CEAT’s performance in Q2FY22 was below consensus expectations and profitability suffered (down ~ 79% yoy) mainly due to gross margin compression (down 975 basis points yoy ). The growth momentum continues to be driven by organic growth in the CV and PV segments coupled with new PV orders (eg Nissan Magnite, Renault Kiger, Mahindra Thar). The outlook for the S2FY22 remains mixed amid concerns over the potential slowdown in demand caused by OEM production cuts due to chip shortages.
However, margins are expected to improve in the second half of the year as price increases are more favorable while input costs have softened a bit (rubber prices in Bangkok down around 23% since Q1 of the year. exercise 22). On the balance sheet side, the consolidated debt amounts to ~ 20 billion yen (FY21: ~ 14.2 billion yen). The intensity of CEAT investment spending is expected to peak in FY22; we expect the FCF generation to improve in FY 23E (~ ₹ 2 billion / ~ 4% FCF return). Hold ADD.
Highlights of the quarter: Revenue increased about 24% year-on-year to around 24 billion yen, driven by faster growth in the OEM segment (revenue share increased 200 basis points in year-on-year change in the first half of fiscal year 21). Gross margin decreased 975 basis points year-on-year to 36.9% due to higher raw material costs. The decrease in EBITDA margin was reduced to 8.9% (589 bps year-on-year decrease) due to lower personnel costs (down 110 bps year-on-year) and lower other expenses from 276 bps due to tighter cost control and potentially lower ad spend. Adjusted PAT fell around 79% year-on-year to ₹ 363 million due to an increase in Fixed Cost Absorption (D&A) expenses (up around 44% year-on-year).
Focus on Industry-Leading Growth: Management continues to focus on achieving above-industry growth, led by a) higher share in the high-growth compact SUV segment in HP thanks to the new Halol ability; b) new product innovations (ie SecuraDrive) are likely to generate market share gains among existing OEMs (eg Hero Motocorp, Mahindra); and c) a strong investment surge for FY22E-23E is likely to be ~ 18-19 billion (FY21: ₹ 6.4 billion); the expansion of high-volume TBR capacity would be the main driver of market share gains in the CV segment.
Maintain ADD: we appreciate CEAT’s plan to stimulate growth through market share gains (product innovations, new customer additions) while focusing on margins; however, sustained investment intensity and lower pricing power in the industry are likely to reduce FCF production and increase leverage (FY23E: ~ 22 billion yen). RoCE improvement is unlikely to exceed 15% in FY24, limiting potential valuation expansion. We reduced our profit for FY22E / FY23E by approximately 34/11%, respectively due to a large increase in fixed costs below EBITDA (eg depreciation expense). The stock has a modest FCF return (~ 4%) on a 23E year basis. We introduce FY24 and the rollover to Sep’23E and we reduce the target multiple for Indian activities to 13x FY23E EPS (previously: 14x) from 112. We maintain our ADD rating with a revised price target of 1,480 (previously: 1,487).