CEAT's Q2FY20 results (Neutral) - Margins surprise; capex weighs onprofitability

Q2FY20 results

• Gross margins surprise; adjusted PAT disappoints: CEATs Q2FY20 Adj PAT of Rs436mn (-28% yoy) was 9% below estimates. While gross margins surprised positively, this was offset by negative operating leverage, a sharp increase in depreciation and a higher tax rate.
• EBITDA margins ahead; depreciation rises sharply: Revenues at Rs 16.9b (-4% yoy) were a tad below expectations. Revenue growth was impacted by a sharp slowdown in the CV segment. EBITDA margins at 10.1% (up 100bps yoy, up 50 bps qoq) were above estimates (9.5%).On the positive side, RM expenses declined (down 180bps qoq on account of improved product mix) and employee expenses trended downwards (-50bps qoq due to a reversal in bonus provision). However, the other expenses rose sharply (up 160 bps qoq) partly due to negative leverage. Consequently, reported EBITDA at Rs1.7bn rose by 7% yoy (4% above expectations). This was however offset by higher depreciation (up 42% yoy/5% qoq on higher capex/ accounting policy changes) even as other income fell 65% qoq. As a result, adjusted PBT at Rs700mn declined by 27% yoy (8% below expectations). PAT was further impacted by a higher tax rate due to an increase in deferred tax rate. On the whole adjusted PAT declined by 31% yoy (9% below estimates).
• Concall highlights: (a) The TBB sales saw steeper decline vs TBR sales. It had an adverse impact on revenues as TBB accounts for 60% of Ceat’s portfolio vs 50% of industry average. (b) The company expects the passenger car radial tyre segment to grow from 13% of the company’s portfolio to 17% as the Chennai plant ramps up. (c)The company expects to incur a capex of Rs13bn (including capex of Rs1-1.5bn on the specialty tyre plant - lower by ~0.5 bn compared to the previous guidance) (d) The debt equity showed an increase to 0.64x (up from 0.57X in Q4) (e) During the quarter, OEM sales declined by 15%, replacement demand was flat while exports grew in single digit

Key positives: Gross margin improvement

Key negatives: Higher depreciation/ interest costs

Change in estimates: We cut our EPS estimates for FY20 by ~4% while increasing FY21 EPS by ~1% to account for weaker volumes and a cut in the tax rate.

Valuations & view

The competitive intensity in the tyre space, particularly in the 2W space seems to be rising sharply. Coupled with concerns around slower volume growth and continued need for high capex, we believe pressure in the segment to persist. With valuations at ~13x FY21 EPS (historical average 9x), we believe upsides are limited. We maintain a Neutral rating with a target price of Rs900 (12XFY21).