 "Apollo Tyres: Clear roads ahead")
The share price of Apollo Tyres has gained 11 per cent this month, on the back of re-rating due to sustained lower input costs, signs of demand recovery, easing concerns related to capital expenditure and raising of the foreign institutional investor limit in the company.
Natural rubber prices are trading at multi-year lows. A fall in crude oil prices will help the company cut its synthetic rubber input costs. Standard Chartered Securities India analysts Aniket Mhatre and Amit Kasat say softening input costs and industry pricing discipline raise the confidence on margin sustainability.
The key would be a recovery in domestic demand, the largest chunk of its overall revenue. Within the various segments, the Street will keep an eye for growth in the commercial vehicle (CV) segment. Analysts expect double-digit growth, as leading indicators such as freight and M&HCV (medium and heavy CV) sales are showing early signs of recovery. Further, a fall in diesel prices is supportive of a recovery, as half the operating cost of M&CVs are accounted for by fuel.
Natural rubber prices are trading at multi-year lows. A fall in crude oil prices will help the company cut its synthetic rubber input costs. Standard Chartered Securities India analysts Aniket Mhatre and Amit Kasat say softening input costs and industry pricing discipline raise the confidence on margin sustainability.
The key would be a recovery in domestic demand, the largest chunk of its overall revenue. Within the various segments, the Street will keep an eye for growth in the commercial vehicle (CV) segment. Analysts expect double-digit growth, as leading indicators such as freight and M&HCV (medium and heavy CV) sales are showing early signs of recovery. Further, a fall in diesel prices is supportive of a recovery, as half the operating cost of M&CVs are accounted for by fuel.
Sales to the replacement market, at least 70 per cent of revenue, will also be key. This market grew at six per cent annually over the past two years and has been the mainstay for all tyre makers, given the slowing in the original equipment manufacturers segment. The growth rate, according to Anand Rathi Research, has been higher at 10 per cent in the past six months.
The key margin trigger, in addition to higher demand and operating leverage, are lower input prices. Rubber prices have been falling over two years and are presently down 25 per cent over a year before. Credit Suisse analyst Jatin Chawla estimates a one per cent change in rubber (accounts for 40 per cent of input costs) prices impacts earnings per share by 1.8 per cent. With crude oil prices falling 15 per cent over the past couple of months, the gains are higher, according to the analyst, as all other input costs are crude oil linked. Analysts expect Ebitda (earnings before interest, taxes, depreciation and amortisation) margins to improve 100-130 basis points (bps) in FY15, due to favourable tailwinds from the FY14 number of 13.5 per cent.
While the stock has had some re-rating over the past fortnight and trades at nine times its FY16 estimated earnings, (from an earlier seven times), further re-rating will depend on stronger volume recovery and pricing discipline in the industry, which has held so far. Given the sharp fall in prices of rubber, any pricing action (reduction in tyre prices) by competitors will alter the scenario.
The key margin trigger, in addition to higher demand and operating leverage, are lower input prices. Rubber prices have been falling over two years and are presently down 25 per cent over a year before. Credit Suisse analyst Jatin Chawla estimates a one per cent change in rubber (accounts for 40 per cent of input costs) prices impacts earnings per share by 1.8 per cent. With crude oil prices falling 15 per cent over the past couple of months, the gains are higher, according to the analyst, as all other input costs are crude oil linked. Analysts expect Ebitda (earnings before interest, taxes, depreciation and amortisation) margins to improve 100-130 basis points (bps) in FY15, due to favourable tailwinds from the FY14 number of 13.5 per cent.
While the stock has had some re-rating over the past fortnight and trades at nine times its FY16 estimated earnings, (from an earlier seven times), further re-rating will depend on stronger volume recovery and pricing discipline in the industry, which has held so far. Given the sharp fall in prices of rubber, any pricing action (reduction in tyre prices) by competitors will alter the scenario.
The second, more specific to Apollo, is the increase in competitive pressure in Europe, where it operates through its subsidiary, Vredestein. The company was forced to take price cuts in Europe, a negative, since margins at European operations at 16-18 per cent are 300-500 bps more than the Indian operations and boost overall profitability.
So far, the price cuts have been lower than the decline in the cost of inputs. Hence, the margin impact for this subsidiary is unlikely to be negative. However, any further pricing cuts at the European operations, 30 per cent of consolidated revenue, could hamper overall margins. Also, economic growth in Europe has been faltering.
On funding of the plan for €500 million capital expenditure, Standard Chartered analysts say the company can fund about €300 mn from internal accrual (Vredestein had an Ebitda of €80 mn in FY14), while the rest will come from debt.
So far, the price cuts have been lower than the decline in the cost of inputs. Hence, the margin impact for this subsidiary is unlikely to be negative. However, any further pricing cuts at the European operations, 30 per cent of consolidated revenue, could hamper overall margins. Also, economic growth in Europe has been faltering.
On funding of the plan for €500 million capital expenditure, Standard Chartered analysts say the company can fund about €300 mn from internal accrual (Vredestein had an Ebitda of €80 mn in FY14), while the rest will come from debt.