| Summary of Contents STOCK IDEAS Apollo Tyres
Cluster: Apple Green
Recommendation: Buy
Price target: Rs53
Current market price: Rs37
Back on buying list Key points - Profitability to surge on benign raw material prices: Apollo Tyres Ltd (APL)’s profitability was under severe strain in FY2009 due to a steep rise in the prices of its key raw materials, such as rubber and crude oil derivatives like carbon black, synthetic rubber, nylon tyre cord fabric and rubber chemicals. The operating profit margin (OPM) had slumped by 464 basis points year on year (yoy) to 8% in FY2009. However, since December 2008 the raw material prices have corrected substantially while the benefit of a lower raw material cost has not been passed on to the consumers through price reductions. As a result, we expect the profit margin of APL to expand significantly in FY2010, leading to a three-fold jump in its net profit.
- Revival in demand to follow overall economic recovery: The economic slowdown severely affected the domestic automobile industry, especially in the second half of FY2009 after the freefall in the global economy in the wake of the Lehman debacle. The resultant jitters were also felt by the auto ancillary industries including tyres. Tyre makers saw a sharp dip in their sales to the original equipment manufacturers (OEMs) and the replacement market, and many were forced to go for production cuts in H2FY2009. However, the tyre industry is showing signs of recovery especially with the significant demand improvement in the passenger car and replacement markets. The ban on the import of truck and bus radials (TBR) since November 2008 has also helped improve the demand for domestic tyres, more so since the Chinese imports have plunged by ~78%. Also, measures like the economic stimulation measures by the government, the passing on of the benefit of the 6% reduction in the excise duty in the later half of FY2009, the lower interest rates and the significantly lower raw material prices are likely to boost the demand environment further.
- High on expansions: APL is the market leader in truck and bus tyres, and light truck tyres in India with a significant market share in the passenger car tyre segment. To improve its market share and expand in these segments, the company is increasing its capacity in India from 850 tonne per day to ~1,000 tonne per day by establishing a new greenfield plant in Chennai. This plant will primarily cater to the growing demand from the TBR and passenger car radial markets. In the international market APL has presence in South Africa where it is the biggest tyre manufacturer. To further expand its international presence the company in May 2009 acquired Vredestein Banden BV (CY2008 sales at 307 million euros/Rs2,087 crore), a high-end passenger car tyre manufacturer in the Netherlands with a capacity of 150 tonne per day. The acquistion gives APL access to the European markets and has increased its current production capacity to ~1,200 tonne per day.
- Attractive valuations—reinitiating coverage: The improving demand in the replacement and OEM markets will drive APL’s revenue growth in FY2010 in the domestic market whereas the substantial improvement in its margin will lead to a multi-fold jump in its bottom line in the same period. The improvement in the demand environment and the commissioning of the new Chennai facility will drive APL’s growth in FY2011. At the current market price, the stock trades at 5.7x and 5.3x its FY2010E and FY2011E earnings per share (EPS; stand-alone) of Rs6.5 and Rs7 respectively. APL is trading at attractive valuations considering the expected growth in its earnings and its historical average price/ earnings (P/E) of 11.6x one-year forward. We, therefore, re-initiate coverage on the stock with a Buy recommendation and a price target of Rs53, valuing it at 7.5x its FY2011 earnings. The price target implies an upside of 39% from the current market price.
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