Ceat: A good grip

Robust demand in the replacement market, a cyclical upturn in new vehicle sales and benign raw material prices spell good times for Ceat. This tyre manufacturer caters to all segments , be it trucks, buses, cars, utility vehicles or bikes. Auto makers such as Tata Motors, Ashok Leyland, Maruti, Hyundai, Hero MotoCorp and Royal Enfield are among its clients.

Market volatility has seen the stock correct about 20 per cent since it touched a one-year high of ₹1,318 in early October 2015. This presents a good buying opportunity for investors with a perspective of one to two years. The stock currently trades at around 9.8 times its estimated earnings for the year ending March 2016. Peers, such as Balkrishna Industries trade at a higher 11.7 times.

Strong demand Tyre makers usually derive a substantial portion of their revenues from secondary market sales, as old tyres need to be replaced. This segment fetches higher margins than direct sale to auto manufacturers, as tyre makers have greater pricing power here. Also, replacement demand is independent of new vehicle sales, which goes through cyclical ups and downs. Ceat derives about two-thirds of its revenue from the domestic replacement market.

Hence, despite deriving 30 per cent of its revenues from the two-/three-wheeler and farm equipment segments, where new vehicle sales are currently in a slowdown, the company has seen 5-10 per cent volume growth in the first half of this year. Good replacement demand in other segments, such as cars and commercial vehicles (CVs), has also helped. Besides, the company has benefited from the cyclical upturn in the sale of new cars and CVs this fiscal.

In the first eight months of fiscal 2015, car industry sales have shown a volume growth of 11.4 per cent over the same period last year. Ceat has been roped in for supplies to recent launches, such as the Renualt Kwid and the Mahindra TUV 300. Sales volumes of heavy trucks and buses have grown 31.4 per cent in the same period. These trends will continue to favour the company over the next two years. Ceat will also benefit from the increasing radialisation levels in CV tyres.

Radialisation is expected to double from current levels of about 30-35 per cent in the next few years. Radial tyres bring higher margins than bias tyres. 

Raw material benefits These apart, benign prices of natural rubber and crude oil favour the company. Prices of RSS 4 variety of natural rubber used by tyre manufacturers, which touched a peak of ₹240 a kg in 2011, have been cooling off since late 2013. They have stabilised at around ₹120 a kg in the last few months. International prices too have followed a similar downtrend. With the International Rubber Study Group projecting adequate natural rubber supply to meet demand until 2017, a sharp spike in rubber prices is not expected in the near future.

Besides, thanks to falling oil prices, crude oil derivatives, such as synthetic rubber, nylon tyre cord and carbon black used in tyres, have also become cheaper. Due to these factors, Ceat has already seen solid expansion in operating margin in the first half of this fiscal.

Financials

For the half year ended September 2015, net sales at ₹2,755 crore was at best flat compared to the ₹2,770 crore recorded in the same period last year. Although volumes grew in high single-digits, price cuts to pass on low raw material costs and competition from Chinese tyres, both in the domestic operations and in exports markets such as Brazil, Indonesia and Nigeria, affected topline. Ceat derives about 10-15 per cent revenues from exports.

But the benefit of cheap inputs has lifted the bottomline. Net profit in the first six months ended September stood at ₹233 crore, up a whopping 80.5 per cent from ₹129 crore in the six months ended September 2014.

With stiff competition from Chinese tyres in the unorganised market, pricing pressures may remain. But benign raw material costs will continue to support profit growth. The company will also benefit from lower interest costs. Debt-to-equity ratio has now fallen to 0.35 from 0.86 a year ago.

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