Stamford Tyres Corporation - Earnings bogged down by lower margins

FY07 results below expectation. Stamford Tyres Corporation (“STC”) posted higher revenue of S$296.0 million (+17% YoY) in FY07, driven by the continued growth of its major brands - Falken, Dunlop and Continental tyres, and increased sales of its proprietary brands - Sumo Firenza tyres and SSW wheels. Net profit, however, fell by a steeper than expected 25% YoY to S$11.6 million (17% below our estimate), due mainly to lower gross margin of 23.9% (-4.7 ppt YoY) in the face of rising raw material costs. While STC seeks to adjust selling prices on a semi-annual basis to mitigate margin pressure, the competitive environment in the tyre distribution business limits its ability to fully pass on the cost increases to its customers. STC has declared a net dividend per share of 1.64 cents.
Revenue should continue to grow on healthy demand and higher capacity. STC continues to see healthy demand for its range of products and aims to improve revenue and earnings in FY08. It has already secured greater allocation of its Sumo Firenza tyres for FY08 and FY09 through its outsource contract manufacturing arrangements. In addition, its second wheel plant in Thailand will commence operations in early 2008. These should underpin our expectation of double-digit revenue growth in FY08 and FY09.
Volatility in raw material prices remains a concern; maintain HOLD. We have lowered our net profit forecast for FY08 by 24% on lower gross margin assumptions and introduced FY09 estimates. Based on our forecasts, we expect STC to resume earnings growth (albeit from a lower base) at a CAGR of 21% in FY08 and FY09, on the assumption that raw material costs remain stable. A stronger than expected take-up of STC’s proprietary brands and easing raw material prices could provide upside surprises to our estimates.
Although we continue to rate management highly, we think that the share price is fully valued at current levels. We marginally raise our Fair Value Estimate from S$0.525 to S$0.53, based on a relative valuation of 8x blended FY08/09 PER. We peg our Fair Value Estimate to a higher earnings multiple of 8x (instead of 7.5x) to reflect a slightly more positive view of STC’s medium term outlook. Maintain HOLD.