Tyre maker Ceat Ltd’s decent performance in the December quarter (FY20), amid weak auto sales, is commendable. A favourable product mix and softer raw material prices boosted profitability. Ceat bettered the Street with a 10.4% Ebitda (earnings before interest, taxes, depreciation and amortization). This not only beat Bloomberg’s consensus estimate of 10.1% in a rough environment, but was 210 basis points (bps) higher year-on-year (y-o-y). One basis point is one-hundredth of a percentage point.

The margin beat was fuelled by soft and stable rubber prices during the quarter. Also, decent sales in the passenger vehicle and two-wheeler tyre-replacement market kept capacity utilization roaring amid the sharp deceleration in demand from original equipment manufacturers (OEMs). Further, soft prices of petro-products used in tyres also shifted the profitability gear-stick up a notch. As a result, raw material costs as a percentage of sales fell by about 150 bps y-o-y, boosting the Ebitda margin. Also, the management did well to contain employee costs and other expenditures at almost the year-ago levels.

As a result, Ceat’s Ebitda jumped 29% yoy, despite a mere 2% rise in net revenue. A report by ICICI Securities Ltd said Ceat’s robust show comes on a better performance (than peers) in both two-wheeler OEMs and the replacement market. New products led to market-share gains and new customers.

Source: Company
Source: Company

However, the moot question is: Will profitability persist in coming quarters? The management commentary at the analysts’ call was cautious regarding growth. It highlighted that the replacement-market sales growth has slipped from double digits to high single digits. Natural rubber prices have moved up from 125-130 per kg to 135-140 a kg over the last few quarters. Both these are a recipe to drain profit margins.

JM Financial Services said in a note: “Continued weakness in the OE (original equipment) segment was largely due to the commercial-vehicle and two-wheeler segments. OEM demand may be subdued in H1 CY20 due to the BS-VI transition."

Another risk to earnings comes from capacity expansion in tough times. Such high capital expenditure is likely to squeeze free cash-flows. “Free cash-flows may be negative in the second half of FY20, with the debt/Ebitda ratio rising significantly." added the ICICI report.

The road bumps may make Ceat’s shares wobble in the near term. At the ruling price, of 1,009, the stock, which had hugely undershot the Nifty midcap index in a year, trades at a reasonable 13 times estimated one-year-forward earnings. Unless the road smoothens out through a strong upturn in OEM and replacement market sales, which support recent capacity expansions, the stock’s potential may be contained.

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