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Operating margins impacted by higher RM costs Replacement and exports to drive growth, input cost to moderate in H2

* Ceat Ltd (CEAT)’s 2QFY25 performance was impacted by higher RM costs, leading to a 100bp contraction in operating margins QoQ, which stood at 11% (est. 11.5%). The outlook for replacement segment across categories and exports remains healthy, with a recovery expected in the OEM segment in H2.

* CEAT’s focus on strategic areas such as PVs/2Ws/OHT/exports (to help margins), along with prudent capex plans (to benefit FCF), should continue to improve its returns in the long run. Valuations at 22.5x/16.8x FY25E/FY26E consol. EPS appear reasonable. We reiterate our BUY rating on the stock with a TP of INR3,450 (based on ~17x Sep’26E EPS). Lower other expenses offset the impact of higher RM costs

* CEAT’s 2QFY25 revenue grew 8% YoY but EBITDA/adj. PAT declined 21%/41% YoY to INR3.6b/INR1.2b (est. INR3.8b/INR1.5b). 1HFY25 revenues grew 8.5% YoY but EBITDA/adj. PAT declined 12%/23% YoY. 2HFY25 revenue is estimated to grow 13.5% YoY while EBITDA/adj. PAT is estimated to decline 12%/21% YoY.

* Volume grew ~6.4% YoY, mainly led by double-digit growth in the replacement and exports markets, while OEM volumes experienced a 3-4% YoY decline.

* Gross margins contracted 590bp YoY (-180bp QoQ) to 37.4% (est.38.2%) due to the higher RM costs.

* EBITDA margin stood at 11% (-400bp YoY; est. 11.5%); the miss was mainly due to the higher RM costs, which were offset by savings in marketing costs, leading to lower other expenses.

* 1HFY25 cash outflow stood at INR114m (INR3.8b cash inflow in 1HFY24) due to the lower operating cash flow of INR4.15b (INR7.7b in 1HFY24) and higher capex of INR4.3b (INR3.9b in 1HFY24).

* Debt increased by INR2.4b sequentially to INR18.85b as of Sep’24. This was due to the higher WC requirement and payment of dividend. Capex stood at INR2.1b for the quarter.

Highlights from the management commentary

* Outlook: A double-digit volume growth is expected in replacement/export segments, with a bounce back in the OEM segment anticipated in H2.

* RM costs are expected to witness a further rise (1.5-2%) in 3Q with some softening expected in 4Q.

* They have taken a price hike of 1.5%/3.5% in the first week of Oct’24. They are looking to take further price hikes in 3QFY25 to pass on the higher cost impact.

* The Sri Lanka business is recovering well and clocked 31% YoY volume growth in 2Q with 19.5% EBITDA margin.

Valuation and view

* CEAT has guided for double-digit volume growth in both replacement and export segments. It also expects OE demand to pick up in H2, led by new model wins and higher share of business in PVs/2Ws/CVs. However, given the rising cost pressure, we have lowered our FY25/FY26 EPS estimate by 9% each

* CEAT’s focus on strategic areas such as PVs/2Ws/OHT/exports (to help margins), along with prudent capex plans (to benefit FCF), should continue to improve its returns in the long run. Valuations at 22.5x/16.8x FY25E/FY26E consol. EPS appear reasonable. We reiterate our BUY rating on the stock with a TP of INR3,450 (based on ~17x Sep’26E EPS).

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