CEAT's Q4FY18 results (Neutral) - Weak operating performance

Q4FY18 results

• Adj PAT below est led by weak operating performance: CEATs Q4FY18 Adj PAT (post adjusting for VRS expense of Rs2.4bn) at Rs929mn (+16% yoy) was 12% below our estimates. This was primarily due to weak operating performance on higher RM costs.
• Higher RM costs more than offset operating leverage benefits: Revenues at Rs 16.7b (+14%yoy) were in-line with expectations, driven by 11.5% yoy volume growth while realizations increased 2.5%  yoy. However gross margins disappointed as RM costs increased by 210 bps due to increase in crude based commodity costs (+100 bps qoq) coupled with an adverse customer mix (+100 bps qoq). Higher RM costs more than offset operating leverage benefits in staff and other expenses (-20 bps qoq and -180 bps qoq respectively). EBITDA margin at 11.8% (-10 bps qoq; +280 bps yoy) was below expectations of 12.7%. Higher tax expenses yoy also affected Adj PAT.
• Concall highlights: (a) Overall volume growth was led by strong OEM growth(+3% qoq) across most of the segments coupled with robust OEM exports. Replacement growth was driven by CVs during the quarter. (b)CEAT has taken an average price hike of 0.5% across all categories excluding two wheelers. (c) Capex timeline- (i)TBR brownfield capacity expansion of 200 TPD ( taking total capacity to 280 TPD) is expected in 3QFY19.(ii)Greenfield PCR capacity to come on stream in FY20.(iii) Ambernath plant OHT expansion in FY20.(d)It expects RM costs in 1QFY19 to increase by 2-2.5% qoq on hardening of crude based commodity prices. It also indicated RM costs to rise by 3-3.5% in 2QFY19 at current crude oil and rubber prices (e) It incurred Rs 3.8bn in capex for FY18, Management guided for Rs 15-17bn of capex in FY18/19.(f) Competitive intensity is rising in 2W segment due to increase in supply

Key positives: Lower interest expenses

Key negatives: Lower than expected gross margins

Change in estimates: Cut estimates for FY19/FY20 by 8%/6% on cost pressures/higher competitive intensity in the 2W segment.

Valuations & view

While CEAT has scripted a commendable turnaround, going forward, the company faces competitive pressures at a time when capex is rising. We expect the company’s PAT to rise at a moderate 8% over FY17-20E (versus 79% over FY12-17) with EBITDA margins lower than the FY16 peak. With valuations at 15xFY20 EPS (historical average 9x), we believe a further re-rating is unlikely. We maintain a Neutral rating and a target price of Rs1,690