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MRF: Challenging environment

Apr 3, 2002

Auto component majors, after touching their 52-week low levels in 2QFY02, have recovered in sync with other auto majors. While the recovery in auto sector would definitely benefit these players, there are some segments like tyres in which pricing power of manufacturers is slowly decreasing. MRF, one of the market leaders in the Indian tyre segment, has also been a victim on account of higher raw material costs and competition.

(Rs m)1QFY021QFY03Change
Net sales 4,589 4,355 -5.1%
Other Income 11 6 -49.1%
Expenditure 4,080 3,880 -4.9%
Operating Profit (EBDIT) 509 475 -6.7%
Operating Profit Margin (%)11.1%10.9%
Interest 145 115 -21.3%
Depreciation 222 213 -4.0%
Profit before Tax 153 153 0.3%
Tax 56 61 9.3%
Profit after Tax/(Loss) 96 92 -5.0%
Net profit margin (%)2.1%2.1%
No. of Shares (m) 4.2 4.2
Diluted Earnings per share* 90.9 86.4
P/E Ratio (x) 9.1

A brief analysis of the performance of the company over the last two years vindicates this argument. The company reported a 10% drop in turnover for the year ended September 2001 to Rs 20,905 m. While four-wheeler sales in FY01 declined by around 7%, the auto sector witnessed a 2% fall in unit sales during the same period. Since the company is one of the major Original Equipment Manufacturers (OEM) for many auto manufacturers, MRF was affected on account of slowdown. Though unit volumes of automotive tyres fell by just 3%, realisations declined drastically by 8% in the same period resulting in significant erosion in profits at the operating level.

The reasons for this are multifold. Competition has increased notably with multinationals like Bridgestone, Goodyear and Michelin increasing their presence in the Indian markets. Since these global tyre majors are OEM suppliers in the international markets to many MNC auto manufacturers, there is increased competition in this segment. Similar trend is witnessed in the replacement segment where in the competition is not only from these global majors but also from imports. Manufacturers are being forced to offer discounts and freebies to boost volume growth and MRF was no exception. Since margins are higher in replacement segment, the pricing pressure did not augur well for the company. Similarly, average realisation has declined significantly in other segments like automotive tubes and treads. In an effort to diversify revenue stream, MRF ventured into converyer belts and speciality coatings. Though these diversifications have benefited the company in terms of higher volume growth, price erosion seems to have set in here too.

Not only was MRF hit from competition but also from higher raw material costs (53% and 48% of operating expenses and revenues respectively). Rubber, carbon black and fabrics are the three major components that account of bulk of its raw material costs (82% of raw material cost). Carbon black prices had gone up by 18% in FY02 with manufacturers like Indian Rayon passing on the rise in input costs to consumers. Operating margins for MRF have come down from as high as 14% in FY98 to 10% in FY01. While the company could have benefited from lower raw material costs in 1QFY03, crude prices have again shot up to US$ 26 per barrel, which is a cause of concern.

Having said that, with auto sales recovering, the company could see a higher growth in turnover in FY03. Just to put things in perspective, 1QFY03 sales fell by just 5% as against 22% in 4QFY02. Estimates suggest that MRF derives close to 32% of tyre sales from CVs and passenger car segment, where margins are on the higher side. Both these segments have promising growth prospects in the long run. However, given the intensity of competition and raw material scenario, profits might continue to remain under pressure.

The stock currently trades at Rs 788 implying a P/E multiple of 9.1x annualised 1QFY03 earnings.

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