New vehicle sales in India have been nothing to write home about in the last few months. Although a few measures have been announced by the government to indirectly stimulate demand, the absence of GST rate cuts or a scrappage policy for commercial vehicles means that new vehicles may not fly off the shelves immediately.
In this context, component makers who derive a sizeable portion of their revenue from after-market sales are better placed than suppliers who serve only auto manufacturers. Apollo Tyres is one such company.
The 36 per cent fall in the stock price in the last year presents a good buying opportunity for investors. It now trades at about 13 times its trailing 12-month consolidated earnings, cheaper than other tyre-makers such as MRF and Balkrishna Industries.
Slowing economic activity, liquidity crunch among finance companies and better utilisation of existing truck fleet, following implementation of higher axle load norms, have taken the sheen off automobile sales in the last one year. Overall growth in new vehicle sales volumes dropped from 14 per cent in 2017-18 to 5 per cent in 2018-19. In the first four months of this fiscal, volumes have plunged 14 per cent.
Deriving 60-65 per cent of its standalone revenues from the replacement demand for tyres in the secondary market, Apollo Tyres is well-placed to ride this slowdown. Apollo tyres has seen its after-market sales grow by double-digits in the truck, passenger vehicles and two-wheeler segments in the June 2019 quarter. The growth is expected to continue.
Besides, radialisation levels in truck and bus tyres — at 45-50 per cent now — is expected to move up to 55-60 per cent. This trend will favour the company.
Sanguine prospects in Europe
Apollo Tyres derives about 30 per cent of its consolidated revenue from Europe. A slowdown in demand in the European markets as well as start-up costs for the Hungary plant, inaugurated in April 2017, have been pulling down the performance in the last few quarters. In the June 2019 quarter, the company was able to grow its car tyre volumes by 5 per cent in a difficult market. It is also gaining good traction in truck tyres — a segment in which it is a more recent entrant.
Ramping up of production at Hungary, ongoing cost-control efforts and higher sales volumes are expected to improve the situation over this year for the European operations.
Although higher replacement volumes helped top line, the slowdown in new vehicle sales in the domestic and European markets ensured that consolidated sales grew only by 0.5 per cent to ₹4,272 crore. Lack of operating leverage from poor volumes as well as increase in raw material costs have resulted in operating margins coming down to 11 per cent vis-à-vis 12.5 per cent in the June 2018 quarter.
Apart from poor operating level performance, higher interest costs from ongoing capex for the upcoming radial tyre facility at Andhra Pradesh and a fall in other income, contributed to a 43 per cent drop in net profits to ₹141 crore.
Postponing a portion of the capex should help ease interest costs a bit. While weak global demand will keep natural rubber prices range-bound, higher replacement demand will aid margins as tyre-makers usually have higher pricing power in the replacement market. Better product mix from higher share of TBRs and the ramp-up in European operations will also improve profitability.