Stock Review: MRF

 

Rising rubber prices could puncture MRF's earnings in coming quarters. But investors willing to take the risk may consider the stock with a horizon of at least 2-3 years, given a strong demand outlook for the tyre sector

 

THE Chennai-based MRF Tyre has posted a strong double-digit sales growth in each of the last three quarters. This is due to robust demand for tyres boosted by higher automobile sales. But rising raw material costs due to rising rubber prices have put its operating profit under pressure, besides eroding its net earnings.The demand scenario of the tyre sector is positive due to expectations of a sustainable growth in the automobile sector, and MRF looks to be its major beneficiary.

BUSINESS:

MRF is the largest domestic tyre manufacturer in tonnage terms with capacity to churn out 3.17 lakh metric tonnes spread across six plants in South India. Although Apollo Tyres has become a large firm by revenue due to its overseas acquisition, MRF has a strong presence in India and a good brand image.

   Its product portfolio comprises auto tyres, pretreads and conveyor belts, with 95% its revenue coming from tyre and tubes. MRF derives a large chunk of its business from commercial vehicles. More than half of its business comes from the replacement market followed by sales to automakers as an original equipment manufacturer, or OEM.

   MRF will invest 1,300 crore to expand its capacity expansion in Andhra Pradesh and Tamil Nadu by the end of 2011. The total installed domestic tyre capacity is projected to increase to close to 180 million tyres by 2012-2013 from 122 million tyres in 2009-10, according to rating and research firm ICRA.

FINANCIALS:

The company's consolidated net sale has grown at a compounded annual growth rate (CAGR) of 14% since FY07 to reach 7,458 crore in FY10. But net profit grew 20% in the same period due to better average realisation.

   For the first half of the current fiscal ended March 2011, net sales grew 35% to 4,967 crore while net profit declined 10% due to a sharp rise in raw material costs due to rubber prices. Raw material costs account for over two-thirds of total operational expenses for tyre makers.

   Natural rubber prices have gone up 20% in the last six months to 24/kg, which has dented the profitability of tyre companies. Although most tyre makers have raised prices 5-6% in the last six months, it has not been adequate to counter cost-push inflation.

   Its strong position in the domestic market has helped MRF post an average return of equity of 20% in the last three years, higher than its peer group which includes Apollo Tyre and JK Tyre. The firm also has a consistent dividend payment record.

VALUATIONS:

With the rise in input costs impacting profitability, the MRF stock has lost almost a third of its value from its peak last October. The margin contraction due to high rubber prices provides an element of risk in the near term, but its brand value and its sustainable business model makes it an attractive investment bet. At the last traded market price of 7,210, the scrip is trading at nine times its stand-alone profit for the last 12 months, which looks attractive, when compared with the industry average of 12.With an assumption of 15-20% increase in revenue in the next two years, we expect the company to close FY13 with consolidated net profit of 500 crore. This means MRF is trading with a 2-year forward earnings multiple of close to seven, which makes it reasonably valued. An investor willing to bear the risk of rising rubber prices which could further dent MRF's earnings in coming quarters can take an exposure with a horizon of at least 2-3 years.