MRF – Fall in rubber price, stakeholders’ equity too low and highly fragmented – Centrum

MRF is a thematic play on booming automobile population in India which has almost doubled in the last 10 years. Further, it draws nearly 75% of its sales from the replacement market which remains largely unaffected by fluctuations in the industrial economy. MRF is fast growing and the first Indian tyre company to cross the Rs.10,000 crore mark in revenues. Its branded sales are expected to double to Rs.20,000 crore in next 3 to 4 years;

MRF has the highest market share of 23.2% in the overall domestic tyre industry. For the period FY2006-2011 (September year ended), Net sales have increased 2.6x from Rs.3,724 crore to Rs.9,735 crore and volumes have increased more than 1.5x from 21.6 million units to 34.3 million units. During Q3FY2012, MRF’s revenue grew 17% YoY while its PAT increased 152% YoY on the back healthy margins. NR prices which were down 15.4% YoY during June quarter at around Rs.193/kg, helped improve EBIDTA margins by 450bps YoY to 10.9%;

The average prices of natural rubber (NR), which is a key raw material for tyres was down 16.9% YoY and 9.1% QoQ for the quarter ended September 2012 at Rs.175/kg. Currently, NR prices are quoting around Rs.174 and despite this decline, realizations remained firm with most companies increasing prices by 4%-5% in the September quarter itself. The expected appreciation in INR is likely to apply some further downward pressure on domestic prices of NR through cheaper imports. Also the government has imposed definitive anti-dumping duty on import of non-radial bias tyres (used in buses and trucks) from China and Thailand for a period of 5 years. We expect another 5%-10% fall in NR prices on account of slowdown in the developed countries;

We believe MRF would be the major beneficiary of the fallen prices and expect the company to spend around Rs.3,000 crore in FY2013 on rubber procurement. A 5% fall in rubber prices would improve the company’s earnings by Rs.375 per share. We expect MRF to maintain margins around 10%-11% and report better results for next few quarters;

MRF’s promoter holding is only 26.95% and is highly fragmented with as many as 114 individual holding this stake. Strategic investors (including financial institutions) hold another 28.87% as on September 30, 2012. As such we believe that MRF can be an attractive target for acquisition going forward. An analysis of some of the acquisitions in the tyre industry across the world, reveals that deals have taken place at valuations of around 6x-9x EV/EBIDTA. MRF is currently trading at ~4.5x its FY2013E EV/EBIDTA levels, signaling a significant discount to global valuations;

MRF is trading at low valuations due to poor stock liquidity. We firmly believe that the company needs to expand its existing tiny equity base (42.41 lakh shares for a market cap of Rs.4,200 crore) and improve its liquidity by issuing bonus / share split or both. The stock has fallen by 10.9% from its 52 week high and at the current price of Rs.10,304, is trading at 7.9x its FY2012E EPS of Rs.1,300 and 6.9x its FY2013E EPS of Rs.1,500. We re-iterate buy on the stock with a fair value of Rs.12,750;

Source: Equity Bulls