Apollo Tyres: Maintaining Speed Despite Automotive Downturn
Apollo Tyres Limited (ATL) is primarily engaged in the manufacturing and sale of tyres with its product portfolio comprising of tyres, tubes and flaps. It markets its products under two brands, Apollo and Vredestein, and its business segment includes India, Europe and other nations. The Indian segment consists of manufacturing and sales operations in the country whereas the European segment includes manufacturing and sales operations at its plant based in the Netherlands and at its subsidiaries as well. These subsidiaries are located in the United Arab Emirates, South Africa and Thailand. In India, ATL has two manufacturing plants located in Cochin and one each at Vadodara and Chennai.
Industry Overview
India’s automobile market grew by 5.2 per cent in FY19 compared to 14.2 per cent and 6.8 per cent growth in FY18 APOLLO TYRES: and FY17 respectively. The passenger vehicle (PV) segment posted a slower growth of 2.7 per cent for FY19 compared to the growth of 7.9 per cent, 9.2 per cent and 7.2 per cent for the previous fiscal years. The commercial vehicle (CV) segment continued to witness a strong growth as it expanded by 17.5 per cent for the financial year whereas two-wheelers witnessed a decline in growth of 4.9 per cent as compared to 14.8 per cent in the previous fiscal year.
The overall automotive sector has been plagued with slow growth despite which the tyre industry has had a stable performance during FY19. As per the Automotive Tyre Manufacturers’ Association, the industry witnessed double digit growth of 11 per cent during FY19 to an estimated Rs.63,000 crore. The CV segment continued to deliver impressive results and recorded a growth of 16 per cent. On the other hand, the PV segment posted flat growth during the year. The domestic tyre demand is expected to go up by 3-4 per cent during FY20. On the basis of comments by tyre makers, the industry is set to invest Rs.17,000 crore by FY22, part of which is expected to be funded by debt. With the industry’s capitalization and coverage indicators expected to remain stable for long-term, the industry revenue is assumed to increase by 6-8 per cent.
Rubber Industry Overview
Natural rubber is an essential raw material for Apollo Tyres Limited or rather any tyre manufacturer. The earlier years witnessed concerns regarding the rubber industry with production of natural rubber in India posting a continuous drop despite rise in consumption. During FY19, floods in Kerala added to the worries. Also of impact is the fact that the export obligation period has been reduced from 18 months to six months with mandatory pre-import clearance. Import of natural rubber is considered an alternative but the inverted duty structure applies a rate of 25 per cent taxes to natural rubber imports as against less than 10 per cent duty on finished tyre.
Beyond natural rubber concerns, volatility of oil prices and of the rupee against dollar also add to the raw material cost of companies engaged in the tyre business. According to data published by Rubber Board, rubber imports fell by nearly 18 per cent year-on-year during April-October 2019. As of mid-December, the domestic price of the premium grade RSS-4 sheet which is used in tyre production rose to Rs.132 per kg from Rs.126 per kg in mid- November. Outbreak of Pestalotiopsis disease in the rubber plantations in top three natural rubber producing countries – Thailand, Indonesia and Malaysia – led to a further increase in rubber prices.
Financials
Looking at ATL’s consolidated quarterly trends, the net sales for Q2FY20 fell by 6.35 per cent to Rs.3,926.06 crore from Rs.4,192.37 crore in Q2FY19. The Indian operations were primarily responsible for the decline in sales due to the current market conditions. With decline in the operating leverage given the lower sales, PBDT in Q2FY20 dropped by 5.44 per cent to Rs.372.04 crore as compared to Rs.393.43 crore in Q2FY19. Subsequently, the net profit gained in Q2FY20 declined by 43.12 per cent to Rs.83.05 crore as against Rs.146.03 crore gained in the same quarter of the previous fiscal year. For Q2FY20, the Indian operations segment witnessed a decline of 10.8 per cent in sales to Rs.27.2 billion owing to volume decline by 12 per cent wherein the OEM segment’s contribution declined by 45 per cent.
The CV segment, in particular, has been a drag. Though the passenger car segment witnessed improvement, the CV segment continues to struggle. On the annual front, ATL reported net sales of Rs.17,273.29 crore in FY19, an increase of 15.70 per cent compared to Rs.14,928.95 crore in FY18. Volume growth and price hikes drove growth in the domestic business. For FY19, PBDT expanded by 5.97 per cent to Rs.1,700.68 crore from Rs.1,604.88 crore posted for FY18. Since raw material costs increased and led to a weaker operating performance, ATL gained net profit of Rs.679.72 crore, which is a decrease by 6.10 per cent compared to net profit of Rs.723.88 crore gained in FY18. During FY19 as well, the company continued to focus on its key segment, namely, Asia Pacific, the Middle East and Africa, including India and Europe, by bagging exclusive supplier orders and increasing its market share.
Valuations
Ongoing demand challenges and increased depreciation and interest cost put pressure on the return ratios with the ROCE profile remaining muted at 8.74 per cent and decreasing by 71 basis points from 9.45 per cent in the preceding year. ATL has a PE ratio of 15.77x which is higher than the average industry PE ratio of 13.6x because the market has high expectations about the earnings growth of the company as compared to its peers. ATL has given 1.86 per cent dividend yield to its shareholders in FY19.
Outlook
Going forward, ICRA has maintained a stable outlook for the Indian tyre industry. Despite negative growth and pricing pressures in the European operations market, ATL’s truck segment continues to deliver volume growth. The Hungary plant continues to stabilize and grow as well, thus improving the company’s cost competitiveness. Responding to the downturn in the domestic market, ATL has downsized its capex plan particularly for the AP greenfield project with an expected apex cut of Rs.600 crore during the current and next year.
An expected decrease in the company’s raw material costs by 2-3 per cent for the next quarters will aid in improving the financial margins. Margins for ATL’s European operations are expected to be doubled. The company was successful in gaining market share without sacrificing margins. Since ATL has been working at 75-80 per cent capacity utilisation, as car sales improve, it will see a further increase in market share. Hence, we recommend a BUY.