Buy This Small Cap Tyre Stock, Shares Can Surge 15%, Revenue Grew 18% YoY: Motilal Oswal

Motilal Oswal in its recent report maintains BUY call on CEAT Limited, a small cap Tyre company, with a target price of Rs 1,950. The brokerage sees a potential upside of up to 15% from its current share price, considering the given target price. It has a market cap of Rs 6,539.57 crore. The company recently announced its Q2FY23 results. It has reported a good performance.

CEAT's 2QFY23 performance was driven by healthy growth in OEM and better gross margins. Strong domestic demand coupled with softening RM prices from 3QFY23E would help drive healthy performance in the near term. Moreover, focus on key strategic areas such as PV/2W/OHT (to help margins) along with prudent capex plans (to benefit FCF) should be the long-term growth catalyst for the company.

Stock Outlook & Returns

The shares of CEAT today jumped 5.53% compared to its previous close, ending at Rs 1,706.05 per share, the current market price. The stock recorded its 52 week high on 16 September 2022 at Rs 1,785 and 52 week low on 20 June 2022 at Rs 890, respectively.

The stock has given positive returns over the years. In a week the shares surged by 11.52% and in 1 month by 8.64%, respectively. In the past 3 months, the stock has given 28.22% positive returns, whereas, in the past 1 year, the stock has given 34.73% positive returns. In 3 years, it has given 74.26% positive returns. However, in 5 years it gave a 0.25% negative return on investments.

 

Gross margin improves sequentially after seven quarters of decline

CEAT's 2QFY23 revenue grew ~18% YoY to INR28.9b while EBITDA/Adj. PAT declined 8%/44% YoY to INR2b/INR237m, respectively. Revenue for 1HFY23 grew ~31% YoY while EBITDA/Adj. PAT declined ~5%/50% YoY. Overall volumes rose 7% YoY, entirely driven by the OEM segment. Gross margin expanded 80bp QoQ (-4.4pp YoY) to 32.5% (v/s est. 33%). RM basket grew ~4% QoQ, offset by avg. price hike of ~4%. EBITDA margin contracted 200bp YoY to 7% (v/s est. 6.7%). EBITDA declined 8% YoY to ~INR2.03b (v/s est. INR1.85b). CEAT's 1HFY23 CFO improved to ~INR3.86b (v/s INR0.8b in 1HFY22), driven by a sharp reduction in W.C. and tax refund. Capex was largely similar at INR4.5b, leading to a negative FCF of just INR0.7b (v/s -INR3.9b in 1HFY22).

 

Highlights from the management commentary

Domestic demand outlook steady: OEM demand should continue to remain healthy while replacement demand shall improve gradually. Exports demand adversely impacted by macro headwinds: There were challenges in international markets like Indonesia and sub-continents. Recessionary pressure in Europe is likely to dent demand. Hence, the management expects exports to be subdued over the near term. RM basket was higher by 4% QoQ but largely negated by price hikes. The management expects RM basket to decline 2.5-3.0% QoQ in 3QFY23. CEAT took an avg. price hike of ~4% in 2Q spread out between Jul'22 and Sep'22. Major price hike of 8-9% was taken for 2W replacement in the mid of Aug'22, as there were no material price hikes in the 2W segment.

 

Valuation and view

Cyclical recovery in OEMs and stable replacement demand will enable faster absorption of new capacities and drive the benefit of operating leverage. This, coupled with softening RM prices, would help a partial recovery in margins in FY23E with full recovery expected in FY24. CEAT's valuations at 40.4x/13.3x FY23E/FY24E consol. EPS do not fully capture the ramp-up of new capacities and softening RM cost. Maintain BUY with a TP of INR1,950 (based on ~13x Dec-24E EPS).

 

Disclaimer

The stock has been picked from the brokerage report of Motilal Oswal. Greynium Information Technologies, the Author, and the respective Brokerage house are not liable for any losses caused as a result of decisions based on the article. Goodreturns.in advises users to check with certified experts before making any investment decision.