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JK Tyre (JK) reported decent top-line growth for 2QFY2011 following higher
off-take in OE volumes. However, EBITDA margin declined substantially due to
the sharp increase in rubber prices and other input cost. As a result, the company
recorded a substantial dip in net profit despite the hike in product prices.
We maintain a Buy on the stock owing to attractive valuations.
Top-line up 20.9%; OPM at 6.5%: JK Tyre reported turnover of `1,139cr (`941cr)
for 2QFY2011, an increase of 20.9% yoy. Top-line growth was aided by volume
growth of ~14% in tonnage terms and ~6% growth in net sales realisation. The
company posted 45.6% yoy decline in operating profit to `74cr (`137cr) for
2QFY2011. Operating margin dipped by a substantial 800bp yoy basis primarily
due to the spurt in rubber prices leading to a significant 1,187bp yoy increase in
raw material cost to 70.6% (58.7%) of sales in 2QFY2011. Net profit came in at
`20.2cr (`59.5cr), registering a 958bp yoy dip in NPM at 1.8% (6.3%).
Outlook and Valuation: We are revising downwards our earnings estimate owing
to the rubber prices sustaining at high levels going ahead and the substantial
impact on OPM thereof. Further, JK’s plans of incurring higher capex would
leverage the balance sheet and poses downside risk to our earnings estimates.
We estimate EPS of `31.1 for FY2011E and `40.4 for FY2012E. At the CMP of
`160, the stock is available at attractive valuations of 5.2x and 4x FY2011E and
FY2012E EPS, respectively. We maintain a Buy on the stock, with a
Target Price of `202, based on 5x, 4.2x and 0.8x FY2012E EPS, EV/EBITDA
and P/BV, respectively.
Top-line up 20.9%: JK Tyre reported 20.9% yoy growth in net sales to `1,139cr
(`941cr) in 2QFY2011. In tonnage terms, the company registered ~14% yoy
growth in volume, while net sales realisation grew ~6% during 2QFY2011.
JK hiked its product prices by 2-3% in 2QFY2011 to pass through the
increase in raw material cost. On the utilisation front, JK operated at higher
utilisation levels of ~93%.
EBITDA margin contracts by 800bp due to increased raw material cost: Operating
profit declined 45.6% yoy to `74.5cr (`136.9cr) during 2QFY2011. OPM fell by
800bp yoy primarily on account of the 1,187bp yoy jump in raw material cost.
Despite the hike in product prices, the company has not been able to pass on the
same entirely. The average procurement price of rubber for the company in
2QFY2011 stood at `177/kg compared to `158/kg in 1QFY2011 and `101/kg in
2QFY2010. Since 2QFY2010, the company has hiked its product prices by ~20%
and has guided subsequent price hikes in the event of increasing rubber prices.
Net profit at `20.2cr, down 66.1%: JK Tyre recorded a 66.1% yoy decrease in net
profit to `20.2cr (`59.5cr) during the quarter, primarily on account of margin
contraction. The drop in net profit growth was restricted due to the decline in
interest expense, which fell 11.3% during the quarter.
Conference call – Key highlights
During the quarter, JK benefitted from the robust tyre demand led by buoyant
economic growth and increased off-take in OE volumes. As a result, utilisation
levels for truck and nylon radials stood at ~100% and that for car radials
between 90–92%. Overall, the company’s utilisation level came in the range
of ~93% during 2QFY2011.
During the quarter, of the total sales revenue, ~68-70% was derived 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’s and the rest from the replacement segment. Volumes grew
~14% in tonnage terms and net sales realisation increased ~6% during
2QFY2011.
The company has hiked its product prices by ~20% since 2QFY2010. Average
rubber prices for the company stood at `177/kg during 2QFY2011,
compared to `158/kg in 1QFY2011 and `101/kg in 2QFY2010. Rubber
prices are currently trading at ~`195/kg. Rubber, NTC fabric and carbon
black prices have increased by ~75%, ~6% and ~25% yoy, respectively. The
company was not able to pass on the entire raw material price hike (13-14%
was absorbed by the company); and if prices remain at current levels, the
company would increase its product prices again going forward.
Capacity expansion: JK has plans of incurring capex of around `2,400cr over
the next 4-5 years to expand capacity. The company proposes to incur
`2,000cr capex towards a green-field 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 (by end 2011): The company’s existing domestic capacity of 97
lakh tyres would be increased to 126 lakh tyres.
2) Phase II (18 months from completion of Phase I): Additional capacity of
30 lakh tyres; this would result in combined domestic capacity at 156 lakh
tyres per annum 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 end of FY2012.
For FY2011, JK has planned capex of `930cr, of which `775cr would be
incurred at the Chennai facility and `155cr at the existing plants. We note
that, out of `930cr capex for FY2011, ~`200-250cr may spill over to the next
fiscal depending on the availability of machinery from the vendors. The capex
of `930cr would be funded through a combination of debt and internal
accruals. The company already has sanctioned loans of ~`630cr, the balance
~`300cr would be funded through internal accruals.
The company plans to increase 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.
Outlook and Valuation
We are revising downwards our earnings estimate owing to the rubber prices
sustaining at high levels going ahead and the substantial impact on OPM thereof.
Further, JK’s plans of incurring higher capex would leverage the balance sheet and
poses downside risk to our earnings estimates. We estimate EPS of `31.1 for
FY2011 and `40.4 for FY2012.
At the CMP of `160, the stock is available at attractive valuations of 5.2x and 4x
FY2011E and FY2012E EPS, respectively. We maintain a Buy on the stock, with a
Target Price of `202, based on 5x, 4.2x and 0.8x FY2012E EPS, EV/EBITDA and
P/BV, respectively.
Key Risk: Volatility in rubber prices dampening industry performance
With the Rubber Board scaling down the 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), the scaling down
of natural rubber growth projections will deepen the rubber availability crisis in the
country as the gap between availability and its off-take has been widening. ATMA
pointed out that 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. The supply is anticipated to grow at a
much slower rate of 2.9% as against 7.2% anticipated earlier.
Consumption of natural rubber is rising at a faster pace than its production.
Rubber imports are, therefore, inevitable. However, rubber prices have been ruling
at all-time high levels and the hefty 20% import duty is hurting bottom-lines of the
tyre companies. At current prices, the import duty component alone amounts to
around Rs38/kg. ATMA has, therefore, asked for easing the import duty on natural
rubber to meet the shortfall. Under the currently applicable ad-valorem rate of
duty when the rubber prices move up, consumers not only have to pay more to
import natural rubber, but have to also bear the burden of the customs duty that
goes up proportionately. For instance, when the rubber prices were at Rs80/kg last
year, the 20% customs duty stood at Rs16/kg. When the price increased to above
Rs190/kg the duty stood at Rs38/kg. ATMA has alluded to the import duty scenario
in China where the import duty on sheet rubber is 20% or Yuan 1,600/tonne,
whichever is less. Thus, at current international rubber prices of Yuan
30,500/tonne, the customs duty works out to just 5.2%.
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 FY2011 and the increase in the OTR segment in
FY2010 is working in favour of JK. 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: The Tornel acquisition could act as an upside trigger
for the 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.
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