MRF's Q4FY18 results (Outperformer) - Weak operating performance

Q4FY18 results

• PAT below estimates on weak operating performance: MRF’s reported PAT at Rs3.4bn (up 20% yoy, +1% qoq) was 13% below estimates on weaker than expected operating performance due to RM cost pressures. Higher tax outflow yoy put further pressure on PAT.  
• Revenue in-line; EBITDA margins weak on cost pressures : MRFs revenues grew by 16% yoy(+2% qoq) to Rs38.6bn which was in-line with our estimate of Rs39.3 bn. Revenue growth yoy seems to have been driven by strong OEM growth during the quarter (especially CVs as 4QFY17 was hit by demonetization). EBITDA at Rs 6.9bn grew by 31% yoy (-2% qoq). EBITDA margins at 17.7% declined by 80 bps qoq (+200 bps yoy). The decline in EBITDA margins for MRF was largely on the back of gross margins pressures (-80 bps qoq) –due to higher raw material prices (Crude based commodity costs hardened while rubber was flat) and adverse customer mix (higher share of OEMs). The decline in staff costs (-30 bps qoq) was negated by rise in other expenses (+20 bps qoq). Besides other income grew sharply (+77% qoq) possibly due to M2M gain on securities. 
• Management Commentary: (a)The management indicated that escalation in crude based commodity costs remains a concern and will add pressure to the bottom line going forward (b)It indicated that  competitive intensity is expected to increase as several Greenfield and brownfield capacities of major players come on stream in the coming months.(c)According to recent media reports the management has stated that it was targeting a turnover of Rs220bn was 2020 (IDFC FY20E: Rs183bn).(d) The company has taken a price hike of 1-2% across segments in the last few days.

Key positives: Higher other income

Key negatives: Higher RM costs

Change in estimates: No change

Valuations & view

We expect MRF to report 13% EPS CAGR over FY17-20E (with EBITDA margin improving from Q1FY18 lows) and revenue CAGR of 14%. With strong competitive advantages (distribution network, brand equity and economies of scale) and a shift in pricing strategy, we believe that the premium valuations for MRF (~14.5x Sep-19E EPS versus 11-13x for peers) are justified. MRF, unlike peers, has not raised any capital in the past decade, despite strong EPS growth, which is comforting. We value MRF  at 17x FY20 earnings . Maintain  Outperformer with target price of Rs85,000