Automobiles Tyre companies ‐ Profitability set to improve:: Prabhudas Lilladher

􀂄 Domestic Rubber prices’ ~23% correction from its peak levels augurs well for
tyre companies: International Rubber futures have corrected ~25% during the
last four months, the most since the global financial crisis in 2008; they are
currently trading at 240 Yen/kg on the Tokyo Commodity Exchange. This was
based on the concern that the biggest buyer, China, may reduce demand on
account of slowdown. At the same time, Bridgestone Corp., the world’s largest
tyre maker, recently indicated that it may extend output cuts in the second half.
Domestic rubber prices mirror the global trend in the rubber prices. As a result,
we have seen a similar correction in the domestic rubber prices to the tune of
~23% from its peak currently quoting at its lowest level of Rs185/kg .

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􀂄 Gross margins likely to improve by ~90‐120bps over the next couple of
quarters: Tyre companies have already started reaping the benefits of the lower
rubber cost, with gross margins expanding by ~220bps in Q4FY12. With a recent
5-6% correction over the last few weeks, we expect a further 90-120bps
improvement in gross margins of the tyre companies over the next two quarters
i.e. Q1FY13E and Q2FY13E (Exhibit 4). We expect both Ceat and Apollo Tyres to
report standalone EBITDA margin in excess of 10.5% for the ensuing quarters.
􀂄 Rubber prices likely to remain soft: Global surplus may reach 402,000 tons in
the second half, from a 134,000-ton deficit in the first six months. According to a
Bloomberg survey published on June 19, Rubber Futures, which entered a bear
market last month, will drop to 200 Yen/kg from the current 240 Yen/kg by the
end of the year, the lowest since October 2009.
􀂄 Sensitivity to rubber prices very high: Rubber accounts for ~45% of the raw
material cost for the tyre companies. We have assumed rubber prices at
~Rs200/kg for both the companies under coverage i.e. Apollo Tyres and Ceat. A
1% reduction in rubber prices leads to 8-11% positive impact on the EPS of the
companies. However, we need to consider that there could be a price cut in the
OEM segment (~25% of the top-line for the tyre companies). In this case, the
positive impact on EPS could be 4-7% for the companies.
􀂄 Reiterate our positive stance on Tyre companies – Apollo Tyres ‐ preferred
pick: The fall in the value of the rupee provides a huge barrier to imports at this
stage and with the fall in crude oil prices the derivatives of crude are also likely
to correct, going forward. Outlook for profitability of tyre companies is
extremely strong, with rubber prices expected to remain weak in the
foreseeable future. Hence, we reiterate our positive stance on tyre companies.
Apollo Tyres’ (APTY IN) stock price has witnessed a correction of almost 14%
from its recent top and at CMP of Rs79, the stock is trading at 6.7x FY13E and
4.0x FY13E EV/EBITDA, which in our view, is attractive.