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Margins recovery to continue

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

CEAT 3QFY23 results were better than estimates as consol gross margins expansion of 200bp QoQ at 34.5% (est 33%) surprised positively. This was led by ~4% decline in blended RM basket QoQ and price hikes. On S/A basis while volumes declined ~6.5% QoQ, ASPs grew 0.5% QoQ. YoY basis large volume growth was led by OEMs while exports/replacement have been weak QoQ. We believe, with stability in key RM prices (such as NR and crude) and aggressive price hikes (management hinted at up to ~1?1.5% 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 and expect Rs5?5.5b of project capex in FY24E. However, we believe it would need capex even in FY24 as utilization of current TBR/PCR (75?80% 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 60?62% over FY24?25E, which would reflect positively on margins. Our FY24/25 consol EPS are largely unchanged. We maintain ‘BUY’ on the stock with revised TP at Rs1,917 based on ~15x Sep?24 EPS. Current valuation of 14x/11.4x FY24/FY25 consol EPS (v/s 10yr LPA of 16x) is attractive.

Result Highlights ? Above Est led by better than expected gross margins

* Consol revenues grew 13% YoY (?5.8% QoQ) at Rs27.3b largely led by combination of price hikes and volume growth. However volumes declined ~6.5% QoQ. 

* Consol gross margins expanded to 34.5% (+200bp QoQ/ +60bp YoY, est 33%) leading to ~17% QoQ EBITDA growth at Rs2.4b (est Rs2b) with margins at 8.7% (+170bp QoQ/ +310bp YoY, est 7.2%). Gross margins expansion was led by ~4% decline in blended RM basket.  

* Led by better operating performance, Consol Adj.PAT came in higher at Rs343m (est Rs318m). However, share from JV declined sharply to loss of Rs62m (v/s Rs6.4m in 2QFY23 and Rs60.8m in 1QFY23), led by change in corporate tax rate in Sri Lanka JV to 30% (v/s 18%) due to prevailing economic conditions.

* Gross consol debt increased to Rs23.4b (v/s Rs22.5b in 1HFY23) and 9MFY23 capex at Rs6.8b (v/s Rs4.5b in 1HFY23).

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