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Below est; Higher RM, other cost impact margins

MRFs sales grew weaker than peers due to weakness in TBB & Farm

* MRF's 2QFY22 performance was impacted by RM cost inflation and higher other cost. MRF lagged peers in revenue growth due to weaker performance of TBB and farm segment. The industry is taking gradual price increases to dilute impact of severe cost inflation.

* We cut our FY22E/FY23E EPS by ~29%/14% to factor in for RM cost inflation and higher other expenses. Maintain Neutral.

Lowest revenue growth and steeper margin decline than peers

* 2QFY22 revenue/EBITDA/PAT grew 15%/-40%/-55% YoY. For 1HFY22 revenues grew 35% YoY whereas EBITDA/PAT declined 16%/18% YoY.

* The revenue growth at 15% was lower than peers [CEAT 24% YoY and APTY (S/A) grew by 25% YoY] as TBB and farm segment (strong segments of MRF) grew weakest during the quarter.

* Gross margins declined 8.8pp YoY (240bps QoQ) at 35.5% (est. 38.5%). The gross margin decline of MRF was steeper than its peers on a QoQ basis (CEAT: -200bps QoQ and APTY S/A -160bps QoQ) due to commodity cost inflation.

* EBIDTA declined by 40% YoY (+5% QoQ) to INR5.1b. EBIDTA margin declined 980bps YoY (120bps QoQ) to 10.6% (v/s est. 14.9%), further impacted by higher other expenses. This margin decline was higher than CEAT (-5.8pp YoY/+30bps QoQ). And APTY (S/A) (-8.6pp YoY/-10bps QoQ)

* PAT declined 54.5% YoY (+14% QoQ) at INR1.83b (v/s est.INR3.2b).

Valuation and view

* Cyclical recovery in both OEM and Replacement will enable faster absorption of new capacities (Gujarat plant) and drive benefits from operating leverage.

* Pricing environment for the industry seems to be stable, with all players gradually raising prices to pass-on substantial cost inflation. While there will be a transitory impact of cost inflation in 3QFY22, we expect margin to start recovering towards FY22-end (assuming stable commodity prices).

* MRF’s competitive positioning within the sector has weakened over the past few years, which is also reflected in the dilution of pricing power in the PCR and TBR segment. This, coupled with the impact of capex carried out over the last three years, has resulted in a substantial dilution in its superior return ratios.

* Current valuations, at 35.4x/24x FY22E/FY23E EPS, fairly capture the changing competitive dynamics for MRF. We maintain our Neutral rating, valuing it at 20x Sep’23E EPS (v/s 21.5x/14.5x its five/10-year average P/E) to arrive at our TP of INR73,700/share.

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