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Margins to gradually start recovering; Capex intensity to reduce

We recently attended the CEAT Investor Day where the management highlighted that the demand environment continues to remain steady. OEM segment remains buoyant led by improving chip supplies. Replacement segment, holding on well, has witnessed some weakness in the rural segment as owing to certain regions getting deficit rainfall. Over the last 5 years, CEAT has gained 2W replacement market share by c.200bps led by superior brand positioning. During the same period, its PV replacement market share expanded by c.500bps to 13% led by expansive product offering and improving brand perception. In the medium term, consumer segments (2W & PV tyres in domestic market) and OHV segment (international market) will be the key focus area. The company intends to nearly double the OHV capacity over next 12 months as it expands its presence in Europe. Overall capex intensity is expected to be limited. And, with INR 5-6bn incremental capex, peak revenue potential is expected to be INR130bn (+40% over FY22). Given the recent correction in NR and crude prices and back-to-back price increases, we expect gradual recovery in EBITDA margin to sustainable 10-12%. We introduce FY25 estimates and ascribe a 14x PE multiple to arrive at Sept’23 TP of INR 1,600. Inability to take price hikes, weakness in replacement sales and reversal in recent RM cost correction are key risks.

* Domestic demand steady, Focus on exports: Demand in the OEM segment remains strong led by improvement in chip supplies. However, in the replacement segment, rural demand has been affected by deficit rainfall in the states of Bihar, Jharkhand and West Bengal. Overall demand has remained steady over last 3-4 months. Recent business wins have been for premium sized PV tyres led by improving product quality and brand perception. CEAT recently added OEMs like Skoda, VW, Ola Electric, John Deere etc. as its customers. In the European market, the company expects headwind in the near-term as the customer may hold back spending due to recessionary fears. However, Indian tyre makers are benefiting from China+1 narrative in both EU and US markets. CEAT’s exports in FY22 grew by 71+% as the company is focusing on making deeper in-roads in EU (PV and OHV segment) market. CEAT is also preparing to enter US tyre market over next 8-10 months. Basis the success of other Indian brands, strong positive perception about Indian OHV tyres will aid the company in expanding in European OHV tyre segment.

* RM cost peaking out; margin expansion likely ahead: RM cost is expected to increase further by 2-3% QoQ in 2QFY23. The company has taken a price hike of adequate quantum to mitigate the impact. Owing to the recent correction in the natural rubber and crude oil prices and the price increases in 2Q, we expect margin to witness gradual recovery in 2HFY23 to sustainable level of 10-12%.

* Capex intensity to decline; focus on ROEs: Total capex for FY23 is expected to be INR9bn. Post the completion of OHV tyres related capex (OHV capacity to double to c.240TPD), no new capex is planned. Post de-bottlenecking related capex of INR5-6bn, peak revenue potential is expected to be INR130bn (+40% over FY22 revenue) at full utilization level. The company targets ROCE of 12-15% on sustainable basis over medium term.

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