MRF - Q2FY14 Result Update - Challenging quarter, maintain Buy - Centrum

Rating: Buy; Target Price: Rs26,000; CMP: Rs21,880; Upside: 19%

Challenging quarter, maintain Buy

We retain Buy on MRF with a revised TP of Rs26,000. Surprisingly, despite correction in rubber prices, gross margins for 2QFY14 at 34.3% contracted by 97bps YoY and 52bps QoQ. We believe that gross margins on QoQ basis were impacted by product mix change (higher contribution from M&HCVs and higher OE off-take) and not by pricing action. Based on interaction with dealers and other tyre manufacturers, we understand that pricing discipline was maintained during the quarter and there was no increase in dealer margins or price cuts. While change in product mix appears to be the reason for impact on gross margins, we await commentary from other players to validate our argument.

Outlook on rubber prices continues to remain benign: Domestic rubber prices averaged Rs149/kg in 2QFY14 (Rs158/kg in 1QFY14) and is currently Rs138/kg. According to Association of Natural Rubber Producing Countries, the surplus in the global natural rubber market in 2014 will be 78% higher than estimated (652k MT in 2014 v/s 366k MT) due to weak demand environment and excess production expected in Thailand. For 2014, world output may rise to 12.2mn tons vs. consumption of 11.5mn tons. On the back of this, prices of international rubber may continue to slide and remain under pressure in the near term. There are indications that worldwide production will outpace demand over the next two years.

Operating results disappoint: Despite challenging environment, revenues at Rs.33bn grew 13.5% YoY and 3.1% QoQ, largely in line with our expectation of Rs33.3bn. However, EBITDA margins at 12.5% contracted by 278bps YoY and 58bps QoQ. Gross margins at 34.3% contracted by 79bps YoY and 52bps QoQ. We believe that QoQ contraction in gross margins has more to do with product mix change than pricing action. Reported PAT stood at Rs1,709mn, lower than our estimate on account of miss at operating level.

Earnings revised downwards: We are revising our earnings estimate downwards for FY14E and FY15E by 5.8% and 6.1% to reflect weaker than expected operating results for 1HFY14. The results for the last two quarters reflected lower than expected expansion in EBITDA margins. The company has indicated a capex of Rs8-10bn on annual basis. On the conservative side, we build higher range of capex for FY14E and FY15E at Rs10bn each.

Valuation and risks: We maintain Buy with a revised TP of Rs26,000 (earlier Rs26,900) to factor in earnings downgrade. The overall sector has seen re-rating on the back of favourable industry factors including sustained growth in replacement demand despite weak OE demand, benign rubber prices and relatively stable pricing environment. Further, rubber prices are currently at four year lows and lend visibility to strong margin profile for the industry in the medium term. Key risks: 1) Longer than expected replacement cycle and 2) Increased price competition from Michelin and Bridgestone.

Source : Equity Bulls

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