Equity Research: Ceat Ltd

Ceat Ltd. looks strong among its peer for further growth and increase in its CMP from its current level imparted by increasing EBITDA margin and PAT by FY24.

CEAT Ltd. With a combined market share of 12%, CEAT is one of India's top four tyre producers. The business was founded in 1958, and the RPG group purchased it in 1982. They also bought the rights to use the brand in a few Asian nations. The business serves both domestic and foreign markets. With factories, the company can produce 1300 MT of tyres per day, or 0.1 million tyres per day, and it has ambitions to increase that capacity. The manufacturing facilities for CEAT are located in Nagpur, Ambernath, Halol, Nashik, Bhandup (Mumbai), and Sri Lanka. The company makes many different kinds of tyres, including those for trucks, buses, 2/3Ws, cars, SUVs, LCVs, farm equipment, and specialty vehicles. The replacement market generates the largest portion, followed by OEMs and exports. With a 40% market share in Sri Lanka, the firm dominates that country's market and hopes to achieve similar success in Bangladesh. With approximately 3,400 dealers, 33 regional offices, and more than 500 C&F agents, CEAT has a sizable distribution network.

Leading tyre producer CEAT is well-positioned for both top-line and bottom-line development, thanks to the robust recovery in the automotive sector. The growth recorded at the beginning of the current year looks encouraging to us, with the 2W category holding a market share of 28% and contributing 28% of the volumes. Positive attitudes, strong monsoons, and the end of the pandemic are all helping the sector. Passenger Cars and Utility Vehicles (PCUV), the company's best-performing division, is gaining from new product introductions and the reduction of the chip scarcity. Along with strong exports, replacement demand improved significantly in Q1 FY23, which will help lift volumes in the following quarters. Margin improvement will also result from capacity increase in the OHT industry, mostly for exports (20% of volumes). With a lag starting in Q3 FY23, the impact of lowering crude oil prices on margins will be felt. The possibility of future price increases for RM should be covered by a pipeline of price increases. Even though capital expenditure is expected to rise, we anticipate financial leverage to stay in check (net debt/equity at 1x and net debt/EBITDA at 3x), which won't put undue strain on the balance sheet. We factor in a sales/EBITDA/PAT CAGR of 19%/40%/110% over FY22-FY24E, taking into account a robust demand outlook and rising profitability and return ratios.

Domestically, the business is seeing solid demand traction from OEMs, with replacement demand being consistent. On the exports front, demand in Europe & Indonesia is muted due to the unfavourable economic environment. However, robust demand is specifically being seen in the PV market with the chip supply issue alleviating. On the other hand, volumes in Sri Lanka are declining by 50–60% while Ceat's margins remain the same. In terms of margins, the business anticipates Q2FY23 to be comparable to Q1FY23, with a recovery beginning in Q3FY22. Over the medium term, Ceat wants to attain operating margins of between 10 and 12%. In terms of profitability, the replacement market industry is still more profitable than the OEM. Out of the 4,000 crores in projected capital expenditures for expanding capacity at the Chennai and Ambernath plants, Ceat has spent 3,300 crores over the last three years. The targeted capex for FY23E is $900 million, while the same amount is anticipated for FY24E to be $700 million, with a peak revenue potential of $ 13,000 million. The business is still dedicated to keeping debt to EBITDA at three times.

CEAT reported a respectable 9% qoq topline growth at 28.1 billion on 8% qoq volume growth and above 1% qoq realisations growth. YoY comparisons won't give us the appropriate picture because the second wave of the epidemic caused the base to be too low. The management reported that they have seen an increase in demand overall for domestic OEMs, replacements, and exports. 2 wheeler replacement demand is increasing nicely (15% qoq growth). The replacement PCUV market experienced the largest growth (20%), while truck demand remained stable. The OHT segment is the best-performing one among exports, with strong growth driven by expansion in Europe. However, because of the higher cost of the raw material basket brought on by high crude prices, EBITDA margins fell to 5.9% from 7.2%. RM to sales increased from 66.5% to 68.3%. As capacities expand, depreciation costs also increased. Recurring PAT decreased from 63% to 94 million (including the share of JVs and associates). With exceptional gains of 7 million, reported PAT totaled 25.5 million.

Margin Drivers Of CEAT:

The management stated that the 2% combined price increase they implemented in July and the 4% price increase they would implement in November will be sufficient to cover the increase in RM expenses and help margins as well. Capacity expansion from 60–70TPD to 80TPD and beyond should result in growth in both topline and profitability. The low margin OEM growth (which is currently looking good due to an eased chip shortage) would eventually be surpassed by higher growth in the Replacement segment (which accounts for 50% of volumes) and help margin growth. Exports (20% of volumes, up from 14% in FY21), will also increase margins. From 7.6% in FY22, we anticipate EBITDA margins to rise to 10%/11.6% in FY23E/24E.

Increasing OEM demand will push growth in CEAT Ltd:

With the exception of CV, most auto categories had a disappointing FY22. The current fiscal year, however, has been considerably different. The beginning of the fiscal year has already showed strong yoy and sequential growth in 2Ws (28–30% market share), a sector that lagged in FY22. Good monsoons, rising rural income, positive attitudes, a low base, the opening of schools and colleges, and the acceptance of the higher purchasing cost should all contribute to improving demand for two-wheelers. As and when the chip issue is resolved, PVs should show exponential growth. With gasoline prices anticipated to decline, the market for PVs is predicted to continue to climb. Newer technologies like EVs and alternative fuels like CNG are also in high demand. The CV cycle is increasing as the economy is recovering, and additional factors such as growing freight rates, domestic investment capex that is increasing, and momentum in the mining and construction industries should all point to a strong performance in the upcoming quarters. With a healthy monsoon and a decent farm produce, tractors should expand at a mid- to high single-digit rate this year. According to management, CEAT showed 9% increase qoq in the previous quarter whereas OEM growth was only 2%. In the upcoming couple of quarters, the demand should normalise across all of the car sector's categories. The introduction of new products in all the segments should help CEAT's volume to increase.

Commercial Vehicles will impart growth to CEAT Ltd:

The Trucks and Buses category, which accounts for 30% of CEAT's overall top line, has the biggest contribution (8% market share in Radial and 12% in Bias). The highest rate of growth among the car industry segments in FY22 was displayed by this segment, which increased by 26%. On a strong basis, this segment's sequential growth was unchanged in Q1 FY23. With each of the major Indian CV manufacturers, CEAT has a sizable portion of the market. In the future, CVs will reap the most benefits from the government's ongoing efforts to maintain momentum in the nation's investment capex. The importance of last mile transportation has increased since the pandemic period, particularly on the LCV side of the spectrum (9% of CEAT's topline). Small trucks are in demand from end-user businesses like FMCG, e-commerce, pharmaceuticals, etc., while bus sales have increased significantly since schools and colleges have resumed operations. Even electric buses are popular right now due to increased industry demand for them and significant investments being made by major OEMs. The category for trucks and buses should continue to grow rapidly as a result of all these causes.

Increase in Replacement Demand and Exports:

Replacement demand increased by 10% year over year in Q1 FY23, from 50% in Q1 FY22 and 56% of topline in FY22. We anticipate that the 2Ws (15% up in Q1) and PCUV (20% up in Q1) categories will continue to have rapid growth in replacement. According to the tyre life cycle, the OEM demand strength exhibited in these two sectors in FY17-18-19 would translate into strong replacement demand in FY23 and FY24. However, we anticipate a reasonable growth to continue in the upcoming quarters. CV demand on the replacement side was flattish in Q1 on high base. Given the high profit profile of the replacement segment along with the Trucks & Buses segment, which is a high margin business, this could also aid in margin expansion. 

In comparison to 14% in FY21 and 12% in FY19, exports made up 20% of revenue in FY22 and Q1 FY23. Exports have been strong due to Europe's large contributions in FY22 and Q1 FY23. The effects of channel expansion over the past few years are now positive. When the TBR tyres were introduced in Q1, the company already had a presence in PCUV and OHT tyres. In the upcoming quarters, the company plans to launch TBR and PCUV in North America. Indian tyre manufacturers are benefiting from the China+1 sourcing strategy in the major export markets.

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Leading domestic and international tyre producer CEAT is expected to experience solid top- and bottom-line growth due to the strong recovery in the automotive sector. With a 28% market share in the 2W segment (which contributes 28% of the volumes), the growth we have witnessed so far this year seems good. Positive attitudes, a strong monsoon, and the end of the pandemic are all helping the sector. The company's best-performing category is Passenger Cars and Utility Vehicles (PCUV), which is gaining from recent launches and the easing of the chip shortage problem. In Q1 FY23, replacement demand also increased significantly, which will help to drive future quarters' figures and bodes well for profitability coupled with strong exports. Margin improvement will come from increasing OHT capacity, particularly for the growing exports (20% of volumes) market. With a lag effect, the impact on margins from falling crude oil prices will be apparent from Q3 of FY23 onward. If there has been or will be any increase in RM prices, the pipeline of price increases should make up for it. We anticipate financial leverage to stay under control (Net Debt/Equity 1x and Net Debt/EBITDA 3x), not placing undue burden on the balance sheet despite rising spending. Taking into account an extremely favourable demand prognosis as well as increasing profitability and return ratios, We factor in a Sales/EBITDA/PAT CAGR of 21%/48%/126% over FY22-FY24E given the solid demand expectation and rising profitability and return ratios, Thus Ceat Ltd look strong at CMP of Rs. 1707 for a target of Rs.2080

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  Shreyansh

  24 November, 2022, 2:04 pm
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