CEAT's Q3FY19 results (Neutral) - Another weak quarter

Q3FY19 results

• PAT below estimates: CEATs Q3FY19 Adj PAT of Rs528mn (-37% yoy; -23% qoq) was 25% below estimates. The miss was largely on account of a weak operating performance on higher than expected other expenses.
• Revenues in-line; EBITDA margins below est: Revenues at Rs 17.1b (+9%yoy) broadly met expectation.  On the positive side, gross margins at 40.9% showed an improvement of 160bps qoq possibly on account of lower prices of crude based derivatives as well as price hikes taken in October/November (3-4%). However, the improvement in gross margins was more than offset by higher other expenses (+210bps), on account of an increase in promotional expenses and sequential operating deleverage.  Consequently, absolute EBITDA margins at 8.3% (-80 bps qoq; -360 bps yoy) was below expectations of 9.1% Absolute EBITDA declined by 24% yoy to Rs 1.6bn. Other income was considerably lower (-39% yoy) on account of lower dividend from the Sri Lankan subsidiary. Also, notably the D/E for the company has shown a sharp increase (uptp 0.47x compared to 0.34x in Q2FY19) – this reflects negative cashflows on high capex and increased inventory levels.
• Concall highlights: (a) Overall volume growth was muted at 2% yoy with OEMs showing a growth and exports reporting a sharp decline due to issues in Indonesia. Notably, even replacement demand was sluggish in the CV segment. (b) Price hikes taken in November to the tune of 1% have been rolled back by most of the industry. The management indicated that the benefit of lower RM costs will be felt in March. (d)It has guided for a capex of Rs 11bn/15bn for FY19/FY20. The management has reduced its capex expenditure for FY19 (previously Rs15bn). (e)TBR plant to be commissioned in 4QFY19 with a capacity of 100 MT/month, while its PCR plant will come on stream by Aug-19.

Key positives: Gross margin improvement

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

Change in estimates: Cut estimates for FY19/FY20 by 8%/4% on cost pressures/higher competitive intensity in the 2W segment.

Valuations & view:

The recent rollback in price hikes seems to highlight the competitive intensity in the tyre space. Coupled with concerns around slower volume growth, we believe competitive pressures are only likely to increase. High capex adds to concerns. With valuations at ~13x FY20 EPS (historical average 9x), we believe upsides are limited. We maintain a Neutral rating with a target price of Rs1050 (12XSept 2020).