nse code ceatltd investment rationalebreport.myiris.com/skp/ceat_20120529.pdf2012/05/29 ·...

May 29, 2012

CEAT Ltd.

Ready to race…….

SKP Securities Ltd www.skpmoneywise.com of 14

CMP Rs 95 Target Rs 145 Initiating Coverage - Buy

Face Value (Rs.) 10Equity Capital (Rs.Cr) 34.2M. Cap (Rs. Cr.) 33552-wk High / Low (Rs.) 117.8/66.2Avg. Daily Volume (qtrly) 5,760,098BSE code 500878NSE code CEATLTDReuters code CEAT.BOBloomberg code CEAT IN

Key Share Data

Shareholding pattern ( as on March 31,2012)

Promoter, 52%

MF/Banks,20%

FII/NRIs, 2%

Indian Public/Others, 26%

Source: Company &SKP Research Financials (Standalone) (In Cr.)Particulars FY11 FY12 FY13E FY14ENet Sales 3468.3 4439.3 5295.4 5715.8Sales Gr. 24% 28% 19% 8%EBIDTA 92.7 223.0 391.5 443.1EBIT 58.4 152.5 287.1 326.5Adj.PAT 21.3 7.6 107.2 133.7EPS (Rs.) 6.2 2.2 31.3 39.0CEPS (Rs.) 16.2 22.8 61.8 73.1Key Ratios FY11 FY12 FY13E FY14EP/E (x) 16.6 46.3 3.3 2.6P/BV (x) 0.5 0.5 0.5 0.4P/CEPS (x) 6.0 4.3 1.6 1.3M.Cap/Sales (x) 0.10 0.08 0.06 0.06EV/EBIDTA (x) 14.1 6.2 3.4 3.2ROCE (%) 4% 8.2% 16.0% 16.4%ROE(%) 3.3% 1.2% 14.4% 15.4%EBIDTAM(%) 2.7% 5.0% 7.4% 7.8%Debt-Equity (x) 1.6 1.6 1.4 1.3

Price Performance CEAT vs BSE Small Cap

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BSE SMALL CAP

CEAT

Company Profile CEAT Ltd. (CEAT), a flagship company of the RPG Enterprises, is among the leading tyre manufacture. CEAT’s market share is 12% of Indian tyre market, manufactures 10 million tyres every year. CEAT owns two tyre manufacturing facilities in Maharashtra (Bhandup & Nasik) and has also set up a green field radial tyre manufacturing facility at Gujarat (Halol). Company has a subsidiary in Sri Lanka which manufactures bias tyre and radial tyre.

Investment Rationale

Industry to move towards Radialisation: Tyre industry is structurally shifting from bias to radial tyre. In India

radialisation is still only16% for the truck and bus (T&B) segment compared to 65% of the global average.

CEAT’s Halol radial plant is expected to ramp up production to 135 TPD by Q4FY13. This will fulfill the appetite, in the dynamically changing market scenario.

Capacity Expansion to propel growth in the company: CEAT launched its radial capacity plant in Q4FY11, ramped up the

production to 90 TPD in Q4FY12 and targets further ramp up to 135 TPD in Q4FY13 and expected to operate at maximum capacity utilization of 145 TPD by FY14.

Growth opportunity with the replacement market to enhance the margin:

We expect replacement demand to increase sharply which will push the margins upward, as the margins are higher in the replacement vis-a vis OEM and export segments.

CEAT is also focusing to shift from the low margin commercial segment (T&B) to high margin Passenger segment (2-3 wheelers).

Capex plan of the year:

CEAT plans to invest Rs 250 cr. toward setting up of a green field bias tyre plant in Bangladesh with an initial production capacity of 65 TPD.

Capex for the new plant will be incurred in FY13 and project is expected to kick off in Q1FY13.The commissioning of the plant is expected in Q1FY15.

Company targets to achieve 60% of the market share of the Bangladesh. Outlook & Recommendation:

We expect CEAT to report improved EBIDTA margins on the back of softening raw material prices and increase in production at the Halol plant. At current market price of Rs 95, Stock is trading at an EV/EBIDTA of 3.5x & 3.02x for FY13E and FY14E respectively.

We recommend BUY rating on the stock with a target of 145 (47%UPSIDE) at the EV/EBIDTA of 4x on FY13E earning over the period of 18 months.

Analyst: Savitree Singh Tel No.: +91 22 2281 9012; Mobile: 9594287717 Email: [email protected]

CEAT Ltd.

SKP Securities Ltd. www.skpmoneywise.com of 13

Industry Overview

The Indian Tyre industry accounts for approximately 5% of the Global tyre demand, generating revenues of approximately Rs 30,000 cr, for FY11, out of which 66% accounts for the replacement market. Truck and Bus (T&B) segment contributes ~60% of the total volume. Top players in the market are MRF, APOLLO, JK Tyre, BIRLA and CEAT. They account for 85% of the total industry sales and rest of the market is occupied by the small players.

27%

19%

16%

12%

11%

15%

Industry Scenario MFR

APOLLO

JK

CEAT

BIRLA

Others

Source: Company & SKP Research.

India has emerged as one of the world’s most competitive tyre market because of huge availability of

its major raw material i.e. natural rubber. However, FY09 was little discouraging for the tyre industry because of recession, hence demand and supply scenario got impacted but industry recovered in FY10 with the fast growth in overall tyre industry.

The Indian tyre market has attracted global players on account of encouraging growth figures. Hence, huge investments are expected in the industry over the next few years.

Tyre Sector Overview:

Tyre industry is highly raw-material intensive industry, wherein raw material cost accounts for approximately 70% of the total turnover of the company & 63% of total Natural Rubber consumption goes in Tyre Sector. A figure shown below depicts volume wise composition of raw material in bias as well as radial tyres.

46%

5%12%

22%

5% 10%

Raw Material Composition in Bias-Tyres

Natural Rubber

Synthetic Rubber

Fabric

Carbon

Chemicals

Others

39%

5%20%

23%

5% 8%

Raw Material Composition in Radial -Tyres

Natural Rubber

Synthetic Rubber

Steel Cord

Carbon

Chemicals

Others

Source: Company & SKP Research

CEAT Ltd.


Raw Material Availability:

1. Natural Rubber: India stands at the fourth place in the production of natural rubber and second place in

world consumption. Lower grade Ribbed Smoked Sheets (RSS4 & RSS5) are used for the for the manufacture

of bias tyres and retreading materials and all other general products. RSS 3 and RSS 4 are the preferred raw material for radial tyres.

Kerala accounts for 90% of the total Indian production of natural rubber wherein 72% of the total rubber production is in the form of RSS.

Rubber form nearly 70% of the input costs of the total tyre production hence, any upswing in the prices of rubber will enforce tyre companies to increase the tyre cost.

2. Nylon Tyre Cord Fabric:

A nylon tyre cord fabric is a core reinforcement material that is used in making bias tyres for trucks and buses (T&B) as well as tyres for other land vehicles.

A nylon tyre cord fabric provides higher tenacity, heat resistance, and higher temperature strength retention to the tyre, also due to its excellent adhesive force over rubber; nylon tyre cord is mainly used to manufacture bias tyres.

3. Carbon black: It provides balance of treads wear, rolling resistance, and traction to the tyre.

4. Others: Two type of synthetic rubber are used in tyre, one is poly butadiene rubber (PBR) and

another is styrene butadiene rubber (SBR). Most of the raw materials used are petro based so directly they are linked to crude prices.

Industry to shift toward Radialisation:

Radial tyres have longer life span compare to non-radial tyre and also have greater mileage and fuel saving.

PV (Passenger vehicle) segment Radialisation has crossed 98% of the mark in India but in CV, MHCV & LCVs radialisation is still very low and we do expect it to go up in the coming years. There are many factors which affect the Radialisation.

Factors that affect Radialisation:

Cost Benefit Ratio: Radial tyre costs are higher compared to bias tyre. Benefit of radial tyres are in

terms of longer life, lower emission of harmful green house gases and easing of pressure on global oil reserves due to fuel efficiencies provided by higher than extra mileage, so these features will increase demand of radial tyres in the coming years.

Road Development: Proper roads infrastructure will leads to demand of radial tyres. Overload Control: Supreme Court had in November 2005 passed an Order directing State

Governments to ensure that commercial vehicles are loaded only as per norm prescribed under the Central Motor Vehicle Rules.

User Education: Demand in India is less compared to other countries due to unawareness about the positive aspects of the Radial tyres. Proper awareness among users will make them confidant to shift there move from bias tyres to Radial tyres.

CEAT Ltd.


OEM growth trend in different category of vehicles:

Growth in the CV segments has gone down from FY10 to FY11 but at the same time there is growth in the PV segments.

Growth in the tyre industry is directly proportional to the growth in the automobile sector.

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2006-07 2007-08 2008-09 2009-10 2010-11

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CV

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3-Wheelers

Source: Company & SKP Research.

Growth in PV car segment is very much dependent on interest rate scenario in the market. PV is

growing at slower rate than CV segment, but with the softening of interest rate and lots of new model is hitting the market, we can expect PV demand to grow by 5%, CV by 7-8% and 2-whellers by more than 10%.

The Company: A Snap Shot

CEAT Ltd. (CEAT), established in 1958, is a flagship company of the RPG Enterprises, is among

the leading tyre manufacture in India. Market Share: CEAT has captured over 12% of market share and manufactures 10 million tyres

every year. Manufacturing facilities: CEAT owns two bias tyres manufacturing facilities in Maharashtra

(Bhandup & Nasik) and has also set up a greenfield radial tyre manufacturing facility at Gujarat (Halol), Details of which are as follows.

Geographies Country Capacity (TPD)* Tyre TypeBhandup India 250 BiasNasik India 200 BiasHalol India 150 RadialSri Lanka (Through the Subsidiary) Sri Lanka 55 Bias & RadialOutsourcing Diff. Countries 150 Bias

Source: Company & SKP Research; *FY12 figures

Bhandup plant is the oldest one and is being operated at the maximum capacity level, but due to heavy octroi duty payment every year, company is planning to shift this plant in Ambernath (Maharashtra).This is expected to take one and half year.

Majority of CEAT revenue is generated from the replacement market. Sri Lanka facility also outsources certain amount of automotive tubes, tyres and flaps.

CEAT Ltd.


CEAT increased its market share from 11% to 14% in FY12 in 2-3 wheeler segments. We expect the company to increase its market share to 17-18% in FY13 in 2-3 wheeler segments, on the back of very strong brand equity.

Revenue breakup and volume –wise distribution:

Company generates its 89% of the revenue from tyre and rest comes from flap and tubes. Company caters to the 66% replacement market and 20%, 15% to the Export and OEM market

respectively as on FY’12.

89%

11%

1%Segmental Revenue Breakup

Tyres

Flaps

Tubes66%

14%

20%

Volume -Wise Product Distribution

Replacement

OEM

Export


Investor Rationale:

1. Industry to move toward Radialisation-improving product mix and margins:

Rate of radialisation is an index of the status of

the road development and economy. Radialisation is slowly gaining popularity in PC segment.

Tyre industry is experiencing a fast and structural shift from bias to radial tyres. Radial tyres have already replaced bias tyres across the world.

PV tyre segment where radialisation has crossed 98% mark in India is expecting to reach 100% in two to three years.

Radialisation in CV is as low as 16% compared to global average of 65%. OEM demand is also driving the tyre industry and thereby have pushed the tyre manufacturer to

increase their production and capacity of their plants. Keeping in view the above details the Company has set up a new greenfield plant in Halol for the

radial tyres with the installed capacity of 150 TPD. Halol plant has started its production from Q1FY12 with the initial production of 35 TPD and now being operated at 90 TPD in Q4FY12.

Halol plant production expected to touch 135 TPD in FY13 & 145 TPD (full capacity) in FY14.


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Trend of Radialisation

Bias Tyre Radialised

CEAT Ltd.


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As from the above chart, increase in production at the HALOL plant for the radial tyre will push the margin toward upside.

Focus on Non-Truck segment to increase Margin: Company is focusing on changing its product portfolio by reducing exposure in T&B bias segment to non T&B segment and T&B radial tyre segment to increase the margin and exposure in the changing market.

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Segment Wise Product Distribution

Speciality

Farm

Car/Jeep

LCV

2-3 Whellers

Truck & Buses


Structural shift from commercial vehicle to passenger vehicle:

Company is shifting its client base from T&B to 2-3 wheelers, which is high margin segment.

OEM segment, is a low margin segment and its contribution has gone up from FY10-FY12.

As from the chart , relpacement segment have gone down on the cost of increase in the share of OEM and export segment contribution.

Replacemnt market, is the high margin business where company is focusing to increase its presence.

We, therefore, expect this to reflect positively on the EBIDTA as well as bottom line of the company in the coming years.

High Margin Segment


69%

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FY10 FY11 FY12 Q4 FY12

Shifting Client Segment Mix

Replacement OEM Export

CEAT Ltd.


Volatility in raw material prices to affect the margins: Natural rubber plays the major role in the composition of raw material, it accounts approximately to 70-72% of the total revenue of the company. Since rubber prices are quite volatile, thus, any volatility in the price will affect the margin. Rubber price volatility at a glance:


After reaching at its peak now the rubber prices are started softening thus, we expect the

margins to improve in the near term. Lag between the Raw material prices and selling price to boost margin in near term: We

believe that increase in tyre prices is lagging behind the increase in input cost. This is because of intense competition in the market.

From the chart below we observe that accelerating increase in raw material prices force the company to increase the prices of the product but now rubber prices have started softening , hence further decrease in the raw material prices will put positive effect on the company EBIDTA, so we can expect improvement in the margin from here onward.

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RM Price Hike


2. Greenfield plant in Bangladesh-Coats to attain 60% of the market:

CEAT plans to invest 250 cr. for setting up a green field bias tyre plant in Bangladesh with an initial production capacity of 65 TPD.

Capex for the new plant will be incurred in FY13 and project is expected to kick off in Q1FY13.The commissioning of the plant is expected in Q1FY15.

Company will spend around Rs.70 cr in FY13 and rest Rs.180 cr in FY14 for the establishment of Bangladesh plant.

CEAT will be manufacturing mainly truck, light truck, 2- wheeler tyres in the Bangladesh plant.

CEAT Ltd.


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FY11 FY12 FY13(E) FY14(E)

Growth in ROE & ROCE

EBIDTA PAT ROE ROCE


We can decipher from the above chart that changes in product mix and move toward high margin

business is expected to provide a good growth in the company.

3. Shift in the Bhandup plant to save octroi duty in the long run: CEAT Bhandup plant is the oldest bias tyre plant. Company is planning to shift this plant in

Ambernath by the end of FY13. Company has already acquired land in Ambernath. Company will end up saving Rs. 40 cr of octroi duty ever year (Company has to pay octroi to govt.

because it comes under the Mumbai district purview so, finished products have to pay octroi duty as per govt. rule) once the plant will shift from Bhandup.

4. Replacement market to improve margin: Margin from the replacement is higher compare to the OEM and export. Company expects to increase the share in the replacement demand by increasing presence in the

market through the advertisements & campaigns. CEAT successfully launched an “IDIOT SAFE” 2W campaign, and because of that company saw

4% increases in market share for the 2-wheelers and PV segments. CEAT has been able to increase its share in the replacement market by increasing its network

through various ways. Increasing network over the period of time:

CEAT with 38 regional offices,8 zones and 3500 dealers provides extreme network in India. CEAT exports to more than 100 countries including USA, Africa, America, Australia and Asia.

CEAT Ltd.


3075

100 70

FY2007Dealers

C&F agents

Sales offices

Export countries 3882

110

FY2011Dealers

C&F agents

Sales offices

Export countries


5. Expenditure toward the Brand building: CEAT recently acquired “CEAT” brand from Italy-based Pirelli for Rs 55 cr. which would enable

the company to export radial and bias tyres to the whole world under the ‘CEAT ‘brand. CEAT Limited is currently the owner of the CEAT brand in nine South Asian countries-India, Sri

Lanka, Bangladesh, Myanmar, Pakistan, Bhutan, Nepal, Afghanistan and Vietnam. Pirelli is the owner of the CEAT trademark in the rest of the world. We expect the company to generate higher export revenue from Q1FY13 onward.

Subsidiaries:

Company has a subsidiary in Sri Lanka which is JV between CEAT and Kelani group. CEAT has acquired 100% stake in Associated CEAT Holding Company Private Limited

(ACHL). Now ACHL has become wholly owned subsidiary of the company. ACHL controls 50% stake in the Joint venture company viz. CEAT Kelani Holding Private

Limited which in turn has three wholly owned tyre manufacturing companies. Sri-Lankan subsidiary is the only manufacturer of the tyre in Sri-Lanka with the strong market share

of more than 40%. CEAT has strong brand equity because of that company margins have been consistently strong and

EBITDA has been at about more than12%. Subsidiary prepares the high margin product. This JV dominates the Sri Lanka tyre market with 50% in LCV, M & HCV and CV market. Company has 18% market share in Passenger vehicle radial segment. This is sort of mutual benefit

kind of thing. Kelani tyres provide market for the CEAT to get in to the Sri Lankan market and CEAT provides technology.

Sri- Lanka capacity is 55 TPD; they export to other market Nigeria, Singapore, Egypt and Dubai. Sri Lanka plant manufactures bias tyres and radial tyres, in which 50% is consumed by the Sri

Lankan market and remaining tyres exported to different countries.. Sri Lanka is hub for the production of Natural rubber, so they don’t need to import the raw material

from the out side. JV company, being the sole producer of tyres in Sri Lanka, has the bargaining power and ability to

pass on increased cost to the market , therefore company margins are quite high compare to CEAT itself.

Subsidiary Performance: Sri Lanka operation reported growth in sales and EBIDTA by 20% & 17% respectively.

CEAT Ltd.


This happened despite of reduction in import duty of 50% in November last year. Company is expecting to grow tyre demand by 10% going forward.

Subsidiary EBITDA has been consistently been at about more than 12% .

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Subsidiary to push the growth on the company: RPG group-owned Ceat has acquired the global rights of brand’ Ceat’ from Italian tyre maker Pirelli for

Rs 55 cr. Pirelli will completely stop sales of tyres under 'Ceat' brand after December 31, 2012, when Ceat will get

all exclusive rights for the brand. The acquisition will enable Ceat to export radial and bias tyres worldwide under the ‘Ceat’ brand. The company currently exports its tyres to Europe and South America under the 'Altura' brand. We do expect, deal will enable Ceat to double its export revenues. CEAT owned the brand CEAT in nine (India, Sri Lanka, Vietnam, Pakistan, Nepal, Myanmar, Bhutan,

Afghanistan, and Bangladesh) south-Asian countries and used to export in Europe and Latin America under the brand name ‘Altura’ brand. But after this company can export radial and bias tyres to whole world, under the CEAT brand name.

Key Concerns:

Rising raw material cost and volatility associated with the rubber prices: Natural rubber is the key raw material for the tyre industry. Domestic prices of the natural rubber rose

almost 280/kg in recent times due to both the global as well as domestic supply concerns .We believe any further rise in the prices of natural rubber would impact profitability of the company. Delay in Capacity expansion at Halol Plant:

Halol plant capacity is 150 TPD but currently it is being operated at 90 TPD so any delay in the capacity addition would adversely affect the company.

CEAT Ltd.


Threat from the Chinese Market: Radialisation is one of the important structural changes that the tyre industry of India has begun to

embrace. The huge supply-demand gap in the Indian market has shown Chinese competitor to invade their way in Indian market with their competitive pricing structure.

Regional Trade agreements of India (RTA) has also helped the Chinese tyre to enter in India market. But to encounter these problem govt. have imposed Anti dumping duty (ADD) to provide India manufacturer with the same platform but despite this though , Chinese tyres remain cheaper and will make their presence in the market.

Rise In crude oil prices:

Most of the raw material of the tyre industry are crude oil by- products like Synthetic rubber ,Nylon tyre cord ,carbon etc.so any upswing in the prices of crude will accelerate the prices of raw material.

Financial Outlook:

Net Sales Growth to remain high on the back of Halol plant capacity addition:

Net sales gone up to Rs. 4439 cr in FY12, registering a growth of 28% on y-o-y basis, due to new capacity addition of Halol plant. Halol plant is expected to increase its production on FY13 which will give the good growth in the company. We expect the net sales of the company to grow at the 15% CAGR over FY10-15 on the back of change in product mix and capacity addition at

the new plant.


High EBIDTA Margin growth: CEAT has witnessed an EBIDTA margin of 5.02% on standalone basis and 6.1% on the consolidated basis .Reason of low margin was very high volatility in natural rubber prices. But company is expecting margin on upside because of softening in rubber prices as well as change in the product mix.

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Net Sales

CEAT Ltd.


Valuation: We expect CEAT to report improvement on EBIDTA level on the back of softening in raw material

prices and increase the production at the Halol plant .At the current market price of Rs 95, Stock is trading at a EV/EBIDTA of 3.5x & 3.02x of EBIDTA FY13E and FY14E respectively.


We recommend BUY rating on the stock with a target of 145 (47% upside) at the EV/EBIDTA of 4x on FY13E earning over the period of 18 months.

CEAT Ltd.


Financial Performance: (In Rs Cr)

Income Statement FY11 FY12 FY13 (E) FY14 (E)FinancialsNet operating income 3468.3 4439.3 5295.4 5715.8Operating Expenditure 3375.6 4216.4 4903.9 5272.7EBIDTA 92.7 223.0 391.5 443.1Depreciation 34.2 70.5 104.4 116.6EBIT 58.4 152.5 287.1 326.5Interest 78.5 192.2 190.6 195.6Other Income 60.2 52.5 63.5 68.6PBT 32.3 9.6 160.1 199.5Tax 11.1 2.0 52.8 65.8Adj PAT 21.3 7.6 107.2 133.7EPS 6.2 2.2 31.3 39.0

Balance Sheet FY11 FY12 FY13 (E) FY14 (E)Equity Capital 34.3 34.3 34.3 34.3Reserves 608.8 618.5 708.5 834.2Share Warrants 6.1 3.6 0.0 0.0Net worth 649.1 656.4 742.8 868.5Loan Funds 1018.9 1070.8 1053.0 1125.9Deffered tax liabiity 24.1 22.4 22.4 22.4Total Liabilities 1165.6 1156.4 1409.7 1544.8Net Fixed Assets 1361.1 1537.5 1433.1 1566.5Capital WIP 123.4 0.0 70.0 0.0Investments 86.5 74.5 74.5 74.5Net Current Assets 121.1 137.6 240.6 375.7Total Assets 1692.1 1749.6 1818.2 2016.7

Cash Flow Statements FY11 FY12 FY13 (E)

FY14 (E)PBT (less exceptional item) 32.3 9.6 160.1 199.5

Add:Depreciation ,interest & Other Expenditure 33.0 69.7 106.4 116.6

Operating Profit before cash flow changes 20.5 -27.3 -97.4 -132.2

Direct Tax paid -15.6 2.0 -52.8 -65.8Net cash from Operating Activities 131.9 48.6 116.2 118.1

Cash flow from invstment activities -483.6 -110.7 -72.0 -180.0

Net Cash from Financing ActivitieS 252.8 47.9 -25.8 64.8

Net (decrease)/ increase in cash and cash equivalent (A+B+C)

-98.9 -14.2 18.4 2.9

Opening Cash Balance 139.6 47.4 33.2 51.6Closing Cash Balance 47.4 33.2 51.6 54.6

Financial Ratios FY11 FY12 FY13 (E) FY14 (E)Valuation Ratios(x)P/E 16.6 46.3 3.3 2.6P/CEPS 6.0 4.3 1.6 1.3P/BV (x) 0.52 0.51 0.45 0.39EV/EBIDTA 14.1 6.2 3.4 3.2Market cap/Sales (x) 0.10 0.08 0.06 0.06EV/Sales 0.38 0.31 0.25 0.25

Earning Ratios (%)EBIDTAM 2.7% 5.0% 7.4% 7.8%ROCE 4% 8.2% 16.0% 16.4%ROE 3.3% 1.2% 14.4% 15.4%

B/S RatiosD/E(x) 1.6 1.6 1.4 1.3Debtors Days 44.5 44.5 46.3 48.5Creditors Days 40.8 38.6 49.7 52.0Inventory Days 52.6 49.6 46.9 52.9FA/Turnover (x) 2.5 2.9 3.7 3.6

CEAT Ltd.


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