Apollo Tyres: Buy

Investors with a two-three year perspective can consider exposure to the Apollo Tyres stock. The company has reported strong profit growth in the latest half-year.

Margin expansion has been achieved in the wake of softer prices of key inputs such as rubber, higher capacity utilisation, greater operating efficiencies and higher replacement sales. Capacity expansion, entry into product lines such as truck-bus radials, off-road tyres and industrial tyres suggest strong earnings prospects. At the current market price of Rs 40, the stock trades at a P-E of around 12 times the trailing 12-month earnings.
Growth drivers

Apollo Tyres is the market leader in the truck and bus (T&B) and LCV tyres with a share of 30 per cent. The company earns almost 65 per cent of its revenues from the replacement market and the rest from the OE (original equipment) sales and exports.

The replacement market has been considered the main growth driver for the tyre industry in the past. But the buoyant trends in automobile sales over the past few years and India’s rise as a manufacturing hub for global automakers, has prompted the company to focus on OE sales, especially in passenger cars.

The company is following a strategy of initiating association with a manufacturer as an after-sales partner and becoming an OE partner once volumes pick up. The company is already an OE partner for Tatas, Suzuki and General Motors. It is likely to be the after-sales partner for the Rs 1 lakh car of the Tatas, and is evaluating partnerships with Skoda and Hyundai.

To sustain growth amidst stiff competition in the replacement market, the company is enhancing its retail presence by tying up with Reliance Retail for the sale of CV (commercial vehicle) tyres and is revamping about 500 dealerships into high-end outlets.

The company is also looking at the ‘Tyre Plus’ concept, which will see outlets selling products complementary to tyres such as alloy wheels.
Capacity expansions

The company is setting up a new plant at the existing location in Vadodara for making off-the-road (OTR) tyres, which may aid higher margins.

Production will commence in the next 12-18 months, for which the company has tied up with BEML (Bharat Earth Movers). Apollo is also planning production of speciality and industrial tyres such as docking tyres and those used in forklifts.

But what may hold better potential from a long-term perspective is the foray into the production of radial tyres for the CV segment. India has low levels of radialisation at less than 5 per cent for trucks and buses due to constraints such as higher costs and maintenance involved and poor road infrastructure.

The fast improving highway infrastructure, the Supreme Court ban on the overloading of vehicles and the move towards a hub and spoke model are expected to indirectly rev-up the demand for radial tyres as they offer better fuel efficiency, have longer life and turn out to be cheaper in the long-run. Apollo Tyres is setting up the required capacities in Tamil Nadu for truck, bus and light truck radial tyres, along with high and ultra-high performance passenger car radial tyre. This will be completed by 2010.

The company has also set-up a re-treading facility at Haryana, which could be a cost-effective option for passenger car and small truck owners. The company also plans to build a manufacturing unit in Eastern Europe, which will start off by making radial tyres for passenger cars. The company already has a toehold in Europe (one of the largest tyre markets) through Dunlop Tyres, South Africa, which was acquired last year. Apollo Tyres’ entry into Europe will begin with exporting tyres from its new factory in Tamil Nadu.

For the six months ended September 2007, net sales were up 13 per cent to Rs 1718.45 crore and net profits were up by a whopping 175 per cent.

Operating margins for the April-September 2007 half year has been at the 12-13 per cent levels compared to the 7-8 per cent levels in the same period last year.
Concerns

Margins are likely to be a concern in the next few quarters as prices of natural rubber, a key raw material has shot up to around Rs 95 per kg in the last one-two months after cooling off to Rs 80 per kg in May-June. Low production in Malaysia and Thailand plus the beginning of the lean season in India may continue to pressurise the margins.

Also, the prices of other petroleum-based raw materials such as carbon black, styrene butadiene rubber (SBR) and poly butadiene rubber (PBR) are tightening, thanks to the soaring crude oil prices. The last price increase was in May 2007 on passenger car tyres.

Given the rising raw material costs, the company expects to increase prices in the next two quarters to keep the margins neutral. But in the process, it may face resistance from OEMs and stiff competition from peers. There is also an ongoing dispute in the Kanwar family which may have a bearing on the stock price.