Graphic by Naveen Kumar Saini/Mint
Graphic by Naveen Kumar Saini/Mint

JK Tyre’s high debt-equity ratio could puncture earnings growth euphoria

  • A jump of 330 bps y-o-y was better than expected, considering that the auto industry has been reeling under a slowdown
  • Analysts said robust replacement market sales, where realizations are higher and growth in two-wheeler sales shored up profit margins

JK Tyre and Industries Ltd’s shares zoomed 9% on the National Stock Exchange (NSE) on the back of a strong operating performance for the September (Q2 FY20) quarter.

Indeed, the consolidated Ebitda (earnings before interest, tax, depreciation and amortization) margin at 13.8% was the highlight of the quarter. A jump of 330 basis points (bps) year-on-year (y-o-y) was better than expected, considering that the auto industry has been reeling under a slowdown. One basis point is one hundredth of a percentage point.

Even the company’s media release reiterated the pain in the sector stating that “production for both passenger and commercial vehicles has been cut drastically during the quarter".

Perhaps, stable and soft rubber prices gave a leg up to the profitability in spite of the negative operating leverage from a 13.6% drop in sales. Raw material costs as a percentage to sales dropped by a sharp 500 bps even as the firm contained other costs.

Analysts said robust replacement market sales, where realizations are higher and growth in two-wheeler sales shored up profit margins.

Meanwhile, JK Tyre’s market leadership in truck and bus radial (TBR) tyres, which normally fetches higher realizations and profitability, has been a bane in the current market scenario.

The commercial vehicle industry is expected to take a few more quarters to recover from the slowdown, given the low utilization of trucks and weak truck rentals. The segment comprises over half the company’s revenue.

The move to BS-VI emission norms, which come into effect from 1 April 2020, is expected to keep auto sales wobbly at least till the first half of FY21, and may prove to be a pain point for the tyre industry. Meanwhile, analysts said JK Tyre’s overseas business in Mexico is still to show a firm trend in profitability.

Further, there is a lurking fear that the company’s high debt-equity ratio, which has been above 2 for about three years, will erode its earnings. This is also among the highest in the automotive sector and peers.

Its borrowings in excess of 5,000 crore, translates into a quarterly interest outflow of about 140 crore (September quarter). This is about 47% of the Ebitda earned.

In fact, investors will do well to bear in mind that the 168 crore profit that was way beyond Bloomberg’s consensus of 10 crore also includes reversal of provision for deferred tax liability, following the reduction in corporate tax rates.

The above factors will limit a re-rating in the stock’s valuations, which trades at 6.5 times the estimated FY21 earnings per share.

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