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Below estimates; performance adversely impacted by higher costs

Commodity cost expected to soften in 2HFY23

* MRF’s 2QFY23 performance was adversely impacted due to RM cost pressures despite good beat on revenues. The industry is taking gradual price increases to dilute the impact of severe cost inflation.

* While we reduce our FY23E EPS by 19% to account for high RM costs, we maintain our FY24E EPS. We reiterate our Neutral rating with a TP of INR86,575 (~20x Dec-24 EPS).

Margins negatively impacted due to higher RM costs

* 2QFY23 revenues grew 18% YoY to INR57.2b (v/s est. INR54.1b) while EBITDA/adj. PAT declined 9%/32% YoY to INR4.7b/INR1.24b, respectively. 1HFY23 revenues grew 26% YoY but EBITDA/adj.PAT declined 5%/31% YoY.

* 2QFY23 revenue growth was similar to that of CEAT.

* Gross margin declined 580bp YoY (down 180bp QoQ) to 29.7% (v/s estimated 32.8%). On the other hand, CEAT reported gross margin expansion of 80bp QoQ (down 4.4pp YoY) to 32.5%.

* EBIDTA declined 9% YoY to INR4.7b (v/s est. INR5.4b) in 2QFY23. EBIDTA margin declined 240bp YoY to 8.2% (v/s est.10%) due to higher RM costs, partially offset by lower ‘other expenses’. Margins for CEAT were lower at 7% (down 200bp YoY).

* PAT declined 32% YoY to INR1.24b (v/s est.INR1.5b) in 2QFY23.

* The company declared an interim dividend of INR3 (for FY23).

* 1HFY23 CFO improved to INR8.5b (v/s negative INR8.6b in 1HFY22) due to improvement in working capital. Further, FCFF improved but was still negative at INR4.9b (v/s negative INR14.3b) as improvement in operating performance was offset by substantially higher capex of INR13.4b (v/s INR5.8b in 1HFY22).

Valuation and view

* The pricing environment for the industry seems to be stable with all the players raising prices to pass-on substantial cost inflation. While cost inflation has peaked out 2QFY23, we expect margin to start recovering from 2HFY23 (assuming stable commodity prices).

* Current valuations at 63.6x/25.7x FY23E/FY24E EPS, respectively, fairly capture the changing competitive dynamics for MRF. We reiterate our Neutral rating, valuing it at 20x Dec’24E EPS (v/s 21.4x for 10-year average P/E) to arrive at our TP of INR86,575.

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