ET Intelligence Group: The stock of tyre maker CEAT has underperformed the benchmark Sensex by 7 per cent in the past three months following demand slack.The trend is likely to continue in the near term given the rising competitive intensity in the two-wheelers tyre market and muted outlook for passenger car and truck demand in the current fiscal.A few years ago, CEATs parent, RPG Group decided to focus on the two-wheelers segment by outsourcing manufacturing to reap rich dividends of the potential growth of the segment.
As a result, the twowheeler and three-wheeler segments contributed about 31 per cent to total revenue in FY19 compared with 13 per cent in FY13.
However, in the past two years several leading companies such as JK Tyres, Apollo and Taiwan-based Maxxis, too, have entered the two-wheelers market, which has limited CEATs pricing power.The biggest threat seems to be from Maxxis, which plans to add a capacity of 7 million two-wheeler tyres, which is around 7 per cent of total segment capacity.
Maxxis has already started supplying tyres to Honda Motorcycles, Yamaha and Suzuki Motorcycles in India.
Also, the largest two-wheeler maker MRF has taken some aggressive pricing decisions.The overall volume growth of the company in FY19 was 6-7 per cent, which has been lower than the sector growth of 11-12 per cent.
In the last quarter of FY19, the companys volumes dropped 1 per cent year-on-year due to weakness in automotive OEM (original equipment manufacturer) and moderation in the replacement segment.
The company expects to clock better volumes in FY20 on hopes that it would be able to take advantage of new model launches during the year.However, the higher proportion of automakers in the total sales volume will be margin dilutive given the slowdown in passenger cars.The operating margin for CEAT fell to 9.7 per cent in the March 2019 quarter compared with 12.1 per cent in the year-ago quarter.
Besides, the commissioning of new capacity of truck radials of 100 tons per day and weak brand positioning in this segment would make it difficult for the company to maintain higher utilisation without discounts to customers.In addition, the ramp-up of production from new off-highway tyres plant was much lower than the Streets expectation.
The capacity utilisation of the plant was about 50 per cent in FY19.
This put further pressure on margins.
At Thursdays closing price of Rs 1,017, the stock was trading at 12.4 times its twelve-month projected profit, a premium of 9 per cent from its long-term average.
This looks expensive in the light of falling margins and volumes, slipping return on capital employed and rising debt-equity ratio.