Higher capex spends likely to impact tyre maker Ceat's return ratios

Muted near term outlook given raw material costs, lower demand

Tyremaker Ceat has announced an ambitious plan to boost its market share and take leadership positions in multiple categories over the next five years. The company is eyeing a market share of 30-35 per cent in the two- and three-wheeler segments as compared to 28-30 per cent now, while targeting 20 per cent from 13-15 per cent now in passenger car radials. 

The company also seeks to among top three players in the truck and bus tyre segment and grow its international business threefold over this period. While the company is a leader in two- and three-wheelers, it trails MRF and Apollo Tyres in most other categories. 

The company is seeking to strengthen its market position on the back of higher advertising spends, distribution expansion, enhancing its manufacturing capacity, and product development. 

Analysts at JM Financial say: “Though the market share target seems aggressive, the above-mentioned enablers augur well for the long-term growth trajectory.”

The company, however, faces near-term, as well as medium-term challenges. The weak sales environment due to the second Covid wave is expected to put pressure on orders from automakers. Further, rising raw material costs are expected to put pressure on profitability; part of this is expected to be offset by price hikes and cost-cutting initiatives. 

Weak auto sector volumes over the past couple of years will also have an impact on the replacement segment — which accounted for 44 per cent of Ceat’s FY21 revenues. Nomura estimates 5-6 per cent replacement growth over FY22-24, given the flat auto sector volumes in the past. 

Further, they point out that the company is expanding significantly in segments (passenger and truck/bus radials) where competition is higher, pricing power is limited, and commodity price headwinds may impact margins. Higher capex spends may put pressure on free cash flows and impact return ratios. 

Given these issues and the muted near-term outlook, the stock was down 1.4 per cent in trade on Friday. Further, the valuation at 13x its FY23 earnings estimates (and over 6x the enterprise value-to-operating profit) does not offer comfort. Investors should await demand trends, margin movement, and steady market share gains before considering the stock.