CEAT's Q3FY18 results (Neutral) - PAT miss; operating metrics weaker than peers

Q3FY18 results

• PAT below est; Operating performance broadly in-line: CEATs Q3FY18 PAT at Rs833mn (-2% yoy) was 8% below our estimates. While the EBITDA was inline with expectations, the variance was on account of a higher than expected interest cost and a sharper increase in the tax rate.
• Higher other expenses offset gross margin improvement: Revenues at Rs 15.7b (3% below expectations) grew by 13% yoy. EBITDA margins at 11.9% (up 40 bps qoq) were in line with expectations – a sharp improvement in gross margins (up 240bp qoq, largely reflecting inventory benefit) was offset by a jump in other expenses (up 180 bp qoq). The increase in other expenses reflect higher advertising expenses/ ramp up costs at new plants. We note that CEAT’s operating margin improvement (+40 bps qoq) is substantially lower than that of MRF (+160 bps qoq). The bottomline was further impacted by higher interest costs/tax rate.
• Concall highlights: (a) Overall volume growth for 3QFY18 was 7% yoy led by double digit growth in 2W/3Ws while tractors and CV volumes moderated.(b) It is operating at close to 100% utilization in TBR and TBB segments.(c) Management indicated growth in TBR segment will moderate as it faces capacity constraints till it ramps up TBR capacity in 3QFY19.(d)  The management expects RM costs to be flat in 4QFY18 qoq, However it  anticipates higher RM costs in 1QFY19 on account of higher crude prices (45% of commodity basket).(e) The Ambernath plant manufacturing OHT is likely to face cost pressures as it ramps up production.(f) It has guided for a capex of Rs 4.5-5 bn for FY18 and Rs 15-17 bn for FY19. Overall the capex expenditure for the next two years seems to have been enhanced by Rs 2-3bn (g) It has targeted 15% of revenues from exports going ahead.

Key positives: Higher than anticipated gross margins

Key negatives: Higher other expenses; higher tax rate

Change in estimates: We cut our estimates for FY18 and FY19 by 4-5% on account of higher tax rate.

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 9% over FY17-20E (versus 79% over FY12-17) with EBITDA margins lower than the FY16 peak. With valuations at 14xFY20 EPS (historical average 9x), we believe a further re-rating is unlikely. We maintain a Neutral rating and a target price of Rs1,800.