CEAT's Q2FY19 results (Neutral) - Steady Operating performance

Q2FY19 results

• PAT below estimates: CEATs Q2FY19 Adj PAT came at Rs644mn (-21% yoy; -12% qoq) was 20% below estimates. The miss was largely on account of weaker than expected operating performance on higher than expected other expenses/employee costs along with lower other income( Rs32.7mn v/s est of Rs 70 mn). Exceptional item of Rs20 mn was on account of compensation for workmen separation.
• Revenues in-line; EBITDA margins below est: Revenues at Rs 17.2b (+15%yoy) were in-line with expectations.  Gross margins at 39.3% were stable as increase in crude based derivative input costs was offset by some price hikes and a reduction in finished goods inventory. The lowered inventory levels led to higher other expenses whilst lowering raw material costs to the extent of 120 bps. Higher other expenses were also rising on account of an increase in promotional expenses. Employee expenses were up 110 bps qoq (+ 80 bps yoy) on account of retrenchment expenses and annual increments. Consequently, EBITDA margin at 9.1% (-120 bps qoq; -240 bps yoy) was below expectations of 10.2%. Absolute EBITDA declined by 9% yoy to Rs 1.6bn. Besides lower other income (-49% yoy) was on account of lower dividend from the Sri Lankan subsidiary.
• Concall highlights: (a) Overall volume growth of 12.5% yoy was led by robust growth in both replacement (CV demand) and OEM (2Ws/PVs). (b) The company has taken a price hike of 1.7% in 2QFY19 and a 4%/ 2% increase in 2W/ TBR segment in Oct-18.~to offset increase in RM costs. (c)It expects RM costs to increase by 5% in 3QFY19, it indicated price increases to be taken in coming months to offset rise in RM costs (d)It has guided for a capex of Rs 31bn for FY19 and FY20 of which Rs 13 bn will be incurred in FY19 and remaining Rs 18 bn in FY20(e) It plans to commission its TBR plant in 4QFY19 with a capacity of 100 MT/month, while its PCR plant will come on stream by Aug-19.

Key positives: Steady volume growth

Key negatives: Higher than expected other expenses, lower other income

Change in estimates: Cut estimates for FY19/FY20 by 14/10% on cost pressures/higher competitive intensity in the 2W segment.

Valuations & view

While the recent price hikes in the 2W space are a positive, we believe they are just about sufficient to offset cost raw material cost pressures. The underlying competitive intensity in the 2W tyre segment remains high in our view. With valuations at 12.7x FY20 EPS (historical average 9x), we believe a further re-rating is unlikely. We maintain a Neutral rating with a target price of Rs1050.