Spiralling costs impact margins

The MRF stock was down about one per cent after the company last week reported a six per cent year-on-year fall in profits for the quarter ended March. Profits were down to Rs 90 crore on the back of doubling of natural rubber prices last year. Sequentially, natural rubber prices, currently at Rs 230-240 a kg, have risen 16 per cent.

Despite the robust demand, companies have not been able to increase their prices to reflect the jump in the raw material costs due to competitive pressures. High raw material prices and inability to completely pass on the rising costs have meant falling margins for MRF.

HIGH RAW MATERIAL COSTS
Raw material costs as a percentage of sales for MRF increased from 67 per cent a year ago to 76 per cent in the March quarter, resulting in a fall in operating profit margins by 260 bps to 9.2 per cent. With raw material costs at over three quarters of sales, the rise in natural rubber prices as also synthetic rubber and of carbon black on the back of rising crude oil prices will continue to keep margins under pressure.
 

REFLECTING MARGIN CONCERNS
In Rs crore	Revenues	Ebitda	Net profit	P/E(x)
MRF	10,343	1,123	445.20	6.21
CEAT	4,224	5.86	98.00	3.84
Apollo Tyres	10,420	1,105	425.52	8.02
JK Tyres	6,521	431.40	126.35	2.17
Source : Bloomberg

DEMAND STRONG
While cost pressures are a key worry, revenues, supported by a surge in volumes as well as a rise in prices, jumped 34 per cent to Rs 2,383 crore. Auto volumes for 2010-11 in key segments such as commercial and passenger vehicles have jumped 20-30 per cent over the previous year. With auto volumes expected to grow 12-15 per cent on a higher base for 2011-12, demand from auto manufacturers as well as the replacement market is likely to remain strong. This should keep the revenue momentum going. However, any further increase in interest rates and weak industrial activity will be key risks to demand, especially, for the commercial vehicle sector, and would impact tyre sales.

FINANCIALS
While the high raw material costs are likely to be an issue, a jump in revenues has helped the company keep staff costs and other expenditure as a percentage of sales under control, as compared to the year ago quarter. The challenge for MRF will be to maintain operating profit margins in double digits in 2010-11 (financial year ends in September). While it closed 2009-10 with a margin of 11.1 per cent, for the first six months of the current financial year, the company has just about managed to maintain margins at 10 per cent. At the current price of Rs 6,519, the stock trades at 7.2 times its annualised 2010-11 earnings per share.