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MRF's Q2FY20 results (Outperformer) - Steady quarter; revenue growth ahead ofpeers

Q2FY20 results

• Higher tax rate drags profitability: MRF reported PAT at Rs 2.2bn (-16% yoy) was 27% below estimates. While EBITDA margins met expectations, PAT was impacted by lower than expected tax rate (the company has not shifted to the new tax regime). 
• Revenues a tad weak; Gross margins surprise: Revenues at Rs39.5bn (flat yoy; -10% qoq) were ~4% below estimates – the weak volumes seem to reflect the slowdown in OEM volumes (~30% of volumes). EBITDA margins of 13.7% were flat sequentially (down 100bps yoy) broadly met expectations. Notably, the gross margins expanded sharply (up 170bps qoq) possibly reflecting a better product mix (higher share of replacement market in the volumes). The improvement in gross margins was however offset by operating deleverage (employee/manufacturing cost rose sequentially by 165bps/30bps respectively). While EBITDA at Rs5.4bn declined at 7% yoy, with  higher depreciation charges/ tax rate PAT declined by 16% yoy. FCF turned negative for the company in the tune of Rs1.4bn during H1FY20 due to capex of Rs14.7bn.
• Revenue growth faster than peers: In the past 2 quarters, MRF revenue growth has been faster than its peers (Q2 yoy revenue growth: MRF: Flat, APTY: - 11%, CEAT: -5%). This in our view reflects its higher market share in the faster growing TBR space. We believe that the revenue growth differential may have narrowed during the quarter, it is likely that MRF may regain market share in FY21 when its new plant at Gujarat comes on stream.

Key positives: Intact EBIDTA margin

Key negatives: Higher tax rate 

Change in estimates: We increase our estimates for FY20/FY21 by 7%/11% respectively to factor in a lower tax rate.

Valuations & view

We are cautious on the tyre sector given the high capex requirements and rising competition when volume growth could slow down. However, with strong competitive advantages (distribution network, brand equity and economies of scale) we believe that the premium valuations for MRF (~18x FY21 EPS versus 10-12x for peers) are justified. Further, MRF could gain market share in FY21 when its new plant comes on stream. Maintain Outperformer with a TP of Rs70,500 (18xFY21E EPS).