Apollo Tyres – 2QFY2011 Result Update- Angel Broking

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Apollo Tyres – 2QFY2011 Result Update

Angel Broking maintains an Accumulate on Apollo Tyres with a Target Price of Rs70.

For 2QFY2011, Apollo Tyres reported weak results because of the shutdown at its

plants and a sharp increase in natural rubber prices. While the top line was

marginally ahead of our estimates, the bottom line was lower than expected due

to higher interest cost. Going forward, we expect rubber prices to remain at high

levels (which will substantially affect the OPM) and an increase in interest cost due

to higher debt levels to fund capex plans. Hence, we downgrade our earnings

estimates and recommend Accumulate on the stock.

Standalone net profit down 63%: Standalone top line posted a 4% yoy decline to

`1,176cr (`1,220cr) in 2QFY2011 mainly due to the lockout at the Perambra

facility, which resulted in volume loss of ~15,000MT. During the quarter, the

company’s EBITDA margin declined by 606bp yoy to 10.3% (16.4%), owing to a

~72% yoy increase in natural rubber prices. Thus, net profit registered a steep

decline of 63% to `37cr (`102cr).

Consolidated net profit down 59%: On the consolidated front, revenue declined

by 5% yoy to `1,949cr (`2,046cr), as subsidiaries in Europe and South Africa

reported muted performance. European and South African subsidiaries reported

declines of 2.3% and 9% yoy, respectively, in revenue. Operating margin at the

consolidated level stood at 9.5% in 2QFY2011 as against 14% in 2QFY2010.

Consequently, operating and net profit fell by 36% yoy and 59% yoy, respectively.

Outlook and valuation: During FY2010, the tyre industry benefited mainly from

the substantial fall in raw-material prices and spike in replacement demand.

Going ahead, we remain positive on the sector as the OEM off-take is expected to

improve on better volume growth in the auto industry; however, the sharp rise in

raw-material prices is a concern and expected to exert pressure on the OPM. We

expect the company to post EPS of `6 in FY2011E and `8.7 in FY2012E. We

recommend Accumulate on the stock with a Target Price of `70, at which level the

stock would trade at 8.0x and 4.5x FY2012E EPS and EV/EBITDA respectively.





Conference call – Key highlights
􀂄 Rubber price and price hike action: During 2QFY2011, natural rubber prices
increased by ~72% yoy and ~6% qoq. Average rubber prices during the
quarter stood at `176/kg compared to `165/kg in 1QFY2011 and `102/kg
in 2QFY2010. Rubber prices are currently trading at ~`205/kg. Prices of NTC
fabric and carbon black increased by ~5% and ~6% qoq, respectively. As a
result, the company hiked its product prices by 5% each in the OEM and
replacement segments in July 2010. However, it was unable to pass on the
entire raw-material price hike; and now, with rubber prices ruling at new
highs, the company is contemplating a hike in its product prices.
􀂄 Perambra shut down: Lockout at Perambra plant resulted in volume loss of
~15,000MT. Revenue loss is estimated to be at `250cr–275cr. However,
operations have been resumed w.e.f. August 21, 2010. There has been a
wage hike of 10% (average hike of `5,250/person) for the current year; and
subsequently, it will be linked to inflation as part of the wage agreement. Also,
as per the agreement, productivity would increase by 10% to ~330tpd.
􀂄 Chennai greenfield expansion on track: The Chennai greenfield capacity is
progressing well and is in a ramp-up phase. Run rate during the quarter stood
at 1,200TBR tyres/day and 6,000PCR tyres/day. Management expects to
commission 100tpd in Phase 1 in FY2011, with 200tpd and 400tpd planned
to be added in FY2012 and FY2013, respectively. The expansion entails total
investment of `2,000cr, out of which around `1,000cr was invested by
March 2010.
For FY2011, the company plans to incur overall capex of `1,300cr. The Indian
operations will see a major portion of the capex of `1,000cr being incurred at
the Chennai facility, where the company further intends to double the existing
capacity for passenger car tyres. Capex of around `120cr will be incurred at
the South African facility, while `80cr will be spent at the European subsidiary.
For FY2012, Apollo Tyres plans to incur capex of `400cr at its Indian facilities.
􀂄 Overseas operations: During the quarter, the company’s South African
operations suffered on account of the general strike at both the plants,
resulting in volume loss of about 2,000MT. Workers at the South African
subsidiary had gone on strike from August 30, 2010. The strike has been
called-off upon signing of the long-term settlement agreement with the
workers and operations have been resumed w.e.f. October 1, 2010. The 8%
wage hike has been granted to workers for the current year and, subsequently,
will be linked to inflation. During the quarter, the company also hiked product
prices by 10% in the South African market.
􀂄 The company’s net debt, on a consolidated basis, stood at `2,100cr, up from
`1,626cr at end-1QFY2011, which increased mainly to fund capex plans.





Investment arguments
􀂄 Tyre industry set for structural shift: Currently, manufacturing radial tyres is far
more capital intensive than manufacturing cross-ply tyres. Investment required
for radial tyres per tpd is 3.2x that of cross-ply tyres at `6.1cr/tpd. On the
other hand, the selling price of radial tyres is around 20% higher than that of
cross-ply tyres. Thus, to generate similar RoCE and RoE, tyre companies would
need to earn EBITDA margins of around 21% compared to around 9% earned
on cross-ply tyres, considering the difference in capital requirements and the
consequent impact on asset turnover, interest cost and depreciation.
Therefore, higher capital requirements will help protect margins from
upward-bound input costs, as the business model evolves bearing in mind
final RoEs rather than margins. With the sector set for a structural shift and
apparent pricing flexibility, RoCE and RoE of tyre manufacturers are expected
to improve going forward.
􀂄 Riding on high domestic demand: The Indian tyre industry is witnessing strong
demand from both the replacement as well as OEM markets, keeping
capacities running at peak. Apollo Tyres is poised to achieve market
leadership through increasing its production from 820tpd in FY2010 to
1,100tpd in FY2012E.
􀂄 Strategic overseas investment offers synergies in the long term: Acquisitions
done by the company in the last two-three years are increasingly contributing
to its revenue. We estimate Vredestein Banden combined with Dunlop SA to
contribute 30% to the company’s overall consolidated revenue, helping it to
further strengthen its foothold in the Indian tyre industry. Acquisitions offer
synergies by way of access to radial tyre technology, wider product portfolio
and presence in newer geographies.




Outlook and valuation
During FY2010, the tyre industry benefited largely from the substantial decline in
raw-material prices and spike in replacement demand. Going ahead, we are
positive on the sector as the OEM off-take is expected to improve on account of
better volume growth in the auto industry. However, the recent run-up in
raw-material prices is a concern and will continue to exert pressure on the OPM
going ahead. Moreover, interest cost is expected to increase because of higher
debt levels to fund capex plans. Hence, we downgrade our earnings estimates and
expect the company to post EPS of `6 and `8.7 in FY2011E and FY2012E,
respectively, compared to `7.9 and `9.8 earlier. Therefore, we recommend
Accumulate on Apollo Tyres with a revised Target Price of `70 (`86 earlier), at
which level the stock would trade at 8.0x and 4.5x FY2012E EPS
and EV/EBITDA respectively.
Key downside risk to our call: A sharp rise in input costs from current levels, slower
growth in international business and lower-than-anticipated growth in tyre off-take
pose downside risks to our estimates.