Buy Apollo Tyres – 3QFY2011 Result Update -Angel Broking

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Apollo Tyres – 3QFY2011 Result Update

Angel Broking maintains a Buy on Apollo Tyres with a Target Price of Rs. 65.

Apollo Tyres reported better-than-expected results for 3QFY2011 led by healthy

qoq margins on account of efficiency in the raw material procurement policy.

However, top-line growth was impacted by weakness in the domestic replacement

demand for CV tyres. We revise our earnings estimates marginally upwards to

factor in the better-than-expected numbers. We maintain a Buy on the stock.

Standalone results beats estimates: Standalone top-line registered 8.2% yoy

(21.8% qoq) growth to `1,432cr v/s our estimate of `1,259cr largely led by in the

increase in price. Volume growth was restricted due to the weakness in demand

for CV tyres in the replacement segment. Operating margin declined by a

significant 510bp yoy to 10.4% (15.5%) primarily due to the ~56% yoy increase

in natural rubber cost during the quarter. Thus, net profit registered a steep

decline of 47.2% yoy to `54cr, though sequentially net profit jumped 44.5%.

Consolidated revenues up 3.2%, net profit declines 35.6%: On a consolidated

basis, net revenue increased by 3.2% (21.5% qoq) to `2,369cr on the back of the

~16% yoy increase in average realisations as volumes declined ~11% yoy. While

revenues of the South Africa operations increased 2.6% yoy, Europe reported a

4.7% yoy decline. Operating margin stood at 11.5% as against 9.5% in

2QFY2011 and 16.7% in 3QFY2010. Consequently, operating and net profit fell

by 28.8% yoy (up 47% qoq) and 35.6% yoy (up 127% qoq), respectively.

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

the substantial fall in the 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

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

expect the company to post EPS of `6.8 in FY2011 and `8.1in FY2012. We

maintain a Buy on the stock, with a Target Price of `65, based on 8.0x and 4.2x

FY2012E EPS and EV/EBITDA, respectively.

Net revenues ahead of estimates, up 8.2% yoy: Standalone top-line registered a

better-than-expected 8.2% yoy growth to `1,432cr (`1,323cr) in 3QFY2011.

Volume growth, which was impacted by the lock-out at the Perambra facility during

1HFY2011, improved on a qoq basis. However, volumes declined on a yoy basis

due to the slowdown in demand for replacement tyres in the CV segment. As a

result, the company witnessed finished goods inventory build-up of ~`650cr,

which is higher than the normal inventory levels maintained by it.

OPM at 10.4%, contraction of 510bp due to higher rubber price: On the operating

front, the company reported a substantial 510bp yoy contraction in operating

margin to 10.4% (15.5%). However, sequentially OPM improved by a marginal

10bp. The decline in margin can largely be attributed to the 55.5% yoy jump in the

cost of natural rubber during the quarter. As a result, raw material cost as a

percentage of net sales jumped by 354bp yoy to 65.6% v/s 61.5% in 3QFY2010.

Noticeably, average natural rubber cost for the company during 3QFY2011 stood

at `185/kg v/s the industry average of `194/kg. The company was able to restrict

the increase in raw material cost during the quarter due to efficiency in purchases.

Operating profit fell by 27.4% yoy to `149cr (`205cr). The decline in other

expenditure arrested further erosion in operating profit.

Net profit at `54cr, down 47.2%: Net profit registered a steep decline of 47.2%

yoy to `54cr (`102cr) during the quarter, but it was substantially higher than our

estimate of `58cr. The decline in profitability can largely be attributed to the

decline in volume and margin contraction at the operating level. Moreover, higher

interest and depreciation costs also negatively affected bottom-line. However,

lower-than-expected tax outgo during the quarter cushioned the fall in net profit to

an extent.

Consolidated performance: Net revenues increased by 3.2% yoy (21.5% qoq) to

`2,369cr (`2,296cr) on the back of the better-than-expected performance in the

domestic markets. Overall performance was driven by ~16% yoy increase in

average realization. Volumes however, declined by ~11% yoy to 110,000MT

(124,000MT). While revenues of the South Africa operations increased by 2.6%

yoy to `300cr, Europe reported a 4.7% yoy decline to `649cr. It may be noted that

the European subsidiary, which is primarily into winter tyres, had its peak season

sales distributed over 2QFY2011 and 3QFY2011.

Operating margins at the consolidated level stood at 11.5% in 3QFY2011 as

against 16.7% in 3QFY2010 and 9.5% in 2QFY2011. Consolidated margins were

better than the standalone entity, as the South African subsidiary reported profit for

the quarter and the European subsidiary recorded a strong quarter owing to

increased winter tyre sales. Overall, operating and net profit dipped by 28.8%

35.6% yoy, respectively.

Conference call – Key highlights

Rubber price and price hike action: During 3QFY2011, the natural rubber

prices increased by ~65% yoy and ~10% qoq. Average rubber prices for the

company during the quarter stood at `185/kg compared to `175/kg in

2QFY2011 and `119/kg in 3QFY2010. Prices of NTC fabric and carbon

black moved up by ~18% and ~10% yoy, respectively. On account of the

continuous increase in the raw material prices, the company hiked its product

prices in the domestic market by 12-15% YTD FY2011. However, it was

unable to pass on the entire hike in the raw material price, and with rubber

prices ruling at new highs, the company is contemplating another hike in its

product prices.

�� Current capacity details: India – 950MT/day, South Africa – 175MT/day,

Europe – 150MT/day.

�� Chennai green-field expansion on track: The Chennai green-field capacity is

progressing well and is at ramp-up phase. Currently, the run rate is at 150tpd.

Management expects to ramp it up to 200tpd by March 2011 and 450tpd by

FY2012E once expansion at the Chennai plant is completed. For FY2011, the

company plans to incur overall capex of `1,300cr. The Indian operations will

see a major portion of the capex to the tune of `1,000cr being incurred at the

Chennai facility, where the company intends to double existing capacity for

passenger car tyres. Capex of ~`120cr will be incurred at the South African

facility, while `80cr will be spent at the European subsidiary. For FY2012, the

company plans to incur capex of `500cr at its Indian facilities.

�� The company’s net debt, on a consolidated basis, stood at `2,130cr,

marginally up from `2,100cr at the end of 2QFY2011.

�� Apollo has seen significant built-up in inventory due to the softened demand

for replacement tyres in the CV segment. However, management expects to

achieve normal inventory levels by March 2011, as CV tyres are witnessing a

rebound in demand. On account of the increase in the finished goods

inventory, the manufacturing facility at Perambara was shut for five days.

�� Capacity utilisation of the domestic operations currently stands at ~85-90%,

while it is ~80% for South Africa and close to 100% for Europe.

�� Management has indicated that the general strike in South Africa during

2QFY2011 resulted in a market share loss of ~5%.

�� During 3QFY2011, Indian operations witnessed ~20% decline in the OE as

well as the replacement segments.

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 ~20% higher than that of

cross-ply tyres. Thus, to generate similar RoCE and RoE, the tyre companies

would need to earn EBITDA margins of ~21% compared to ~9% earned on

cross-ply tyres, considering the difference in the capital requirements and

consequent impact on asset turnover, interest cost and depreciation.

Therefore, higher capital requirements will help protect margins from

the 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 the 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 is poised to achieve market leadership on

the back of increasing production from 820tpd in FY2010 to ~1,300tpd 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 revenues, 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

the 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 OPM going

ahead. Moreover, interest cost is expected to increase because of higher debt

levels to fund capex plans.

We revise our earnings estimates marginally upwards to reflect the better-thanexpected

3QFY2011 performance. We expect the company to post EPS of `6.8

and `8.1 in FY2011 and FY2012, respectively. We maintain a Buy on the stock,

with a Target Price of `65, at which level the stock would trade at 8.0x and 4.2x

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.