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High costs inventory dents Q4FY23, performance set to meaningfully improve, going forward…

About the stock: JK Tyre (JKT) is a leading tyre manufacturer with annual capacity pegged at 6.2 lakh MT. It serves various automotive segments via India, Mexico plants with dominance in truck/bus radial (TBR) space domestically.

* FY23 segment mix – truck/bus ~54%, PCR ~28%, 2-W, 3-W ~4%

* FY23 channel mix – aftermarket ~60%, OEM ~23%, exports ~17%

Q4FY23 Results: JKT’s performance in Q4FY23 lagged peers on the margin front.

* Consolidated net sales were flat QoQ at | 3,632.5 crore

* Consolidated EBITDA margins rose 100 bps QoQ to 10.4%

* Standalone gross margin improved just ~215 bps QoQ vs. peers reporting ~400-500 bps QoQ expansion. Management guided for high-cost inventory utilised in Q4FY23 with RM decline benefits to accrue in coming quarters

* Consequent PAT was at | 108.4 crore, up 65% QoQ

What should investors do? JKT’s share price has grown at ~6.5% CAGR over the past five years (~| 147 levels in May 2018), outperforming the Nifty Auto index

* We maintain BUY tracking margin expansion on the anvil and accelerated debt reduction amid controlled capex spends & healthy CFO generation

Target Price and Valuation: Revising our estimates and rolling over our valuations, we now value JKT at | 210 i.e. 5x EV/EBITDA on FY25E numbers.

Key triggers for future price performance:

* Uptick in domestic demand, particularly in the CV space amid higher fleet utilisation, pick-up in replacement demand and vehicle scrappage

* Focus on premiumisation in the form of smart tyres, puncture-guard tyres & EV-specific tyres that offer low rolling resistance and increase efficiency

* Controlled capex spends and healthy CFO generation with net debt seen declining from ~| 4,500 crore in FY23 to ~| 3,700 crore in FY25E

* Building in the visible positives, we build 6.3% CAGR net sales over FY23- 25E with margins seen at 11% in FY25E. Return ratios are seen turning to 15% in that timeframe with debt: equity to reduce to 0.9x by FY25E

Alternate Stock Idea: Besides JKT, in our coverage we like Mahindra CIE.

* Focused on growth capex in India & efficiencies in European operations

* BUY with a target price of | 520

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