Apollo Tyres: BUY. ApolloTyres: On a smooth ride

The cyclical upturn in domestic commercial vehicle and car sales, improved outlook for its European business and benign input prices imply that Apollo Tyres is a good bet for investors with a perspective of one to two years.

The valuation too is reasonable, with the stock discounting its trailing 12-month consolidated earnings by about nine times. This is cheaper than peers, such as MRF and Ceat, which trade at 12-13 times.

Apollo derives about 70 per cent of its consolidated revenue from its India operations. After a slowdown until early 2014, sale of trucks and buses picked up sharply last fiscal. Robust sales are being seen this fiscal too. An economy on the mend will help sustain commercial vehicle sales over the medium term.

Higher new vehicle sales will also have a trickle-down effect on replacement demand for tyres, which is a big market for manufacturers. In addition, the company will benefit from the increasing preference for radial tyres for trucks and buses.

Apollo Tyres is the second-biggest player in commercial vehicle tyres after JK Tyres and has a 27 per cent market share in this segment.

The company expects radialisation in truck and bus tyres, which stands at 35 per cent currently, to double over the next five years. A richer product mix driven by a higher share of radial tyres will help realisations and margins as well.

Besides, low inflation and interest rate cuts are helping consumers loosen their purse strings. Hence, car sales are witnessing good growth too, with volumes in the first five months of this fiscal growing by about 10 per cent over the same period last year. Apollo derives about half its revenue from truck and bus tyres and a little more than one-third from passenger car tyres.

Benign prices of natural rubber and crude oil also favour the company. Prices of natural rubber, which touched a peak of ₹240 a kg in 2011, have been cooling off since late 2013.

They have now stabilised at about ₹120-130 a kg. International prices too have followed a similar trend. With projections of adequate supply to meet demand in the near to medium term, a sharp spike in rubber prices is not expected.

Thanks to the halving of oil prices in the last one year, crude oil derivatives, such as synthetic rubber, nylon tyre cord and carbon black, used by the tyre industry have also come down. As a result, Apollo has already seen a big expansion in operating margin in the June 2015 quarter to 17.6 per cent  vis-à-vis  13.1 per cent a year ago.

For the quarter ended June 2015, the company’s consolidated net sales at ₹2,832 crore was 12 per cent lower than the ₹3,223 crore recorded in the same period last year. For the India operations, lower volumes due to influx of Chinese imports and price cuts to pass on low raw material costs and to take on Chinese competition have affected top-line growth. In the European market, while revenue did grow 2 per cent in euro terms, a depreciation in the euro vis-à-vis the rupee affected the consolidated revenues. However, the benefit of cheap inputs along with a drop in employee and finance costs helped consolidated net profits grow a healthy 27 per cent to ₹290 crore.

Higher vehicle sales domestically should help push up volumes in the months to come. Pricing pressures may remain in place due to stiff competition from Chinese tyres in the unorganised market. But benign raw material costs will continue to support profit growth in the coming quarters.

The outlook for the European markets also appears sanguine, with overall economic growth prospects looking up and auto sales gathering steam.

While the company predominantly provides winter tyres for the replacement markets under the Vredestein brand, it has taken steps to diversify the revenue stream. Apollo introduced all-season tyres and SUV tyres last fiscal and is also expecting to begin supplies to car manufacturers soon. Considering that vehicle owners tend to choose the same brand when replacing old tyres, supplies to auto manufacturers will also help strengthen its position in the replacement market.

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