Apollo Tyres - Europe business beneficial to some for sure":: LKP

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Standalone business disappoints on higher RM costs and low replacement demand

Apollo Tyres (Apollo)’s standalone volumes for the quarter increased by 37% yoy mainly on the back of low volumes in Q2 FY11 due to strike at its Perambra plant. Standalone net sales grew by 57% yoy, but on qoq basis declined by 6%. This was mainly due to weak replacement demand and higher demand on low margin OEM PCR side. Higher raw material expenses as a % of sales (77.8%) was because the impact of falling natural rubber prices was offset by adverse currency movement, while prices of crude and its derivatives were still high. Also lower contribution from high margin replacement demand led to a margin fall as demand for it failed to recover. EBITDA margins came in at 6.8%, the lowest since Q3 FY09. Due to underperformance at the operating level, PAT came in at Rs221mn, down 50% qoq and 41% yoy.

Going forward, the impact of falling rubber prices will be seen Q3 and will improve in the ensuing quarters. The plantation of significant amount of natural rubber plantation in India and China done in 2005-06 will started yielding from 2012 (it takes 6-7 years for a rubber plant to get matured and start producing). This may reduce the demand supply gap, thus resulting in a further price fall. Replacement demand is expected to pick up on both TBR as well as PCR sides. There is no news on lifting up of ban on imported tyres, which will have no negative impact on volumes going forward in the domestic markets.

Consolidated business driven by Europe; South Africa subdued

On a consolidated basis, the performance was better as Europe made up for the underperformance in India and South Africa. Revenues grew by 47% yoy and 2% qoq. Volumes came in at 120,000 MT, a growth of 32% yoy. EBITDA margins came in at 8%, a decline of 50 bps qoq and 150 bps yoy on strong European margins. PAT came in at Rs781 mn a growth of 47% yoy.

Pre-buying of winter tyres in Q2 led to a solid performance from the European markets, as Vredestein BV reported revenue growth of 44% while EBIT margins came in at 10.6%, a growth of 260 bps yoy and 80 bps qoq. South Africa saw subdued demand on the auto replacement side and continued to post muted growth as topline grew by 7%, while at the bottomline the company continued to incur losses, though it was not quantified by the management. However, at the operating levels, margins were at 1%, against -2% in Q1 FY12 and -3% in Q2 FY11. Going forward, we expect sale of winter tyres to be strong seasonally as seen in Q3 and Q4, in which margins may go as high as 13-15%. South Africa is expected to continue its muted performance as lifting up of ban on imported tyres has made this market very competitive with strong influx of Chinese players.

Outlook and valuation

Apollo’s results were subdued considering the weak replacement demand in India and South Africa. Margins seemed to have bottomed out as we believe the impact of falling rubber prices will start showing from the ensuing quarters and may offset the negative impact of adverse currency movement if any. Recovery in replacement demand and increase in production from Chennai (250 MT per day at the end of Q2) will ensure strong volume growth, mainly in FY 13. Europe is expected to continue its outperformance with strong sale of winter tyres and expansion of distribution channels. However, on disappointing results in Q2 and delayed replacement demand, we have cut our estimates and target price. We now value the stock 8x times FY 13E EPS of Rs9.6 and arrive at a lower TP of Rs 77, while maintaining BUY on the stock, and an upside of 26%.