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Margins resilient due to healthy replacement mix

CEAT’s Q3FY21 performance was a beat on consensus expectations. EBIDTA margin came in at 14.7% (close to 19 qtr. high of 14.8%). Margin improvement was likely driven by: i) higher growth in replacement segment vis-à-vis OEM, and ii) high capacity utilisations across radial/bias segments. On balance sheet side, consolidated debt was lowered by ~Rs251mn QoQ to ~Rs15.6bn (FY20: ~19.3bn), debt/equity ratio has reduced to 0.49x (Q2FY21:0.59x). Demand outlook for FY22 remains positive due to a combination of improving OEM production and strong replacement aided by import restrictions; however, profitability is likely to remain in check due to rising input costs (e.g. natural rubber ~up ~19% QoQ). Current valuations remain inexpensive as stock trades at ~7% FCF yield on FY22E basis; however, commodity prices remain a key risk to estimates. We maintain BUY. Conference call on Jan 20, Wednesday, at 16:00 hours IST. Number: +91 22 62801224.

* Key highlights of the quarter: Revenue grew ~26% YoY to ~Rs22bn due to improvement in replacement sales in Q3 aided by rebound in OEM production growth in the festive season. Gross margins improved 239bps YoY to 45.5bps driven by better mix amidst rising commodity costs. Gross margins were also aided by better fixed cost absorption on account of higher production levels. CEAT’s employee costs remained sticky (down only 8bps) even as other expenses fell 183bps as the company maintained tight cost control on discretionary spends (e.g. travel costs). Debt stood at ~Rs15.6bn vis-à-vis ~Rs18.2bn in Q3FY21 reflecting superior cashflow management. CEAT has continued its VRS scheme for its employees aggregating ~Rs123mn in Q3FY21. Further, the company has also taken an exceptional loss of Rs15mn towards the loss due to fire in its facility.

* Resilient margin as replacement segment fares better: CEAT has likely fared better vis-à-vis domestic peers, which we believe is attributable to: a) Relatively high share in rural driven segments and 2Ws in revenues (~39%), which have witnessed consistent recovery vis-à-vis the industry; b) new product innovations continue to drive market share gains in existing OEMs (e.g. Hero Motocorp, Maruti Suzuki); and c) entry into high demand new OEM launches (e.g. Hyundai i20, Nissan Magnite).

* Maintain BUY: As we enter CY21, we like the growth rebound story; however, we remain cautious on consistent delivery of current margin levels, and believe margins will revert lower (albeit higher than previous cycle) as the mix normalises. Commodity price inflation of natural rubber (up ~19% QoQ) also remains a key risk. We upgrade our earnings multiple for FY21E/22E/23E by ~34%/36%/18%, respectively. We value CEAT on SoTP basis, maintain our BUY rating on the stock with a revised target price of Rs1,741 (earlier: Rs1,432).

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