Rising input prices may cut MRF’s margins

The country’s largest domestic producer of automotive tyres, MRF, reported a double digit net profit growth for the second consecutive quarter during the three months to end March due to improved volumes from tyre sales to car makers, as well as strong revival in demand for commercial vehicles starting November 2009.

Share price of MRF Tyres closed flat after the results despite robust 39% growth in net profit over the year ago period. Investors have been cautious due to the impact of relentless increase in rubber prices, which make up half of the cost for tyre producers.

The company reported a 26% sales growth for the quarter ended March 2010 on the back of improved volume across segments. The company has benefited greatly from a revival in auto sales, which has pushed-up the demand for tyres. According to figures by Society of India Automobile Manufacturers, vehicle sales — including cars, utility vehicles, trucks, buses, motorcycles and scooters — jumped 39% on year-on-year basis in March 2010 quarter to over 34 lakh units.

But, MRF’s operating margin is under pressure due to the continued firmness in the raw material prices. Input costs, as a percentage of revenues, rose to 66% from about 57% in the year-ago period and the company recorded a 60 basis points (bps) decline in operating margin last quarter. Price of rubber has almost doubled to Rs 149/kg in the past one year and was trading at Rs 168/kg as of April 28.

On a sequential basis, MRF witnessed a lower revenue growth of 7% compared to 12% for the three months to end December 2009 as volume growth rate has moderated. Moreover, the erosion in operating margins on a sequential basis is much higher with 300 bps (basis points) due to faster increase in raw material and other operating costs, like employee remuneration, compared to revenue growth.

This is expected to result in hike in tyre prices in the current quarter (April-June). But given that the increase in rubber prices and other raw material is estimated at 30-40%, and the tyre price increase is projected to be relatively modest, the company will continue to face margin pressure in the coming months. This is also reflected in lower margins for the past quarter even as MRF hiked prices twice in March.

The net profit, however, was partly boosted by moderation in interest and depreciation cost. Given this background, if rubber price continues to go up, it would further dent margins in the coming quarters and as growth rate of vehicles is expected to decelerate, then profit at absolute level could get impacted.