BackCeat: funding expansion plans mars benefits of good September quarter
Investors are concerned about Ceat's ability to sustain profit growth given its expansion plans over the next two years that could weigh down future cash flows
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Ceat Ltd fared well during the September quarter as sales grew and rubber prices fell, which arrested falling margins. On higher tyre sales in the two-wheelers and utility vehicles segments, consolidated net revenue rose by 7.7% to ₹ 1,437.8 crore. But sale of truck and bus tyres, replacement market sales and exports disappointed, pulling down revenue growth.
The September quarter’s operating performance was dented by poor volume and higher outsourcing, promotion and advertising expenses. Consolidated operating margin narrowed by 120 basis points from the year-ago period to 12.2%. One basis point is one-hundredth of a percentage point. Export contribution to total revenue and profitability from exports fell significantly from a year back due to severe Chinese competition. Further, the Sri Lankan subsidiary saw a decline in realizations on sales.
Yet, analysts are hopeful of better profit margins in the ensuing quarters on the back of lower commodity prices. An Antique Stock Broking Ltd report says, “Led by a 20% decline in crude prices, we expect favourable margin impact from the fall in crude derivative prices to occur with a lag, as almost 35% of revenue value worth of input commodities are linked to crude derivatives." On the flip side, the company has also given a significant wage hike that will reflect on future profit margin.
In fact, Ceat’s consistent performance and margin expansion over the last several quarters led to a re-rating of the stock. From a historical 4 to 5 price-to-earnings (P-E) multiple, Ceat’s shares trade at 8-10 times one-year estimated P-E. The stock has outperformed benchmark index and quadrupled in a year.
That said, investors are concerned about Ceat’s ability to sustain profit growth given its expansion plans over the next two years that could weigh down future cash flows. Surjit Arora, an analyst at Prabhudas Lilladher Pvt. Ltd, points out that nearly half of Ceat’s ₹ 1,300 crore expansion plan would have to be funded by debt and equity. One is likely to see negative free cash flows in the coming quarters.
Capacity addition would imply higher interest and depreciation costs over the longer term that could squeeze profits. Only a strong rebound in sales volume across segments and benign raw material prices will help lift revenue and operating profit growth.
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