In line with a weak demand environment, tyre maker Ceat Ltd reported muted sales growth of 6% for the March quarter. Volumes and realizations fell by 2% in the quarter. But thanks to a favourable product mix, the company was able to report higher revenue. On a sequential basis, volumes grew by 11%. Greater focus on two-wheelers and utility vehicles helped the company sell more tyres than in the third quarter of the last fiscal year.

Easing rubber prices led to a 3% drop in raw material costs. But that did not translate into operating profit due to high employee expenses and other expenditure. Consequently, operating profits grew by only 1.1%. As the company passed on some of the benefits of low raw material costs to customers, Ebitda (earnings before interest, taxes, depreciation and amortization ) margins softened 48 basis points to 10.7% from a year ago. With net debt coming down by 273 crore, finance costs declined 17.3%. This, along with a sharp rise in other income, led to a 33% rise in net profit.

Strong volumes and margin expansion (up 188 basis points) on a sequential scale came as a pleasant surprise to the market participants, pushing up the stock. Easing commodity prices, reduction in debt and steady increase in promoter shareholding have helped the stock outperform the broader markets in the past one year. The sustainability of outperformance in the stock price will depend on improvement in automobile sales and replacement market.

True, Ceat is benefiting from easing natural rubber prices. But low input costs can help the company only to a certain extent. Automobile manufacturers are asking the tyre companies to pass on the input cost gains to them. Similarly, increasing competition in the replacement market has led to tyre companies offering discounts to retailers to safeguard their market share. In March this year, competition has forced tyre companies to reduce the prices of car radials.

The Ceat management maintains that discounts are confined to certain types of tyres and has limited impact on overall pricing in the replacement market. That said, the company is not expecting margins to expand significantly in the near term. Stable raw material prices and recent price cuts leave little room for further expansion in margins.

In terms of sales, the current quarter is expected to be better because of a seasonal rise in demand. Growth is expected to be driven by non-truck segments such as motorcycles, cars and light commercial vehicles. Business from original equipment manufacturers (OEMs, or automobile companies) is estimated to grow by 15% in the current fiscal. The replacement sales are expected to increase by around 5%.

The muted growth in the replacement business can weigh on the company’s overall sales and margin expansion. The replacement segment accounts for a majority of the company’s sales and has relatively higher realizations. The reduction in debt and easing interest rates will lead to lower finance costs in coming quarters. But subdued demand in the replacement market and high competition would mean that the company will continue to depend on low-margin OEM business for earnings growth.