Stock Review: MRF

THE weakness in the stock price of MRF, the largest domestic producer of tyres, over the past month comes in the wake of a sharp rise in rubber price, which is near its all-time high. Given the close link between rubber price and profit margins, MRF is likely to report sombre performance for the quarter ending December 2010. This is because a hike in tyre price may fail to make up for the much faster growth in input prices.

   The rising raw material costs dented profitability for the second successive quarter in the current fiscal despite growth in automobile demand that boosted revenues and volume offtake. Other tyre-makers, too, have reported lower net profit compared with the year-ago period despite double-digit growth in topline.

   MRF's sales grew 42% in the September quarter on the back of improved demand from passenger car and commercial vehicle segments, which account for close to half of its sales volumes. But profitability was dented by a twofold increase in raw material costs, which account for about three-fourth of the total operational cost. Operating profit declined 16% to . 215 crore, shrinking operating margin by 700 basis points to 10% from the year-ago levels. With an increase in interest cost, MRF's net profit dropped by a fifth over the year-ago period.

   The hit on margins is primarily due to the cost of rubber shooting up 56% to . 166/kg for the quarter ended September 30 on a year-on-year basis. Although the moderate rise in the cost of rubber sequentially over the last two quarters translated into 25% sequential growth in net profit, this is unlikely to continue in the next quarter. Rubber price has move up another 10% over the last month and is expected to gnaw at margins further. Efforts to meet the rising cost of production with product price increase have been inadequate even with tyre prices moving up 15-20% since January.

   Although domestic rubber production is estimated to grow a tad faster than consumption for the current fiscal, according to the Rubber Board of India, the impact of high input costs is unlikely to wither away anytime soon due to the demand-supply gap and firm international prices. The growing demand for automobiles in India is expected to further push up demand for rubber and thereby its price, hurting prospects of any improvement in margins of MRF in the nearterm. While the company may continue to see high revenue growth backed by higher volumes, it is expected to struggle with margins in the coming quarters.