Tuesday, August 4, 2009



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.

Buy-back may not materialise
The company had announced a buy-back of its shares from the open market beginning April 23, 2009 which will be open till March 18, 2010. As part of the buy-back the company intends to buy a minimum of 67 lakh shares (current equity: 50.4 crore shares) at a price not exceeding Rs25 per share. The maximum amount set aside for the buy-back is Rs122 crore. With the market price ruling over the buy-back price since the announcement of the offer and considering our price target of Rs53 on the stock, we do not expect the buy-back to materialise. Hence, we have not factored any reduction in the equity in our estimates.

Key risks

Raw material and exchange rate volatility
Most of the raw materials needed by APL have shown significant volatility over the years based on the demandsupply factors. The prices of crude derivatives, such as carbon black, synthetic rubber, nylon tyre cord fabric and rubber chemicals, move in tandem with the price of crude oil. Also, the price of rubber, which accounts for 58% of APL’s raw material cost, is a key determinant of the company’s profitability and can play spoil sport, as was
seen in FY2009.

Performance of international operations
APL has substantial international presence in South Africa and now in Europe with the recent acquisition of Vredestein Banden BV. We believe that these markets provide a significant opportunity to APL to become a significant global player as the scale and size of the available opportunity has increased. However, the near-term performance of the international business is susceptible to the difficult business environment in these markets.

To see full report: APOLLO TYRES