The margin beat was fuelled by soft and stable rubber prices during the quarter
As a result, Ceat’s Ebitda jumped 29% yoy, despite a mere 2% rise in net revenue
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.
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.