Buy CEAT Ltd For Target Rs.1,775 - Motilal Oswal
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Op performance in-line; encouraging recovery since June
Price increases to pass on cost inflation happening gradually
* CEAT’s 1QFY22 operating performance was in-line, but higher depreciation and interest impacted PAT. Demand recovery has been encouraging since Jun’21 and is back at 2HFY21 levels. While cost inflation is moderating, the industry is taking gradual price increases to dilute the impact.
* We cut our FY22E/FY23E EPS by ~15%/7%, factoring in RM cost inflation, higher depreciation, and higher interest cost. Maintain Buy.
Price hike dilutes cost impact; capitalization drives higher depreciation
* Revenue/EBITDA grew 70%/63% YoY (-17%/-36% QoQ) to INR19b/INR1.66b in 1QFY22.
* Volumes declined 21% QoQ and OEM/replacement volumes were down 30%/20%, while exports grew in the mid-single digits. ASP was up 4% QoQ.
* Gross margins contracted 130bp YoY (-310bp QoQ) to 38.9% (est. 40%), reflecting RM cost inflation (12% QoQ increase) and an adverse mix.
* The EBITDA margin declined 40bps YoY (-270bps QoQ) to 8.7% (est. 9.1%), further impacted by op. deleverage, but partially offset by lower ad spends.
* Higher depreciation costs (due to the capitalization of ongoing capex) and interest expenses (due to an increase in debt) hurt PAT – which stood at INR240m (est. INR339m; v/s loss of INR155m in 1QFY21 and PAT of INR1.53b in 4QFY21).
* Gross debt increased by INR3.67b QoQ to ~INR17.85b on higher working capital and capex.
Highlights from management commentary
* Demand recovered to 2HFY21 levels in Jun’21. PCR and 2W are seeing strong momentum, but the T&B segment is yet to catch up.
* As per the 2HFY22 outlook, high single-digit growth is difficult to achieve due to the high base, but value growth would be much higher owing to price hikes.
* RM cost inflation is estimated at 3–4% QoQ for 2QFY22.
* Price hikes taken in 1QFY22 stood at ~4%. It has already taken a 1–2% price hike in Jul’21 and expects to take a further 2–3% hike by end-Jul’21. It would need to take another 3% hike to reach normal margins of 10–12%.
* It aims to source 50% of its FY23 power requirement from renewable sources and is committed to installing solar power at all of its plants.
Valuation and view
* Cyclical recovery in both OEMs and replacements would enable the faster absorption of new capacities and drive the benefit of operating leverage. Coupled with the gradual pass-through of cost inflation, this would support margins over the medium term.
* Valuations at 11.3x FY23E consolidated EPS do not capture the ramp-up in new capacities in an improving demand environment, which would lead to margin recovery. Maintain Buy, with TP of ~INR1,775 (~13x Sep’23 consol EPS).
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