2b (est Rs1.5b) with margins at 7% (+110bp QoQ/ 200bp YoY, est 5.4%). Gross margins expansion was led by ~4% price hikes offsetting RM inflation of ~4% in 2QFY23.  

* CEAT reported exceptional charge of Rs237m due to the exchange loss towards dividend and other receivables from subs/JV in Sri Lanka on devaluation in SL currency. Consequently, consol Adj.PAT came in higher at Rs240m (est Rs10m). However, profits from JV declined sharply to Rs6.4m (v/s Rs60.8m in 1QFY23 and Rs51.9m in 2QFY22).

* Gross consol debt increased to Rs22.5b in 1HFY23 (v/s Rs20.6b in FY22) and 1HFY23 capex at Rs4.5b.

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