Margin pressure may continue for MRF led by raw material costs, product mix

Analysts at Anand Rathi Research are positive on the outlook for the company as demand in TBRs, PCRs and two wheelers has started to pick up

MRF’s June quarter (Q1) performance was broadly in line with the Street’s expectations. While revenues were up 70 per cent year-on-year (YoY), they declined by 13 per cent sequentially. However, it trailed rival Apollo Tyres, which reported a 80 per cent YoY growth and a 11 per cent sequential decline.
 
The sequential drop was caused by double-digit decline in demand from automakers, but the replacement segment fared better. Both companies, though, benefited from a strong recovery in exports.
 
In terms of revenue growth, MRF trailed peers Apollo Tyres and Ceat in financial year 2020-21 (FY21) and that appears to be continuing in FY22. Analysts at Motilal Oswal Research, led by Jinesh Gandhi, say MRF’s competitive positioning within the sector has weakened over the past few years, reflected in the dilution of pricing power in the passenger car radial (PCR) as well as truck and bus radial (TBR) segments. This, coupled with the impact of capex over the last three years, has resulted in substantial dilution in its superior return ratios.
 
On the demand front, brokerages expect a recovery of volumes from automakers and the replacement market, which bodes well for MRF. Analysts at Anand Rathi Research are positive on the company’s outlook as demand in TBRs, PCRs and two-wheelers has started to pick up. They expect demand momentum to pickup in subsequent quarters, led by a surge in the replacement segment. This should help drive volumes, improving utilisation given additional capacity in Gujarat.

The other key factor for tyre makers, including MRF, would be its ability to sustain margins amid higher input costs. Gross margins reduced 60 basis points sequentially due to a 10 per cent rise in raw material costs, though the decline was lower than peers.
 
Operating profit margins at 11.8 per cent (390 bps down sequentially) are at a multi-year low. The positive for the sector is the improvement in tyre prices — after announcing price hikes in Q1 the industry is expected to raise prices in Q2 as well. While international rubber prices have come down from peak levels, domestic rubber prices continue to be on an uptrend.
 
Analysts at Kotak Institutional Equities expect MRF’s gross margins to remain under pressure led by raw material costs and an inferior product mix with a higher share of sales to automakers in Q2. They expect input cost pressures to ease in the second half of FY22. The brokerage has cut the company’s FY22-24 earnings per share estimates by 6-11 per cent, led by 140-160 bps lower operating profit margin assumptions due to raw material headwinds.
 
Raw material pressures and uncertain demand led to a correction in the MRF stock from the highs it hit in October, with the stock trending flat since May. While higher volumes should improve operating leverage, the extent of price increases and raw material prices will decide the margin movement.
 
Valuations at 21-22 times FY23 earnings per share estimates are on the higher side. Investors should await signs of reversal of market share loss, improvement in margins before considering the stock.