CEAT

A sustained revival in passenger vehicle sales, signs of recovery in commercial vehicles production, healthy replacement demand and cost controls paint a good picture for tyre manufacturer, CEAT. At Rs 163, the stock trades at a valuation multiple of 10.2 times its trailing 12-month earnings, cheaper than most peers. CEAT’s tyre-client portfolio is far-reaching, covering passenger cars, two-wheelers, trucks and buses, light commercial vehicles, earth-moving equipment and so on, with a 13 per cent market share. However, concerns linger over effects of exchange rate fluctuations, vulnerability to rubber prices and sustenance of demand from commercial vehicles. Investors can retain the stock, but can use price falls linked to broader market declines to accumulate it.
Demand revival

Supply to auto manufacturers has been on the wane in the past year but CEAT has made up for the fall through its strength in the replacement market. This segment grew overall by 10 per cent in June ’09 with the trucks and buses (T&B) segment and light commercial vehicles (LCV) segment accounting for a lion’s share.

About 79 per cent of the June 2009 quarter sales for CEAT can be attributed to the replacement market, up from the 70 per cent for 2008-09. Even with a good part of sales stemming from trucks and buses, given that tyres for such vehicles are generally replaced in 12-18 months, there remains a substantial demand for replacement tyres. To reach its wide customer base, CEAT has a national store network of 3,500 dealers, including 100 exclusive outlets called CEAT Shoppe for passenger cars, up from the 75 that it had the year before. Besides, the company has around 96 CEAT ‘HUBs’ for trucks and buses.

On the OEM front, production is showing signs of recovery in the key commercial vehicle segment. Tyre production in the T&B segment showed a growth of 6.2 per cent in June ’09 over the same period last year. OEMs account for just about 8 per cent of CEAT’s sales, but cater to a broad range of manufacturers such as Hero Honda, TVS, Piaggio, Maruti, Ashok Leyland, Eicher, John Deere and others.
Radial tyres

Radialisation is a technological development that reduces tyre friction and improves fuel economy. The domestic passenger car segment is almost fully radialised, but the T&B segment is at 10-12 per cent levels only against the global average of 60 per cent. It is this segment that holds promise for CEAT, with very few players in the segment currently.

Towards this end, the company is setting up a 140 tonnes per day (tpd) radial tyre plant in Gujarat with an investment of Rs 500 crore, funded by debt and internal accruals.

The plant will be operational from mid-2010 and is expected to contribute to revenues from the second half of FY-10. Besides this, capacity expansion for its plant at Nashik by about 35 tpd is on the cards, which will aid volume growth. CEAT is aiming at improving its passenger vehicle offtake though it will remain focused on the T&B segment.
Role of raw material

The primary raw material for making tyres is rubber, accounting for 42 per cent of raw material consumption. This cost played a significant role in the 77 per cent operating profit fall in FY-09 over the preceding year. As a percentage of sales, raw material costs moved from 66 per cent in FY-08 to 72 per cent in FY-09.

During the year, rubber prices touched a high of Rs 135 per kg, only to crash to Rs 65 per kg in early 2009. Consequently, the company pulled out of losses, posting a net profit of Rs 60 crore in the June ’09 quarter over a loss of Rs 10 crore in the corresponding previous period.

But in response to the upswing that rubber prices are now riding, the company will hike tyre prices by 3-5 per cent, and which may ensure that tabs are kept on cost overruns. On another positive note, CEAT managed to marginally improve turnover of inventory in FY-09 to 9.8 times from the 9.3 times the year before.
Financials

Sales grew at a CAGR of 13 per cent in a three-year period, due largely to the poor performance of FY-09. Though the company sustained losses at the net level in FY-09, it still maintained operational profitability.

Operating profit margins for FY-09 stood at 3 per cent, improving to 16.3 per cent in the June quarter. Net profits margins are at 8.9 per cent. Debt-equity ratio stands at 1.14 times, on a par with most peers, but interest costs could cut into gross profit margins with additions to debt likely to fund its new plant.
Risks

Investors must, however, note that the company faces quite a few risks. For one, it is vulnerable to fluctuations in raw material prices. Exports contribute 17 per cent of sales numbers and CEAT imports raw materials as well; the company has hitherto suffered sustained forex losses. Though radial tyres hold promise, the segment is still in its infancy and will begin to contributing to revenues from the next financial year.