Buy JK Tyre – 3QFY2011 Result Update Angel Broking

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  JK Tyre – 3QFY2011 Result Update

Angel Broking recommends a Buy on JK Tyre with a Target Price of Rs. 166.

JK Tyre reported a mixed set of results for 3QFY2011, with strong top-line growth

following higher offtake in OEM volumes; however, the bottom line was down

significantly due to contraction in EBITDA margin. The company’s EBITDA margin

declined substantially due to the sharp increase in rubber prices. However, the

stock is available at attractive valuations due to the recent correction in

the stock price. We recommend Buy on the stock.

Margin pressures overshadow strong top-line growth: JK Tyre reported turnover of

`1,179cr (`802cr) for 3QFY2011, an increase of 46.9% yoy. Top-line growth was

aided by volume growth of ~27% in tonnage terms and ~17% growth in net

sales realisation. The company posted a 36% yoy and 11.5% qoq decline in

operating profit to `61.9cr (`96.8cr) for 3QFY2011 due to contraction in

operating margin. The company’s operating margin dipped substantially by

681bp yoy and 89bp qoq, primarily due to the unprecedented and unabated

spurt in rubber prices, leading to a significant 901bp yoy increase in raw-material

cost at 71.3% (62.3%) of sales in 3QFY2011. As a result, net profit came in at

`9.1cr (`36.5cr), registering a decline of 74.9% yoy and 54.7% qoq.

Outlook and valuation: We estimate JK Tyre to post an EPS of `22.1 for FY2011E

and `34.5 for FY2012E. At `118, the stock is available at attractive valuations of

5.3x and 3.4x FY2011E and FY2012E earnings, respectively. Due to the recent

correction in the stock price, we recommend Buy on the stock with a Target Price

of `166, valuing the company at 4.8x (40% discount to market leader Apollo

Tyres’ multiple of 8x) FY2012E earnings. At our target price, JK Tyre will trade at

0.6x and 4.2x FY2012E P/B and EV/EBITDA, respectively.

Strong top-line growth of 46.9%: JK Tyre reported robust 46.9% yoy growth in its

top line to `1,179cr (`802cr) during 3QFY2011. On a sequential basis, the

company’s revenue grew by 3.5%. In tonnage terms, JK Tyre registered ~27% yoy

growth in volume, while net sales realisation grew by ~17% during the quarter.

During 3QFY2011, the company hiked its product prices by 2–3% to pass on the

increase in raw-material costs. On the utilisation front, JK Tyre operated at higher

utilisation levels of ~93%.

EBITDA margin contracts 681bp yoy due to higher raw-material costs: During

3QFY2011, operating profit declined by 36% yoy to `61.9cr (`96.8cr) on account

of contraction in operating margin. The company’s operating margin dipped

substantially by 681bp yoy and 89bp qoq, primarily due to the unabated and

unprecedented spurt in rubber prices, leading to a significant 901bp yoy increase

in raw-material costs at 71.3% (62.3%) of sales in 3QFY2011. However, margin

erosion was arrested by a 175bp and 40bp yoy reduction in staff cost and other

expenditure, respectively. The average procurement price of rubber for the

company stood at `194/kg during the quarter, compared to `177/kg in

2QFY2011 and `119/kg in 3QFY2010. Since 2QFY2010, JK Tyre has hiked its

product prices by ~23% and has guided subsequent price hikes as rubber prices

continue to inch upwards.

Net profit at `9.1cr, down 74.9%: JK Tyre recorded a 74.9% yoy and 54.7% qoq

decrease in net profit to `9.1cr (`36.5cr) during the quarter, primarily on account

of operating margin contraction. Further, higher interest expense during the

quarter led to a decline in net profit. As a result, net profit margin contracted by

379bp yoy and 100bp qoq to 0.8% (4.5%).

Management call – Key highlights

􀂄 During the quarter, JK Tyre benefitted from the robust tyre demand, led by

buoyant economic growth and increased offtake in OE volumes. As a result,

utilisation levels for truck and nylon radials stood at ~100% and that for car

radials stood at 90–93%. Overall, the company’s utilisation level came at

~93% during 3QFY2011.

􀂄 During the quarter, of the total sales revenue, the company derived 68–70%

from the truck and bus radial (TBR) segment and 30–32% from the car (radial

and bias) segment. Within TBR, ~20% revenue came from OE and the rest

from the replacement segment; whereas in the car segment, ~50% revenue

came from the OEM and the rest from the replacement segment. Volumes

grew by ~27% in tonnage terms and net sales realisation increased by ~17%

during 3QFY2011.

Since 2QFY2010, the company has hiked its product prices by ~23%.

Average rubber prices for the company stood at `194/kg during 3QFY2011,

compared to `177/kg in 2QFY2011 and `119/kg in 3QFY2010. Rubber

prices are currently trading at ~`235/kg. Rubber, NTC fabric and carbon

black prices have increased by ~63%, ~2% and ~14% yoy, respectively.

During 3QFY2011, the company was unable to pass on the entire rawmaterial

price hike.

Capacity expansion: JK Tyre has plans of incurring capex of around `2,400cr

over the next 4–5 years to expand its capacity. The company proposes to incur

`2,000cr capex towards a greenfield facility in Chennai over the next 4–5

years (has signed an MoU with the Tamil Nadu Government), which is broadly

divided into two phases:

1) Phase I: JK Tyre’s existing domestic capacity of 97 lakh tyres would be

increased to 126 lakh tyres by the end of 2011.

2) Phase II: Additional capacity of 30 lakh tyres would be available 18 months

after the completion of Phase I; this would result in combined domestic

capacity at 156 lakh tyres per year on completion of the expansion

programme.

Thus, additional capacity of 4 lakh TBR tyres (~68tpd) and 25 lakh PCR tyres

(~64tpd) would be available at the Chennai facility by the end of FY2012.

For FY2011, JK Tyre has planned capex of `930cr, of which `775cr would be

incurred at the Chennai facility and `155cr would be incurred at existing

plants. We note that out of `930cr capex for FY2011, `200cr–250cr may spill

over to the next fiscal, depending on the availability of machinery from

vendors. Capex of `930cr would be funded through a combination of debt

and internal accruals. The company has already sanctioned loans of ~`630cr,

the balance ~`300cr would be funded through internal accruals.

JK Tyre plans to increase the capacity of its Mysore plant from 8 lakh TBR to

10 lakh TBR. Overall capacity (including Tornel) will increase to ~162 lakh

tyres by the end of Phase I and to ~196 lakh tyres by the end of Phase II.

Investment arguments

􀂄 Margins to increase on account of high investment on radials: Currently,

manufacturing radial tyres is far more capital-intensive than manufacturing

cross-ply tyres. Investment per TPD is 3.2x of cross-ply at `6.1cr per TPD. On

the other hand, selling prices of radial tyres are about 20% higher than crossply

tyres. Considering the difference in capital requirements and the

consequent impact on asset turnover, interest cost and depreciation cost, to

generate similar RoCE and RoE, tyre companies would need to earn EBITDA

margin of around 21% compared to around 9% being earned on cross-ply

tyres. Thus, 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. We believe the expected structural shift and

apparent pricing flexibility in the sector will result in improved RoCE and RoE

of tyre manufacturers going forward.

􀂄 Favourable product mix: Commissioning of the new T&B radial capacity in

October 2009 (up from 0.4mn to 0.8mn tyres), expansion of the PCR capacity

by 10% to 5mn tyres in FY2011E and the increase in the OTR segment in

FY2010 are working in favour of JK Tyre. Given the shortage of radial tyres in

the T&B segment, the company is in pole position to fully utilise its enhanced

capacity at higher realisations (65–60% of India's total truck/bus radial tyre

production).

􀂄 Tornel turns profitable: Tornel’s acquisition could act as an upside trigger for

JK Tyre’s stock. The acquisition turned profitable in FY2010, reporting net

profit of `60cr from net loss of `39.9cr in FY2009, aided by the company’s

ongoing restructuring exercise.

Outlook and valuation: We estimate JK Tyre to post EPS of `22.1 for

FY2011E and `34.5 for FY2012E. At `118, the stock is available at attractive

valuations of 5.3x and 3.4x FY2011E and FY2012E earnings, respectively. Due to

the recent correction in the stock price, we recommend Buy on the stock with a

Target Price of `166, valuing the company at 4.8x (40% discount to market leader

Apollo Tyres’ multiple of 8x) FY2012E earnings. At our target price, JK Tyre will

trade at 0.6x and 4.2x FY2012E P/B and EV/EBIDA, respectively.

Key risk

Volatility in rubber prices dampening industry performance: With the Rubber Board

scaling down its projections for natural rubber growth in the country, the tyre

industry has expressed dismay over the impending rubber crisis. As per Automotive

Tyre Manufacturers Association (ATMA), India has scaled down the supply

anticipated for this year to 844,000 tonnes from the earlier forecast of 879,000

tonnes, largely on account of unseasonal heavy rains during October. Thus, the

supply is anticipated to grow at a much slower rate of 2.9% as against 7.2%

anticipated earlier. The scaling down of natural rubber growth projections will

lower rubber availability in the country, as the gap between availability and its

offtake has been widening. Currently, rubber prices have been ruling at an all-time

high level of `235/kg (RSS-4 grade on January 25, 2011).