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Turning FCF positive key as margin bottoms out

CEAT’s Q2FY23 EBITDA margin at 7% (up ~115bps QoQ) missed consensus estimate of 9.9% as despite price hike of ~4% QoQ, adverse currency movement, elevated power/fuel cost and higher mix of outsourced tyres impact negatively, thus, restricting gross margin and EBITDAM improvement QoQ. Gross margin was up 82bps QoQ with last leg of raw material basket increase being taken care of by price hikes with no under recoveries impacting margin incrementally. Around 8% weaker INR impacted Q2 and is set to impact raw material costs ahead too as ~10-20% decline in prices of key input commodities are getting partly negated as sourcing is done on import price parity basis. We believe with RM costs stabilising finally, investment in OHT and radial segments bodes well towards CEAT’s strategic intent to focus on improving RoCE from present lows as against investing heavily in TBRs. We downgrade the stock to REDUCE from Hold

Key highlights from earnings call

* Volume remained flattish QoQ with exports and CVs being the drag, PCRs remaining flattish and 2Ws recovering. On YoY basis, volume growth was 7%. Exports is likely to remain subdued for next couple of quarters, though post monsoon quarter, domestic CV tyre replacement demand is recovering well. Post effective price hike of ~4% in Q2, further price hike of 1% is likely in November, post which no prices hikes are planned as of now.

* Raw material basket (RMB) increased 4% QoQ and commensurate price hike resulted in 80bps gross margin improvement. In Q3, with ~3% expected decline in RMB (net of weaker INR) and 1% price hike, further gross margin recovery is desirable to take EBITDA closer to ~10% levels. Post elevated other expenses in Q1 led by marketing spends for IPL, despite flat volume QoQ, elevated power and fuel costs and higher outsourced tyre sourcing this quarter resulted in elevated other expense rising further.

* Project capex plans remain unchanged at ~Rs7.5bn for FY23 and will get reassessed in Q3, if needed. With H1 total capex at Rs4.5bn and similar outflow expected in H2, deficit in operating cashflow amidst margin pressure and elevated working capital resulted in rising net debt profile and is expected to rise in H2FY23, too. In order to manage cashflow efficiently and improve business RoCE, CEAT is taking steps like expanding Ambernath OHT capacity from 80TPD to 105TPD by mid-CY24, changing 18TPD of Bhandup TBB capacity to OHT capacity other than having no plans of expanding asset intensive TBR capacity further, with present utilisation levels of ~75% in it. CEAT accounted for Rs230mn of VRS from its various old plants this quarter to control its staff costs and improve scope of automation going ahead, improving per employee productivity.

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