Stock call. Apollo Tyres: Taking a turn for the better - Buy

While prices of most commodities have been heating up, natural rubber prices have seen a slide in the last one year. Domestic natural rubber prices of the RSS-4 variety now hover around ₹120 a kg, down from the ₹140 levels seen a year ago. Besides, domestic automobile sales have also seen a strong rebound in the last few months after hiccups due to the BS-IV/GST transition a year ago.

Both these factors favour tyre manufacturers, among which Apollo Tyres appears well-placed to cash in on the opportunity. The company’s performance has taken a turn for the better in the quarter ended March 2018, thanks to improving sales and cheaper rubber. Earlier, the slowdown in the European markets and high depreciation and interest costs due to ongoing capacity expansions, both in India and abroad, had weighed on the company’s earnings in the first three quarters of 2017-18.

The stock is also attractive because it trades at a discount to peers such as MRF and Balkrishna Industries. At the current price, the valuation multiple is at about 22 times its trailing 12-month consolidated earnings, in comparison with peers which trade at 29-31 times.

Key positives

Apollo Tyres derives 60 per cent of its consolidated revenues from the India business. The company has about 25 per cent market share in tyres for trucks and buses and 15 per cent market share in passenger car tyres in the country. Following the challenges due to the BS IV and GST transition until July 2017, the sales of new trucks and buses have improved. For the year 2017-18, both light and heavy vehicles recorded volume growth (year-on-year) of 12 per cent and 25 per cent respectively. The good run is expected to continue into this year as well, with a revival in economic activity.

Besides, the Government is also expected to come up with a scrappage scheme for old commercial vehicles, which will boost new vehicle sales further. Other tailwinds for trucks and buses include the improving radialisation levels for truck and bus tyres and the abating of Chinese imports.

With radialisation levels in truck and bus tyres moving up to 45-50 per cent, the company is on a strong wicket. It counts leading commercial manufacturers such as Tata Motors, Ashok Leyland and Volvo-Eicher, among its clients, and has a 21 per cent market share in truck-bus radials alone. It is ramping up its capacity for truck and bus radials at Oragadam, Chennai. From an average of 8,000 tyres per day in 2017-18, the production has moved up to 10,000 per day and will go up to 12,000 tyres per day this fiscal. The threat of Chinese imports for truck and bus tyres has fallen after the imposition of anti-dumping duty in September 2017.

On the passenger vehicles side, the company is in the process of expanding its capacity for car radials, for which there have been capacity constraints.

A greenfield plant is being set up for car radials at Chittoor in Andhra Pradesh. This plant is expected to commence operations in 2020. In the interim, Apollo caters to the demand for car radials through de-bottlenecking at the existing facility in Oragadam.

Europe looking up

The company supplies Apollo and Vredestein brand tyres to the passenger car replacement market in Europe. A slowdown in demand in the continent affected Apollo in the first nine months of 2017-18. Besides, the start-up costs for the Hungary plant inaugurated in April 2017, affected the company’s bottom-line in the first three quarters, where it reported a dip in profits vis-à-vis the previous year.

But things are taking a turn for the better. According to the company, the European market is on track to recovery with revival in major markets such as Germany. This apart, the company expects increasing private consumption, improving labour market and growing disposable incomes to aid further recovery in the European markets.

Besides, to increase its presence, the company is beginning to cater to auto makers directly in Europe. It has signed up with Ford and SEAT. Finally, the Hungary plant inaugurated a year ago has ramped up its capacity and achieved break-even towards the end of the March quarter. This plant will supply to the replacement markets and then to auto manufacturers.

Financials

For the quarter ended March 2018, consolidated sales moved up by 22 per cent to ₹3,982.43 crore. Thanks to benign rubber prices and a pick-up in demand both in India and in Europe, consolidated operating margins came in at 12. 9 per cent vis-à-vis 11.35 per cent a year ago.

But consolidated profits grew only by about 10 per cent to ₹250.11 crore due to high interest and depreciation costs. Profit growth will get a boost in the coming quarters as the Hungary plant begins making profits.

While natural rubber prices are not expected to shoot up sharply, what could pressurise operating margins is the inching up of the prices of crude oil-based inputs such as synthetic rubber and carbon black.

But given that tyre makers usually have higher pricing power in the replacement market, the company can pass on the increase to customers to protect its margins.

As commercial vehicles rapidly adopt radial tyres, bettering product mix from higher share of radial tyres will also improve profitability.

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