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MRF likely to underperform peers due to weak competitive position

* MRF’s 4QFY23 performance surprised positively as lower RM costs boosted EBITDA margin to 14.7% (est. 11.9%). EBITDA margin recovery is expected to continue in FY24 on the back of softening RM costs and operating leverage.

* We upgrade FY24E/FY25E EPS by 16.6%/4.7% to factor in the benefits of lower RM costs, which will support margin. However, we maintain Sell with a revised TP of INR75,400 (18x Mar-25E EPS) as its pricing power has diluted over the years due to its weakening competitive position.

Better gross margin leads to 8-quarter high EBITDA margin of 14.7%

* 4QFY23 revenue/EBITDA/Adj. PAT increased by ~10%/60%/1.26x YoY to INR57.2b/INR8.4b/INR3.5b. FY23 consolidated revenue/EBITDA/Adj. PAT grew 19%/17%/15% YoY.

* Revenue rose 10% YoY to INR57.25b (in line) likely on the back of stable domestic demand and price hikes. Consolidated export revenue improved 5% YoY to INR18.8b for FY23.

* Gross margin expanded 490bp QoQ/YoY to 37% due to lower RM costs and price hikes.

* The above factors, coupled with lower employee costs, led to a 460bp YoY/480bp QoQ expansion in EBITDA margin to 14.7% (est. 11.9%). EBITDA grew 60% YoY to INR8.4b (est. INR6.9b).

* There was an extraordinary item of income tax impact on account of a refund from a wholly owned subsidiary amounting to INR803m. Despite higher tax, adj. PAT jumped 1.26x to INR3.5b (est. INR2.75b).

* The board has declared a special dividend of INR169 per share. The total dividend for FY23 stood at INR175 per share.

* FCFF was negative INR5.3b (v/s negative INR22.8b in FY22) mainly due to high capex of INR32.9b (v/s INR17b in FY22). Operating cash flow stood at INR27.5b (v/s negative INR5.8b in FY22) due to a decrease in WC.

Valuation and view

* MRF’s competitive positioning within the sector has weakened over the past few years, which is also being reflected in the dilution of pricing power in the PCR and TBR segments. This, coupled with the impact of capex to be carried out, should result in limited expansion in return ratios. We expect MRF’s return ratios to see a relatively lower uptick v/s peers over the next two years as its RoE is expected to reach 10.5% by FY25 (lower than APTY/CEAT at 12.2%/13.7%).

* The current valuation at 22.3x FY25E EPS represents an almost 100% premium to its peers, despite a weakening competitive position and similar capital efficiencies. Maintain our Sell rating.

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