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UBS Investment Research
Apollo Tyres
Multiple growth drivers
„ We initiate coverage with a Buy rating and a Rs78.00 price target
Apollo Tyres is India’s leading tyre manufacturer with the highest truck tyre
market share. We believe the company will extend its industry leadership through
the expansion of its radial tyre plant in Chennai. We expect its low cost structure to
support future ROE and that demand for radial truck tyres will drive EPS growth.
Apollo Tyres is trading at historical low multiples on what we believe are very
conservative earnings assumptions.
„ Concerns about impact of rubber prices and overcapacity overdone
The market remains concerned about the impact of high rubber prices on tyre
industry profitability. However, Apollo Tyres has maintained its contribution
margin and reported 23% QoQ EBITDA growth in Q3 FY11. Additionally, our
analysis of capacity addition suggests there will be supply constraints in the next
three to four years.
„ Well positioned to benefit from a robust market environment
We believe Apollo Tyres is well positioned to benefit from favourable industry
trends, such as the increasing penetration of radial tyres in India’s truck sector and
growth in demand for passenger vehicle and commercial vehicle tyres. The
company may also benefit from the launch of Dunlop-brand tyres in more African
countries and the export of Apollo-branded tyres to Europe, although we have not
factored this into our estimates.
„ Valuation: multiples-based sum of the parts
We derive our price target from a sum of the parts. We value the company’s India
business at 4.5x the average of FY12-13E (September 2012E) EV/EBITDA and its
international business at 5.5x. At our price target, Apollo Tyres would trade at 8.7x
September 2012E PE, in line with its historical PE multiple.
Investment Thesis
Apollo Tyres (APLO) has historically been the most efficient tyre manufacturer in
India. In FY04-FY10, it achieved a 39% higher EBITDA/MT than its competitors.
We estimate the company’s FY11-FY15 EBITDA and PAT CAGRs at 12% and
18%, respectively (with a 1.5% dividend yield). Our profitability assumptions for
the tyre industry are conservative due to high rubber prices (a long-term rubber
price of Rs225/kg). We value Apollo Tyres using separate EV/EBITDA multiples
for its India and international businesses. At our 12-month price target of Rs78.00,
the company would trade at 8.7x September 2012 PE. Our numbers are
trough/bottom of the cycle numbers, and we believe there is significant potential
upside as rubber prices stabilise and as operational synergies from higher radial
tyre production kick in.
Apollo Tyres has also demonstrated its ability to deploy capital profitably; it has
made two acquisitions—Dunlop’s operations in South Africa in 2006 for an equity
investment of Rs2.9bn, and Vredestein, Europe in 2009 for an equity investment of
Rs2.5bn. In FY10, the two entities generated a combined net profit of Rs2.1bn. We
are very impressed that Apollo Tyres, despite being in a capital intensive industry,
had the buying power to acquire a high quality business (Vredestein, Europe);
Vredestein generated PAT of Rs1.5bn in FY10.
An increase in raw material prices has impacted tyre manufacturer profitability. As
rubber prices stabilise, we expect the industry to return to normalised profitability.
Apollo Tyres was adversely affected by a strike at its Kerala plant in H1 FY11, but
that issue has now been resolved. We expect an increase in volume and subsequent
operating leverage from fixed costs to drive the company’s EBITDA.
While the industry experienced declining EBITDA margins in FY03-FY10, the
EBITDA/MT of both the industry and Apollo Tyres grew over the period. The
company recorded an 11% CAGR in its per tonne operating profit in FY03-FY10,
in line with the India tyre industry, which also recorded an 11% EBITDA/MT
CAGR over the same period.
Apollo Tyres has been successful in turning around its South African and European
operations. These overseas operations provide it with strategic options—to expand
the presence of Dunlop brand in other African countries and to sell Apollo-branded
tyres in Europe through Vredestein’s distribution network.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
UBS Investment Research
Apollo Tyres
Multiple growth drivers
„ We initiate coverage with a Buy rating and a Rs78.00 price target
Apollo Tyres is India’s leading tyre manufacturer with the highest truck tyre
market share. We believe the company will extend its industry leadership through
the expansion of its radial tyre plant in Chennai. We expect its low cost structure to
support future ROE and that demand for radial truck tyres will drive EPS growth.
Apollo Tyres is trading at historical low multiples on what we believe are very
conservative earnings assumptions.
„ Concerns about impact of rubber prices and overcapacity overdone
The market remains concerned about the impact of high rubber prices on tyre
industry profitability. However, Apollo Tyres has maintained its contribution
margin and reported 23% QoQ EBITDA growth in Q3 FY11. Additionally, our
analysis of capacity addition suggests there will be supply constraints in the next
three to four years.
„ Well positioned to benefit from a robust market environment
We believe Apollo Tyres is well positioned to benefit from favourable industry
trends, such as the increasing penetration of radial tyres in India’s truck sector and
growth in demand for passenger vehicle and commercial vehicle tyres. The
company may also benefit from the launch of Dunlop-brand tyres in more African
countries and the export of Apollo-branded tyres to Europe, although we have not
factored this into our estimates.
„ Valuation: multiples-based sum of the parts
We derive our price target from a sum of the parts. We value the company’s India
business at 4.5x the average of FY12-13E (September 2012E) EV/EBITDA and its
international business at 5.5x. At our price target, Apollo Tyres would trade at 8.7x
September 2012E PE, in line with its historical PE multiple.
Investment Thesis
Apollo Tyres (APLO) has historically been the most efficient tyre manufacturer in
India. In FY04-FY10, it achieved a 39% higher EBITDA/MT than its competitors.
We estimate the company’s FY11-FY15 EBITDA and PAT CAGRs at 12% and
18%, respectively (with a 1.5% dividend yield). Our profitability assumptions for
the tyre industry are conservative due to high rubber prices (a long-term rubber
price of Rs225/kg). We value Apollo Tyres using separate EV/EBITDA multiples
for its India and international businesses. At our 12-month price target of Rs78.00,
the company would trade at 8.7x September 2012 PE. Our numbers are
trough/bottom of the cycle numbers, and we believe there is significant potential
upside as rubber prices stabilise and as operational synergies from higher radial
tyre production kick in.
Apollo Tyres has also demonstrated its ability to deploy capital profitably; it has
made two acquisitions—Dunlop’s operations in South Africa in 2006 for an equity
investment of Rs2.9bn, and Vredestein, Europe in 2009 for an equity investment of
Rs2.5bn. In FY10, the two entities generated a combined net profit of Rs2.1bn. We
are very impressed that Apollo Tyres, despite being in a capital intensive industry,
had the buying power to acquire a high quality business (Vredestein, Europe);
Vredestein generated PAT of Rs1.5bn in FY10.
An increase in raw material prices has impacted tyre manufacturer profitability. As
rubber prices stabilise, we expect the industry to return to normalised profitability.
Apollo Tyres was adversely affected by a strike at its Kerala plant in H1 FY11, but
that issue has now been resolved. We expect an increase in volume and subsequent
operating leverage from fixed costs to drive the company’s EBITDA.
While the industry experienced declining EBITDA margins in FY03-FY10, the
EBITDA/MT of both the industry and Apollo Tyres grew over the period. The
company recorded an 11% CAGR in its per tonne operating profit in FY03-FY10,
in line with the India tyre industry, which also recorded an 11% EBITDA/MT
CAGR over the same period.
Apollo Tyres has been successful in turning around its South African and European
operations. These overseas operations provide it with strategic options—to expand
the presence of Dunlop brand in other African countries and to sell Apollo-branded
tyres in Europe through Vredestein’s distribution network.
Key catalysts
Q EBITDA and EPS CAGR and low valuations. We expect a 12% EBITDA
CAGR and an 18% EPS CAGR in FY11-FY15 with a 1.5% dividend yield.
Apollo Tyres currently trades at only 7x FY12E PE. We believe this is
attractive given a FY11-FY15E EPS CAGR of 18% and 1.5% dividend yield.
As the company posts EPS growth and increases in size, we believe the stock
will rerate. Our estimates are based on conservative assumptions of
profitability; however, as rubber prices stabilise, there could be upside to our
profitability assumptions.
Q Growth in radial tyre volumes and improvements in profitability. Radial
tyres have higher contribution and EBITDA margins. We expect Apollo
Tyres to generate higher EBITDA margins as we believe the contribution
from radial tyres will be higher than bias ply tyres.
Q Continued demonstration of profitability in international business. As
Apollo Tyres reports stable revenue and margins in its international
operations, some of the investor concerns about exposure to Europe may
diminish.
Q Improvement in investor sentiment as rubber prices stabilise. We believe
rubber price stabilisation will provide a key impetus to the stock—it should
reignite commercial vehicle (CV) tyre volume as well as drive margin
expansion. Our estimates are based on very conservative profitability
assumptions and our view that rubber costs remain near the peak level of
Rs225/kg.
Risks
Q Continued increase in raw material prices. Apollo Tyres’ average rubber
cost in Q3 FY11 was Rs185/kg, compared with the current rubber price of
Rs250/kg. We estimate that it will need to raise prices 5-6% to accommodate
the full extent of the raw material cost increase.
Q Any further production interruptions, whether in plants in India or
South Africa. South Africa’s tyre industry has periodically faced labour
strikes (in Q2 FY08 and Q2 FY11). Additionally, there was a strike by port
workers in South Africa in Q1 FY11. Apollo Tyres also had a strike at its
Kerala plant in H1 FY11 Strikes not only hurt production, but also impact
market share.
Q Any ruling against Apollo Tyres (and other tyre companies) by the
Competition Tribunal in South Africa. The South Africa tyre industry has
faced price fixing allegations in the past—the Competition Commission in
South Africa has filed a complaint with the Competition Tribunal alleging
tyre manufacturers engaged in anti-competitive behaviour in August 2010.
There has not yet been any resolution of this case.
Q Industrial slowdown and subsequent decline in CV tyre growth rates
below 10-year average growth rates. Industrial production growth in India
has disappointed investors in the past few months. The growth rate truck tyre
demand has declined from 13.3% in FY10 to 6-7% in FY11. Our demand
model assumes demand growth of 5.5%, and hence it is conservative.
Valuation and basis for our price target
We use a multiple based approach to value Apollo Tyres. We apply an EV/EBITDA
multiple of 4.5x to value its domestic business and 5.5x to value the international
business. Our multiple of 4.5x for the company’s domestic business is in line with
its historical average. European specialty tyre companies, such as Nokian Renkaat
and Cooper Tyres, are trading at an average 7.6x FY11F EV/EBITDA, based on
Bloomberg consensus estimates, and hence 5.5x EV/EBITDA is a conservative
multiple for the international business, in our view.
At our 12-month price target of Rs78.00, Apollo Tyres would trade at
September 2012E PE of 8.7x, which is in line with its historical average
multiple. As Apollo Tyres increases in scale and its PAT grows to Rs5bn in
FY13E, we think the stock can rerate above its historical average trading range,
and hence there is potential upside to our valuation.
We believe our assumptions on Apollo Tyres and the tyre industry are very
conservative. As rubber prices stabilise/moderate, we think profitability will
improve and could surpass our estimates.
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