Apollo Tyres - REDUCE-Lag in passing costs likely to cap profit rise:: IIFL

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Lag in passing costs likely to cap profit rise
• Natural rubber (NR) prices in international and domestic
markets have spiked over the past one month on account of
decline in production (due to floods in Thailand and an
extended monsoon in Kerala).


• The commerce ministry’s proposal to cap the import duty on
NR at Rs20.46 per kg is yet to be notified (as per newspaper
reports, the commerce secretary had said in the second week
of September 2010 that the problem of import duty will be
sorted in a month’s time).
• At present, the domestic NR price is ~Rs7 per kg higher than
the international prices, without factoring in import duty.
• Few tyre producers continue to defer price hikes on account of
increasing competition and imports.
• We cut our FY12 earnings estimate for Apollo Tyres by 6% to
reflect the likely lag in passing cost increases.

NR production likely to fall short of demand: The extended monsoon
in Kerala has resulted in NR production declining by 7.6% YoY in October
2010, causing YTD production growth to decelerate to 4.5%. Recent
floods in Thailand (the world’s largest producer of NR) and Malaysia are
also likely to reduce global NR production. As a result, we expect a
marginal shortfall in production in the current year (as against our
expectation at the start of 2010 of a demand-supply balance). This is
likely to keep prices firm for the rest of the year.

Sharp increase in capacities and slowdown in demand growth
reducing pricing power for industry: Our interaction with tyre
producers indicates demand growth at ~8% for 1HFY11 against ~12% in
1HFY10 for the key truck and bus (T&B) segment tyres (official data is
yet to be released), primarily on account of sluggish demand in the
replacement market. Capacities, on the other hand, are ~15% higher
YoY, causing some producers to defer price hikes. We expect margin
pressure to continue as more new capacities stabilise.


Notification on cap for NR duty gets delayed: The tyre industry’s
long-pending request to reduce import duty is being favourably
considered by commerce ministry, which has proposed a cap for import
duty at Rs20.46 per kg; however, this cap is yet to be notified. Our
channel checks indicate that the delay was primarily on account of local
body elections in Kerala held in the fourth week of October. NR prices in
the domestic market declined by ~15% on the expectation of a sharp
cut in import duty in August 2010. Domestic NR prices have since then
increased by 27%, as prices in international markets have risen 26% in
the same period. At present, the domestic NR price is ~Rs7 per kg
higher than the international price, without factoring in import duty. We
believe domestic prices will not fall sharply if the cap on import duty is
notified, as the gap between international prices and domestic prices
has reduced.