Apollo Tyres - Cooper deal called off; Stock likely to play catch up :: Prabhudas Lilladher

As we had mentioned in our update dated 14th Nov’13 in case the deal with
Cooper Tires does not go through, it would be a big positive for the stock. Cooper
Tires called off the deal in the last week of Dec’13. Cooper was unable to file its
financials for the September quarter due to unavailability of financials of the
Chinese venture. We believe thatthe termination ofthe deal is a positive for Apollo
tyres as the deal would have put significant pressure on the consolidated balance
sheet(acquisition cost of $2.5bn mainly funded through debt).Now thatthe deal is
called off, we revert back to our earlierthesis of Apollo being better placed among
the tyre companies in terms of balance sheet and strong Free Cash Flow. Now, in
our view, it will play a catch up game with other tyre stockslike JK, MRF and CEAT
which have run‐ up by 50‐70%. With valuations attractive at 6.5x FY14E and 6.2x
FY15E EPS, we recommend BUY rating on the stock with a Target price of Rs138
(@8x FY15E P/E ‐  in line with its average P/E).
 Termination of the deal a big positive: We believe that the termination of the
deal is a positive for Apollo tyres as the deal would have put significant pressure
on the consolidated balance sheet. Moreover, there was a high risk of Cooper
not being able to service the huge debt asmargins were under pressure. With an
annual interest outgo of USD 180‐200m, it would have put pressure on servicing
the debt. Now that the deal is called off, we revert back to our earlier thesis that
Apollo is better placed among tyre companies in terms of balance sheet and
strong Free cash generation. We do not take into account any termination fee /
damages that may arise to either of the entities. We are of the view that Apollo
Tyres would not have to pay any termination fee as the earlier two rulings by
the Delaware court were in Apollo’s favor.

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 Ourreport dated 14thNov’13: APTY won a preliminary victory in its court battle
over Cooper Tire & Rubber Co.’s demand that it complete a US$2.5bn buyout
when a Delaware judge ruled the Indian company fulfilled its obligations to
negotiate with a U.S. labour union. Cooper Tire acquisition is likely to be
completed by end of this calendar year. Till then, it would continue to be an
overhang on the stock. We continue to keep our rating ‘Under Review’.
However, we are turning positive on the stock, given the developments over the
last week. In case the deal does not go through, it would be a big positive for the
stock.
 Rubber prices trending downwards: Natural rubber prices have already
corrected by 9% QoQ in the December quarter. Already for the current fiscal,
rubber prices are down 24% YoY which augurs well for the EBITDA margins of
the company. Margins are likely to improve by 280bps YoY at the standalone
level and 160bps on the consolidated level mainly led by gross margin expansion
in FY14E.
 FCF positive for next two years: APTY is likely to generate FCF to the tune of
Rs6.0bn and Rs8.1bn in FY14E and FY15E respectively. As a result, we expect the
a reduction in consolidated debt to the tune of Rs3.3bn. This would lead to 8-
10% savings in interest outgo in FY15E.
 P/E could revert to its average 7.5‐8x 1 yr fwd: On account of Cooper Tire deal
unlikely to go through, the stock has reverted back to Rs100 levels (levels it
corrected from) from Rs70 levels. Now, in our view, it will play a catch up game
with JK, MRF and CEAT which have run up by 50-70% on account of lower
rubber prices. At the same time, rubber prices continue to drift lower, thereby,
leading to strong ensuing quarters and healthy margins. At the CMP, the stock
trades at 6.5x FY14E and 6.2x FY15E earnings, which in our view is attractive.
Despite the recent run up, we recommend BUY rating on the stock with a Target
price of Rs138 (@8x FY15E P/E - in line with its average P/E). At our Target price,
the stock would trade at 4.2x FY15E EV/EBITDA (at a discount to its average
multiple of 4.5x).