Apollo Tyres: Taking a turn for the better - Buy

Apollo Tyres has been facing quite a few challenges this year. Domestic sales were affected due to disruptions caused by the switchover to BS IV emission norms and the transition to GST. Capacity constraints in the passenger car radials segment, slowdown in the European markets and high depreciation and interest costs due to ongoing capacity expansions both in India and abroad also pulled down its performance in the April and September 2017 quarters.

However, things are improving. Domestic demand has recovered. Imposition of anti-dumping duty has seen import of Chinese tyres abate. Rubber prices have stabilised. European operations too are expected to take a turn for the better in the near to medium-term.

With prospects looking up, the stock looks promising. At the current price, it trades at about 20 times its trailing 12-month consolidated earnings. This is at a good discount to other tyre stocks such as MRF, Ceat and Balkrishna Industries which trade at 30-33 times. Investors with a one to two-year perspective can buy the Apollo Tyres stock.

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. After initial hiccups due to the BS IV and GST transition until July 2017, sale of new trucks and buses have improved. This segment has clocked strong double-digit volume growth in the August-December 2017 period. Lower borrowing costs have also helped passenger car sales volumes pick up.

Besides, the double-digit volume growth seen in new truck and bus sales in fiscals 2015 and 2016 imply that replacement demand for tyres in these vehicles will come up soon. The move to GST will benefit organised players such as Apollo in the replacement segment as the price differential between tyres in the organised and unorganised market will come down.

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. To cater to the increasing demand, the company has doubled its capacity for truck-bus radials at Oragadam, Chennai.

The threat of Chinese imports for truck and bus tyres has also abated after the imposition of anti-dumping duty to the extent of $ 245.35-$ 452.33 per tonne in mid-September 2017.

According to the company, this has resulted in the price differential between Chinese and Indian tyres narrowing to 15-20 per cent levels in the last few months from the earlier levels of about 25 per cent. Import numbers have also come down to less than 70,000 tyres a month from the 1.5 lakh tyres a month seen in pre-demonetisation days.

The company is also in the process of expanding its capacity for car radials as it is faced with capacity constraints in this segment as of now. 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 is trying to add about 10 per cent capacity for car radials through de-bottlenecking at the existing facility in Oragadam.

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.

Additionally, Apollo had to redirect its export capacity in the Indian operations to cater to the shortage in the domestic car radials, which also led to the company losing market share in the replacement segment in Europe. Besides, the start-up costs for the Hungary plant inaugurated in April 2017, also affected the company’s bottom-line in the first two quarters.

But the situation is expected to get better. For one, in the immediate future, winter tyre demand could help drive growth to an extent in the third and fourth quarters. This apart, the company expects increasing private consumption, improving labour market and growing disposable incomes to aid recovery in the European markets. Three, to increase its presence, the company is catering to auto manufacturers directly in Europe. It has signed up with players such as Ford and SEAT. Initial supplies will begin this year from the company’s Dutch plant. Four, the ramp-up at Hungary will also help meet demand in Europe. While it is happening in stages now, the plant will fully scale-up in 2019-20. This plant will initially supply to the replacement markets and later to auto manufacturers as well.

For the half-year ended September 2017, consolidated net sales grew by 5 per cent to ₹6,676 crore over the April-September 2016 period. A run-up in natural rubber prices from the multi-year lows of early 2016 impacted operating margins.

It came in at 9.6 per cent vis-à-vis 15.3 per cent in the same period the earlier year. Capital expenditure of about €475 million (₹3,500 crore approximately) for the Hungary plant as also the capacity expansions at the Oragadam plant impacted interest costs, which increased by about 50 per cent.

These factors, along with higher depreciation costs dented profits for the half-year ended September 2017. Net profits dropped by about 60 per cent to ₹228.48 crore. Debt to equity ratio stands at 0.5 times. In October 2017, the company raised about ₹1,500 crore through a qualified institutional placement for further capex such as the setting up of the new plant at Chittoor.

Though this will result in equity dilution in the near term, better demand and further ramp up in production will help improve profitability. Also, prices of natural rubber are not expected to rise sharply. It has stabilised at around ₹130 a kg on an average, in the last few months.

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