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Below est.; higher RM cost hurts margin; to expand TBR capacity

Cost inflation to keep margin under pressure over the next two quarters

* CEAT’s 4QFY21 performance was impacted by RM cost inflation and weaker mix. While cost inflation will impact near-term performance, strength in demand will enable gradual pass through of cost.

* We cut our FY22E/FY23E EPS by ~31%/6% to factor in near term impact from the second COVID wave and RM cost inflation. Maintain Buy.

Volumes stable, smaller price increase fails to offset cost pressures

* Revenue/EBITDA/PAT grew 46%/30%/116% YoY in 4QFY21 to INR22.9b/INR2.6b/INR1.53b. Revenue/EBITDA/PAT grew 12%/36%/100% YoY to INR76.1b/INR9.8b/INR4.6b in FY21.

* Volumes grew 45% YoY in 4QFY21 YoY (stable QoQ). On a QoQ basis, exports and OEM volumes grew in mid to high single-digits, while Replacement volumes fell 5-6% (as TBR and 2W volumes declined QoQ).

* Gross margin contracted 370bp YoY (360bp QoQ) to 42% (est. 44.4%) as RM cost per kg rose 12pp QoQ, partially offset by price hikes of ~3% in Dec’20.

* EBITDA margin contracted 130bp YoY (340bp QoQ) to ~11.4% (est. 14%). EBITDA grew 30% YoY to ~INR2.6b (est. ~INR3.2b).

* Adjusted PAT grew 116% YoY to INR1.53b (est. ~INR1.15b), benefitting from lower tax as it adopted the new corporate tax scheme – necessitating it to reassess current tax for FY20 and revalue deferred tax liabilities based on the lower tax rate. This resulted in a current tax credit of INR125.4m in 4QFY21.

* Gross debt declined by ~INR5b YoY to INR14.2b in FY21, aided by a sharp improvement in FCF generation (INR7.2b in FY21 v/s -INR1.6b in FY20).

* It has proposed a dividend of INR18/share (v/s INR12/share in FY20).

Highlights from the management commentary

* PCR and TBR demand are expected to be good, while the same for 2Ws could be challenging. The management remains optimistic on TBR OEM growth. Near term demand has been impacted by the second COVID wave. Overall mix for FY22 should be similar to FY20.

* The management is expecting a further 8-10% RM cost inflation in 1QFY22, whereas it has taken a 1-2% price hike till the end of Mar’21.

* Capex: The board has approved additional capex of INR12b to enhance TBR capacity in Chennai by 190tpd in two phases over the next four years. As a result, it would be incurring a capex of ~INR11.5b each in FY22 and FY23 for ongoing capacity addition in PCR, 2W, and OTR as well as new TBR capex.

Valuation and view

* The near term outlook for CEAT is challenging, given the demand weakness due to COVID-19 and sharp RM cost inflation. The latter will be gradually passed on over the next 2-3 quarters once demand returns when the pandemic ends. However, a cyclical recovery in both OEMs and Replacement will enable faster absorption of new capacities and usher operating leverage benefits.

* Valuations at 10.2x FY23E consolidated EPS captures in a ramp-up of new capacities in an improving demand environment, leading to a recovery in margin. We maintain our Buy rating with a TP of ~INR1,700 per share (~13x Mar’23E consolidated EPS).

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