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MRF's Q2FY19 results (Outperformer) - Steady gross margins

Q2FY19 results

• PAT decline on weaker revenue growth: MRF’s reported PAT at Rs2.6bn (down 13% yoy was ~4% below estimates. The variance was on lower than anticipated revenues.  
• Gross margins maintained ; Other expenses increase : MRFs revenues grew by 9% yoy to Rs39.2bn(4% below expectations). Revenue growth yoy was visibly lower than that of peers (CEAT +15%) for a second quarter in a row – this may be reflective of market share losses due to radialisation (where MRF has a lower markets share). However, the gross margins of the company (39.7%) remained flat at on a sequential and yoy basis despite significant cost pressures – this seems to reflect an improvement in product mix/price hikes to offset cost pressures. The stronger than expected improvement in gross margins was partially negated by an increase in other expenses – possibly reflecting higher advertisement expenses. We note that other expenses do tend to be lumpy in nature. Consequently, EBITDA margins at 14.8% (down 90 bps yoy) were just a tad ahead of expectations. 
• Management Commentary: (a)The management indicated that tyre volume growth could be between 8-10% with OEM growth at 8-10% whilst the replacement market could grow at 6-8% (b)Amongst other factors, the growth of the used car market could drive tyre volumes in the coming years. CV tyre demand could increase on the back of infrastructure spending and (c) Capacity addition will be a key theme dominating the industry. This could lead to higher competitive.(d)The industry could possibly bear the brunt of higher raw material costs even in FY19.

Key positives: Steady gross margins

Key negatives: Lower revenue growth 

Change in estimates: We cut our earnings by 15%/13% in FY19 and FY20 to factor in higher raw material cost pressures and weaker volume growth.

Valuations & view

We expect MRF to report 29% EPS CAGR over FY18-20E and revenue CAGR of 12%. 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 (~15x FY20 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 Rs73,000