A lacklustre market notwithstanding, shares of MRF Ltd jumped 2% to Rs 10,145.60 each in response to the stellar year-on-year growth in profit. Driven by strong volumes, net revenue rose 16.9% to Rs 3,008.3 crore from the year-ago period. This was possible, perhaps, because the replacement market growth was sustained in spite of a contraction in the automotive segment’s growth rate.

However, the key trigger, which lifted profitability from a year ago, was that rubber prices (which account for over two-thirds the cost of making a tyre) fell 23% from the highs scaled about 15 months ago. Raw material costs as a percentage of sales dropped 590 basis points to around 70%, although this was in line with the March quarter. Operating leverage as a result of full capacity utilization also aided profitability. Operating margin bounced back from the lows of 6% touched a year ago to 11%, though it was at the same level as in the March quarter. A basis point is one-hundredth of percentage point.

MRF’s strong brand equity and operating efficiency is mirrored in the investor confidence in the stock. In spite of trying times in the last few quarters, the stock has outperformed all benchmark indices and jumped 64% from its 52-week low of Rs 6,200 in August 2011. During the quarter, interest costs rose 61% to Rs 39.3 crore. But this is not worrisome, given the operating profit of around Rs 323.4 crore, which more than doubled from the year-ago period. The 4.5 times jump in net profit to Rs 144.6 crore was, of course, on a very low base.

The company management, however, reiterated the cautious outlook stated about three months ago. They feel the impact of flat growth in passenger vehicles, 30-40% cutback in original equipment demand from commercial vehicles and rising inventory reported in two-wheelers, will be felt in the ensuing quarters. This, along with capacity expansion in the tyre industry, could exert pressure on margins going forward.

Analysts seem to think otherwise. Rajen Shah, chief investment officer at Angel Broking Ltd, said, “We are positive on the tyre industry as a whole. We expect MRF to report a 15% compounded earnings growth rate over the next two fiscal years.”

Tyre firms are hopeful rubber prices will stay at current levels in the medium term, if not ease further in domestic markets. Internationally, too, falling consumption of rubber in China will keep prices easy.

MRF’s drawback has been its poor liquidity on the Street. However, given the estimated earnings momentum, it trades at an attractive valuation of eight times one-year forward earnings. This leaves room for upside, even after the rally seen in the stock in the past one year.

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