Apollo Tyres

Shareholders can stay invested in the Apollo Tyres stock with a two-year perspective. At the current market price of Rs 72, the stock trades at about 8.6 times and 7 times its estimated consolidated earnings for FY11 and FY12, respectively. But uncertainty on two counts implies that fresh exposures to the stock can wait one, the unrelenting rise in the prices of rubber, the key raw material; two, the success of the company's European debut.



However, over the medium to long-term, the strong demand scenario for automobiles, the company's market leadership position in the truck and bus segment and the addition of capacity for radial tyres at Chennai holds promise. Besides, any fall in rubber prices will also trigger greater earnings visibility for this raw material-intensive industry.

IN A TIGHT CORNER

Amidst rising demand from automakers, the standalone India operations of the company, which contribute about 65 per cent to the total revenues, witnessed a tepid first quarter. This was on account of two factors: first, a continuous increase in the price of rubber and second, a lock-out in the Perambra plant in Kerala for the most part of June, which shaved off about Rs 300 crore from revenues.

For the quarter ended June 2010, net sales were down 5 per cent to Rs 1,121 crore, and profits were down by about 57 per cent to Rs 41 crore on a year-on-year basis. The plant has reopened only last week, well into the second quarter, implying that the September quarter results, too, will be marred by production losses.

Besides, with demand outpacing supply, rubber prices are expected to be higher than the average of Rs 165 a kg witnessed in the April-June period. Higher import of rubber (the company currently imports 10-15 per cent of its requirements) is an option, considering that international rubber prices are slightly lower. But the inverted duty structure (where duty on import of rubber, the raw material, is higher than duty on import of tyres, the finished product) doesn't make the option very attractive.

Although the company managed a 10.5 per cent operating margin in the first quarter, the bleak outlook on rubber prices is expected to dampen it in the near to medium term. This is compounded by the fact that the company has already taken three price increases in May, June and July, totalling 10 per cent in the replacement segment and an increase of about 5 per cent in the original equipment (OE) segment in April and July. Its buyers may not easily accept a further increase . OE manufacturers are beginning to face pricing pressures and are willing to import low-priced tyres from countries such as China.

EARLY DAYS FOR EUROPE

On a standalone basis, the company's performance was lacklustre; however, on the consolidated front, aided by a particularly favourable quarter in Europe, the company posted a 11 per cent increase in net sales to Rs 1,821 crore. Profits were flat at Rs 74 crore. The company had, during the first quarter of 2009, acquired Netherlands-based Vredestein Banden, a niche player in the European market. Apollo Vredestein supplies the unique ‘Spacemaster' tyres to Porsche, Daimler, Mercedes, Audi, Volkswagen and Ferrari. It is also a specialised supplier to farm tractors.

Going forward, it needs to be seen whether the European operations can sustain this performance. Notwithstanding that it supplies high-end products predominantly to the replacement market where margins are high, the results in the first quarter were achieved on the back of a strong and prolonged winter (implying higher demand for winter tyres), lower inventory levels and the fact that higher rubber prices are expected to hit them only with a lag.

Aside of this, the company has also used this acquisition as a platform to start selling its ‘Apollo' brand tyres in Europe (through Vredestein's network). In June this year, it made its debut in Germany, the Netherlands and the UK, where it will initially sell tyres for the small and mid-size segment. Only time can tell how fruitful this foray will be.

Europe is the most advanced market in terms of performance parameters, customer demands and premium products. Moreover, while the demand for passenger cars in Europe grew in the first three months of the calendar year, it has been showing a downtrend since April; commercial vehicles, though, point to a cautious recovery. Considering the end to support schemes from the government and the challenging economic situation in the EU, the outlook for the auto industry in Europe is not rosy.

ON A STRONG WICKET

Back home, the sustained demand for automobiles since the industry recovered from the slowdown in 2008, will benefit the company both in the OE and in the replacement markets. The company is already the market leader in the truck-bus and the light trucks segment, with about 28 per cent market share. Higher sales now would translate into higher replacement demand two or three years down the line.

Although OE margins tend to be lower than replacement margins for tyre companies because of better pricing power in this segment, they can make up in terms of volumes in years of high demand. Passenger cars being the fastest-growing segment, Apollo has added new cars such as Chevrolet Beat, Ford Figo, Volkswagen Polo and Indigo Manza under its OE clients.

Besides, due to the benefits of fuel efficiency and higher productivity, radialisation is catching on. This is apparent from the fact that OE makers and tyre dealers have recently lobbied to get the ban lifted on the import of radial truck tyres, imposed in November 2009.

From the current levels of about 13-14 per cent, radialisation in CVs is expected to go up to 25-30 per cent over the next three years. But industry capacity has been lagging behind, with JK Tyres being the only notable player until recently.

With its Chennai unit for radial tyres dispatching its first supplies in July, the company appears well poised to ride on this demand.

via BL