CEAT is now on a smooth path, and how! | Economic Times

Tyre maker CEAT is among the few companies in the auto ancillary sector which is likely to report profit growth for FY21 following a strong demand from the high margin replacement business. Its stock has outperformed the benchmark index by 26% over the past three months. The momentum is expected to sustain in the medium term given that an expected earnings growth of 10-12% for the current fiscal year may arrest the deterioration in the company’s return on equity over the past four years.The company reported a 7% sequential improvement in realisation to Rs 211 per kg in the September quarter even though the share of volume sold to automobile manufacturers fell by 10 percentage points to 17%. The uptick in realisation was due to the strong growth of 25-80% in the replacement demand across the segments from farm to trucks. The share of the replacement segment grew to 71% in the second quarter from 58% in FY20. As a result, overall volume of the company grew by 17% year-on-year to 93,175 tonnes. The operating margin improved by 470 basis points to a multi-quarter high of 14.8% due to a superior product mix and lower raw material prices.A few factors would help in sustaining the demand in the coming quarters. First, higher utilisation of farm equipment given good monsoon and higher sowing of crops, and rising farm income will keep the rural demand upbeat. The fleet utilisation by truck owners has also been improving as the economic activity in the country gathers pace. Lower reliance on tyres imported from China is another positive factor. About four years ago, India imported 1.5 lakh tyres monthly from China, which is now reduced to just 20,000 tyres.In addition, automakers have produced a record number of vehicles to cater to the festive demand. This will further support the volume growth. CEAT has consistently increased the wallet share among automakers which are growing more than markets. For instance, it has new orders form Kia Motors and MG Motors, which has helped in gaining market share in the passenger car category.Though CEAT’s volume dropped by 7.5% in the first half of the current fiscal year, the full year volume may grow by 4-5% given the current demand scenario. Analysts expect a volume growth of 15% for FY22. They have upgraded the operating profit forecast by 10-14% after the second quarter result.At Monday’s closing price of Rs 1,105.5, the stock was traded at 17 times one-year forward earnings, which was a 54% premium to the long-term average valuation. A sustainable volume recovery, improvement in the margin and richer product mix may support premium valuation in the medium term.