Apollo Tyres: Valuations reflect positives, margin expansion a key trigger

After hitting its 52-week high last week, the stock of Apollo Tyres is down about 6 per cent. Prior to the correction, the stock had witnessed a rerating and upgrades, rising 23 per cent since the start of the current financial year (FY24).

The gains came on expectations of rising margins -- led by lower raw material costs, pricing discipline (focus on profitability over market share), moderate capex intensity and better product mix. In addition to this, the company, in a recent analyst meet, has reiterated its medium term goals of improving its revenues, return ratios, margins and capping its debt.

From FY23 revenues of $3.1 billion, the company is eyeing a revenue target of $5 billion in FY26, an operating profit margin upwards of 15 per cent from 13.5 per cent and net debt to operating profit level of below two times (broadly at the current levels of 1.4 times). It also seeks to improve its return on capital employed from 10.1 per cent to 12-15 per cent.

However, brokerages highlight that a large part of the recent stock gains, especially on the margin front, are already reflected in the price. While Kotak Institutional Equities has increased the earnings per share estimates over the next two years by 3-4 per cent, it has a ‘sell’ rating on the stock.

Rishi Vora and Praveen Poreddy of the brokerage highlight that the current profitability is not sustainable in the medium term, and margin recovery is completely priced in. The stock is trading at 16 times its estimated FY25 consolidated earnings per share. This is expensive as the business is unable to generate returns higher than the cost of capital over the cycle, say the analysts.

While margin gains on the back of falling raw material prices should benefit the company, the Street will also track the demand trajectory across its product segments. The replacement segment of the truck and bus sector in India is witnessing strong recovery with double digit growth over the last few months.

The passenger car radial (replacement) business, however, remains muted currently though this could improve going ahead, given the robust volume growth trends in the passenger vehicle industry. Demand trends from the car and truck makers (original equipment business) remains positive.

Though the company expects the India business to register a mid-high single digit growth in FY24, demand conditions in Europe are expected to be sluggish. While the company is outperforming the sector in that market, sales growth for the geography could remain flattish this year.

Even as the company has lost market share by 100 basis points in the Indian truck and bus tyre segment, it has indicated that it will not resort to aggressive price cuts to gain share. Given the current capacity utilisation of 75-80 per cent and debottlenecking efforts, it won’t require large capacities before FY26 and capex intensity is expected to reduce.

While lower raw material cost is the biggest driver of profitability, higher share of the premium tyre segment -- both in the European and Indian operations -- would help it register margin expansion. Investors can consider the stock on further corrections.