Apollo Tyres: Available at attractive valuations

Apollo Tyres is the second largest tyre manufacturer and sells its products under the Apollo and Vredestein brands. The truck and bus segment accounts for around half of its sales. The passenger car and light trucks segments account for around a third of its sales. These two segments contribute to close to 85% of its sales. Around three fourths of its revenues are from the replacement market. Outside of the domestic market, Europe contributes around a fourth of its revenues. Opportunities in the European could drive the  unfolding of the Apollo Tyre story in the next 12 to 18 months.

The truck and bus segment in India is going through the phase of radialization where TBB (truck and bus bias) are being replaced by TBR (truck and bus radials). Apollo Tyre has a market share of about 28% in TBR’s and is looking to double its capacity for TBR’s. We dont expect Apollo Tyre to deliver significantly superior volume growth compared to the industry. The increased capacity for TBR will only support the shift away from TBB but not deliver any significantly superior volume growth. The radialization while not driving volume growth will support improved margins and drive earnings growth.

The passenger car segment has around 18% market and is expected to grow in line with the overall industry growth. We don’t expect any significantly superior growth as compared to the industry.  The expected improvements in the automotive industry will support the stock but not create a basis for differentiated performance.

While we are not looking for volume growth, we are looking at earnings growth given an environment of falling and low crude and commodity prices. Raw materials account for half of the sales. 80% of the raw material costs are accounted for by five key raw materials namely natural rubber, synthetic rubber, carbon black, tyre cord fabric, steel wire. The margin improvement driven by an environment of benign raw material prices will drive the stock prices in the short to medium term. The margin improvement will be  muted on account of pricing pressure due to the cheap imports for China. The cheap imports from China are a significant threat and could become very serious for Apollo Tyres unless supported by anti dumping measures by the government. While anti dumping measures would be helpful, we are not including them in our assessment.

In Mar-16, Apollo Tyres launched two wheeler tyres. The company is hoping to reach around 10% market share in the next two year. However, we would like to wait and watch before formulating our opinion. We would like to see action on the ground and see how Apollo is taking on the established manufacturers like MRF, Ceat and TVS Srichakra.

While the domestic market can provide earnings growth on account of improved margins, we looking at the European market to provide volume growth. Apollo acquired Reifencom a leading distributor in Germany with presence in multiple markets in Europe. Germany is the largest market for Apollo Tyres and the acquisition of distribution will help it gain market share.

Apollo is also setting up greenfield capacity at a plant in Hungary. The plant is expected to be operational from early 2017. The capacity will help it improve replacement market share given the distribution it has acquired via Reifencom. A plant in Eastern  Europe could also be helpful in gaining market share in the OEM side of the business. We have seen news that Apollo Tyres is having difficulty in hiring human  talent in Hungary. Given this news we would not be very surprised if see delays in the plant getting operational.

So do we buy the stock?

The stock is available at a PE of less than 8, which makes it look attractive. However,in the absence of the a story which is unfolding at a fast pace the expectations from the stock will play out over a period of time. Since things will unfold over a period of time anyone thinking of buying it should do so by using the volatility in the stock to ones advantage. It would be better to buy the stock when the stock market is going through a bad time and the stock price looks weak. A good buying price could provide a short term cushion so that one can be patient for the long term story to unfold.

Where is the margin of safety?

The stock not only looks attractive from the perspective of PE, a price to book of around 1.5 gives some cushion. We were pleased to see the acquisition of Reifencom via internal accruals. We don’t expect to see the debt equity ratio to be adversely impacted by the brownfield (India) and greenfield (Hungary) capacity expansions which would provide a cushion to the stock.

Apollo Tyres management had set a target of $6 billion revenue by 2016. The target was missed and shifted to 2020. Now it seems even the 2020 target will be missed. Missing targets is one part of the story but the absence of a road map is a bit more troubling.

We are not sure if the stock has the margin of safety to weather missing targets around capacity expansions both in India and China. The sustained pricing pressure from Chinese imports and increase in raw material prices could hurt the story we are building.

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