JK Tyres and Industries (JKTYRE) 152

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1 Result Update Rating matrix Rating : Hold Target : 155 Target Period : 12 months Potential Upside : 2% What s changed? Target Changed from 215 to 155 EPS FY18E Changed from 18.1 to.7 EPS FY19E Changed from 31 to 22.1 Rating Changed from Buy to Hold Quarterly performance ( Crore) Q1FY18 Q1FY17 YoY Q4FY17 QoQ Revenues 1,86.6 1, , EBITDA EBITDA (%) bps bps Reported PAT Key financials Crore FY16 FY17 FY18E FY19E Net Sales 6,898 7,689 8,231 9,119 EBITDA 1, , ,258. Net Profit FDEPS ( ) Valuation summary FY16 FY17 FY18E FY19E P/E (Dil.) (x) EV/EBITDA (x) Tar. EV/EBITDA (x) P/B (x) RoNW (%) RoCE (%) Stock data Particular Amount Market Capitalization ( Crore) Crore Total Debt (FY17) ( Crore) 5,376.1 Cash & Investments (FY17) ( Crore) EV ( Crore) 8, week H/L ( ) 185/79 Equity capital ( crore) 45.4 Crore Face value ( ) 2 Price performance 1M 3M 6M 12M JK Tyres Apollo Tyres Ltd CEAT Ltd MRF Ltd Balkrishna Industries Ltd Research Analyst Nishit Zota nishit.zota@icicisecurities.com Vidrum Mehta vidrum.mehta@icicisecurities.com Operational loss clearly disappoints! August 18, 217 JK Tyres and Industries (JKTYRE) 152 On a consolidated basis, JKTIL s revenues came in at 1,87 crore (up 1.5% YoY). Gross revenue from India increased 2.8% YoY to 1,828 crore while revenue from Mexico declined 2% YoY to 285 crore. Domestic demand was mainly impacted by 1) higher import of Chinese radial tyres, 2) lower CV production due to de-stocking of inventory post transition to new emission norms and after 3) dealers in the replacement market were reluctant to partake tyres ahead of implementation of GST We believe the India business is largely driven by CIL, which clocked revenue of ~ 39 crore vs. ~ 143 crore in Q1FY17. Ex-CIL, JKTIL performance remained weak, due to a decline in its overall volumes It posted operational loss of 1 crore and was impacted by 1) higher input cost that resulted in gross margin contraction of 1839 bps YoY & 78 bps QoQ and 2) due to higher other expense up 225 bps YoY & 544 bps QoQ. Subsequently, adjusted net loss came in at 18 crore against our net profit estimate of 51 crore According to the management, overall demand situation is likely to improve, going forward, considering smooth rollout of GST. Further, the expected anti-dumping duty on cheap Chinese imported tyre will be a welcome step and should improve the CV tyre market in India Q1FY18 result to dampen FY18 prospects; await margin clarity! JKTIL, on a consolidated basis, posted an operational loss of 1 crore mainly due to higher raw material cost & higher other expense. For Q1FY18, we witnessed a margin contraction trend for most domestic tyre players, due to high cost raw material inventory procured in the past. Thus, we believe the benefit of lower input cost inventory will be seen from Q2FY18E onwards thereby reviving the margin trajectory for most tyre players. However, we believe two expense heads viz. (interest & depreciation) account for ~8% of JKTIL sales. Hence, if the company is unable to register >8% operating margin, it would be unable to post profits, going forward. Thus, FY18E earning estimate has witnessed sharp downward revision. However, with a stabilisation in demand, its FY19E performance may see a revival (both in terms of revenue & margin). We await margin clarity, going forward. Radialisation story intact to benefit market leader! The CV tyre space is clearly witnessing a secular radialisation trend with the share of radial tyres in the CV segment rising from 4% in FY7 to 46% in FY17. JKTIL enjoys a leadership position in M&HCV truck bus radial (TBR) segment with market share >3% while in the passenger car radial (PCR) segment its share is >12%. Its overall product mix in terms of radial: bias tyre has changed significantly from ~33:66 in FY13 to ~66:33 in H2FY17. Thus, the radialisation story stays intact for JKTIL. Further, anti-dumping duty soon expected to be levied on imported Chinese TBR tyres will fuel the growth for domestic tyre players, including JKTIL, which is the market leader in the space. Growth to revive though margin to remain uncertain; HOLD! JKTIL being the market leader is well placed to benefit from the demand recovery thereby driving its revenue in coming months. However, higher interest outgo & depreciation expense compel JKTIL to post a strong operating performance (>8% margin). This looks challenging in the medium term. Thus, we value JKTIL at 5.5x FY19E EV/EBITDA and change our target price to 155 (earlier 215) with a HOLD rating. ICICI Securities Ltd Retail Equity Research

2 Variance analysis Q1FY18 Q1FY18E Q1FY17 YoY (%) Q4FY17 QoQ (%) Comments Total Operating Income 1,87 2,219 1, , Raw Material Expenses 1,22 1, , Employee Expenses Domestic demand was mainly impacted by higher import of Chinese radial tyres, lower CV production and after dealers in the replacement market were reluctant to partake tyres ahead of implementation of GST Higher input cost (we believe it is due to high cost inventory procured in the past) resulted in gross margin contraction of 1839 bps YoY & 78 bps QoQ Other expenses Higher other expense, up 225 bps YoY & 544 bps QoQ also impacted the operational performance of the company Operating Profit (EBITDA) EBITDA Margin (%) bps bps Higher input cost & other expense impacted its margin Interest Depreciation PBT before Exceptional Items Less: Exceptional Items PBT after Exceptional Items Total Tax Profit from Associates PAT With JKTIL posting operational loss, it registered net loss EPS Key Metrics India sales ( crore) Indian business was largely supported by CIL, which clocked revenue of ~ 39 crore in Q1FY18 vs. ~ 143 crore in Q1FY17. We believe ex-cil, JKTIL's performance was weak as the company must have witnessed a sharp decline in its overall volumes Mexico sales ( crore) Mexican business reported marginal revenue de-growth EBIT - India Higher raw material cost and other expense impacted profitability as it posted EBIT loss EBIT - Mexico Change in estimates FY18E ( Crore) Old New % Change Old New % Change Comments Revenue 8,987 8, ,97 9, EBITDA 1, ,522 1, EBITDA Margin (%) bps bps PAT FDEPS ( ) ; Assumptions India Tonnage Sales (MT) (Standalone + CIL) Average realizations ( /kg) of standalone operations Mexico FY19E Current Earlier Comments FY16 FY17 FY18E FY19E FY18E FY19E We believe CIL contribution to the overall performance in FY17 will have a normalised impact, going forward After registering loss at the operational level in Q1FY18, we have reduced over margin estimate Loss in Q1FY18 is likely to impact overall FY18 performance. However, we believe FY19 should see recovery 36, , , , , ,599 We have moderated our volume estimates Tonnage Sales (MT) 47,446 7,563 76,26 81,348 76,29 81,544 We have moderated our volume estimates Average realizations ( /kg) ; ICICI Securities Ltd Retail Equity Research Page 2

3 ( crore) 9119 (%) Company Analysis Demand revival to drive revenue growth JKTIL s revenues largely comprise the domestic (Indian) operation, which accounts for ~86% of revenue while the remaining 14% comes from its Mexican subsidiary Tornel. Further, the customer wise revenue mix is OEM: replacement: export at 33%: 57%: 1%, respectively. Segment wise, CV & PV tyres account for 74% & 21% of its overall revenue, respectively, while 5% is contributed by other segments. Product wise radial: bias mix is at 66:33, respectively. The company faced headwinds in terms of revenue growth in the past two years (FY15 & FY16), mainly on account of a slowdown in demand environment and stiff competition from Chinese tyres. The capacity constraint on the radial side of the truck and bus segment, to some extent, had restricted growth in the rising trend of radialisation in India. However, it has expanded its TBR capacity in the past, which has helped the company to register decent growth in FY17. Apart from its regular quality tyres, JKTIL has launched the Challenger brand in the TBB segment. It has created a slightly lower quality brand, which competes well against imported cheaper Chinese tyres. The acquisition of Cavendish Industries (CIL) has further taken the overall capacity (including Mexico) to ~35 million tyres per annum, with nine plants in India and three in Mexico and is all set to cater to the rising industry demand. Thus, we believe JKTIL revenue is likely to register revenue CAGR of ~9% CAGR in FY17-19E. Exhibit 1: Revenue growth likely to recover! (3.5) (6.6) - (5) 4 FY13 FY14 FY15 FY16 FY17 FY18E FY19E (1) Total Operating Income Growth ICICI Securities Ltd Retail Equity Research Page 3

4 Q4FY11 Q1FY12 Q2FY12 Q3FY12 Q4FY12 Q1FY13 Q2FY13 Q3FY13 Q4FY13 Q1FY14 Q2FY14 Q3FY14 Q4FY14 Q1FY15 Q2FY15 Q3FY15 Q4FY15 Q1FY16 Q2FY16 Q3FY16 Q4FY16 Q1FY17 Q2FY17 Q3FY17 Q4FY17 Q1FY18 ( crore) Exhibit 2: JKTIL combined capacity (JKTIL + CIL + Tornel) Combined Capacity (Lacs. No.pa) Sr no Particulars JKTIL CIL Total India Tornel Mexico Total India + Mexico 1 Truck Bias Truck Radial Total Truck Passenger Radial W & 3-W Others (LCV, Farm, 5 OTR) Total (Lakh pa) Total Tonnes per day 7 (TPD) Exhibit 3: Sales remain largely flat in domestic business Near term pressure on margin to remain; recovery expected in FY19E! Average natural rubber (NR) prices have surged from lows of 94/kg in February 216 to the high of 159/kg in February 217. The sharp surge in NR prices was mainly due to 1) production cut of top NR producing countries; and 2) floods in Thailand. This impacted the margins for JKTIL, which reported a sharp decline in Q3FY17 & Q4FY17 thereby impacting its profitability. Post that, we expected margins to stabilise and then gradually expand. However, in Q1FY18 JKTIL posted an operational loss thereby raising concern on its ability to post higher margins, going forward. Even after considering a sharp recovery from Q2FY18 onwards, we believe its FY18E performance has already dampened. A gradual price hike and better product mix (higher share of radial) will support margins in FY19E. However, the same looks challenging. ICICI Securities Ltd Retail Equity Research Page 4

5 Q1FY11 Q2FY11 Q3FY11 Q4FY11 Q1FY12 Q2FY12 Q3FY12 Q4FY12 Q1FY13 Q2FY13 Q3FY13 Q4FY13 Q1FY14 Q2FY14 Q3FY14 Q4FY14 Q1FY15 Q2FY15 Q3FY15 Q4FY15 Q1FY16 Q2FY16 Q3FY16 Q4FY16 Q1FY17 Q2FY17 Q3FY17 Q4FY17 Q1FY18 (%) Sep-11 Feb-12 Jul-12 Dec-12 May-13 Oct-13 Mar-14 Aug-14 Jan-15 Jun-15 Nov-15 Apr-16 Sep-16 Feb-17 Jul-17 ( /Kg) ( crore) (%) Exhibit 4: Margins to moderate, going forward FY13 FY14 FY15 FY16 FY17 FY18E FY19E - EBITDA EBITDA Margins (%) Exhibit 5: Natural rubber price has been volatile in past Production cut by top natural rubber producing countries like Thailand, Indonesia and Malaysia led to rise in NR prices Floods in Thailand & demand from China led NR prices to move northwards Exhibit 6: Net raw material expense trend of domestic business ICICI Securities Ltd Retail Equity Research Page 5

6 ,97.4 2,545.7 ( crore) ( crore) ( crore) (%) PAT margin to recover in FY19E! JKTIL s FY17 profit looks muted mainly due to the acquisition of CIL. A disappointment in operating performance in Q1FY18 and higher interest & depreciation is further expected to dampen its FY18 performance. Its performance is expected to recover in FY19, assuming a sharp recovery in operating margin. Thus, we expect profits to increase at ~15% CAGR in FY17-19E to 52 crore (primarily supported by margin expansion & lower interest & depreciation cost in FY19E). Exhibit 7: Margin to recover in FY19E FY13 FY14 FY15 FY16 FY17 FY18E FY19E PAT PAT Margin (%) CIL acquisition perks up debt levels! JKTIL has completed the acquisition of CIL wherein it has a 64% stake while the remaining 36% has been acquired by JK group s associates/group companies. The deal size for the same was at 2,17 crore, with a mix of equity & debt of 7 crore & 1,47 crore, respectively. This has increased overall gross debt to 5,376 crore in FY17. The management has guided that debt levels have peaked out. With no major capex (only maintenance capex of 7-8 crore over the next two years), debt is likely to reduce, going forward. Exhibit 8: CIL acquisition perks up debt! ,8.8 4, , , ,59.8 2, FY14 FY15 FY16 FY17 FY18E FY19E Capex CFO Net Debt (RHS) ICICI Securities Ltd Retail Equity Research Page 6

7 ,97.4 (%) (x) Exhibit 9: CIL assets temporary drag asset turnover; to recover in FY18E FY13 FY14 FY15 FY16 FY17 FY18E FY19E RoCE RoE Asset turnover Exhibit 1: Strong CFO/EBITDA indicates good working capital management FY14 FY15 FY16 FY17 FY18E FY19E 2 CFO CFO/EBITDA ICICI Securities Ltd Retail Equity Research Page 7

8 Outlook & valuation The CV tyre segment is clearly witnessing a secular radialisation trend with the share of radial tyres in the CV segment increasing from 4% in FY7 to 46% in FY17. Penetration of truck & bus radial tyres in the OEM segment is 72% while the replacement segment radialisation was at 33% in FY16. JK Tyres market share in India in the M&HCV TBR segment is >3% while it is >12% in the passenger car radial segment. Going forward, as radialisation in the truck and bus segment increases rapidly, we believe JK Tyres would be a major beneficiary leading to higher capacity utilisation levels in the TBR space. JKTIL being the market leader is well placed to benefit from the demand recovery thereby driving its revenue in coming months. However, higher outgo of interest & depreciation compels JKTIL to post a strong operating performance, which looks challenging in the near to medium term. Thus, we value JKTIL at 5.5x FY19E EV/EBITDA and change our target price to 155 (earlier 215) with a HOLD recommendation on the stock. Exhibit 11: Valuations Sales Growth EPS (Diluted) Growth PE EV/EBITDA RoNW RoCE ( cr) (%) ( ) (%) (x) (x) (%) (%) FY16 6,898.2 (6.6) FY17 7, FY18E 8, (95.7) FY19E 9, , ; ICICI Securities Ltd Retail Equity Research Page 8

9 (%) ( ) Recommended history vs. consensus Aug-15 Oct-15 Jan-16 Mar-16 Jun-16 Aug-16 Oct-16 Jan-17 Mar-17 Jun-17. Aug-17 Source: Bloomberg, Company, ICICIdirect.com Research Price Idirect target Consensus Target Mean % Consensus with BUY Key events Date Event Apr-8 Acquisition of 1% shareholding in Tornel for 27 crore Jun-8 Rights issue at 85 per share in the ratio 1:3 Oct-8 Stock falls after reporting loss in Q4 Jan-9 Major tyre makers cut prices as natural rubber prices fall sharply Apr-9 Reiterates capex plan of 27 crore for Mysore plant despite poor demand scenario Jul-9 Labour troubles at MRF lead Maruti to increase sourcing from JK Tyres Oct-9 Announces setting up of new plant in South India by investing ~ 12 crore over three to four years Oct-1 Rubber prices start moving up on production concerns in Thailand on excessive rains Feb-11 Rubber prices hit a high of ~ 25/kg before falling gradually Jun-12 CCI starts investigation on tyre cartelisation Oct-13 JK Tyres to invest additional 14 crore in Chennai plant Nov-13 Rubber prices start cooling off after the tapping season starts leading to sector re-rating May-14 Muted results but strong management guidance for growth Jan-15 The increased Chennai capacity addition of TBR and PCR coming on stream Feb-15 May finish its expansion plan at Chennai by mid-215, taking total PCR and TBR capacity to 98 lakh tyre and 1.5 million tyre per annum Sep-15 Signs binding term sheet with Kesoram Industries to acquire 1% stake Cavendish Industries for ~ 22 crore Top 1 Shareholders Name Latest Filing Date % O/S Position (m) Change (m) JK Organisation 3-Jun Edgefield Securities, Ltd. 3-Jun Dimensional Fund Advisors, L.P. 3-Jun Invest AD 3-Jun Tasha Investment Advisors Pvt. Ltd. 3-Jun LSV Asset Management 3-Jun SBI Funds Management Pvt. Ltd. 3-Jun RAM Active Investments S.A. 31-Dec Florida State Board of Administration 31-Mar Van Eck Associates Corporation 3-Jun Source: Reuters, ICICIdirect.com Research Shareholding Pattern (in %) Jun-16 Sep-16 Dec-16 Mar-17 Jun-17 Promoter FII DII Others Recent Activity Buys Sells Investor name Value Shares Investor name Value Shares Invest AD Schroder Investment Management Ltd. (SIM) Florida State Board of Administration APG Asset Management LSV Asset Management Baillie Gifford & Co Nuveen LLC NFJ Investment Group LLC Sundaram Asset Management Company Limited.52.2 UTI International (Singapore) Pvt. Ltd Source: Reuters, ICICIdirect.com Research ICICI Securities Ltd Retail Equity Research Page 9

10 Financial summary Profit and loss statement Crore (Year-end March) FY16 FY17 FY18E FY19E Total operating Income 6, , ,23.6 9,119.5 Growth (%) Raw Material Expenses 3, , , ,51.2 Employee Expenses Other Expenses 1, , , ,421.4 Total Operating Expenditure 5, ,557. 7, ,861.5 EBITDA 1, , ,258. Growth (%) Depreciation Interest Other Income Exceptional Items PBT Total Tax PAT Growth (%) ,9.8 FDEPS ( ) ; Cash flow statement Crore (Year-end March) FY16 FY17 FY18E FY19E Profit after Tax Add: Depreciation (Inc)/dec in Current Assets , Inc/(dec) in CL and Provisions CF from operating activities (Inc)/dec in Investments (Inc)/dec in Fixed Assets , Others CF from investing activities , Issue/(Buy back) of Equity.... Inc/(dec) in loan funds , , Dividend paid & dividend tax Others CF from financing activities , , ,35.6 Net Cash flow Opening Cash Closing Cash ; Balance sheet Crore (Year-end March) FY16 FY17 FY18E FY19E Liabilities Equity Capital Reserve and Surplus 1,76.1 1, , ,327.8 Total Shareholders funds 1, , , ,373.2 Total Debt 2,66. 5, , ,526.1 Deferred Tax Liability Other non-current liabilities Minority Interest Total Liabilities 5, ,63.8 8,98.6 8,11.1 Assets Gross Block 6,44.9 8, , ,544.1 Less: Acc Depreciation 2, , ,74. 3,22.7 Net Block 3, , , ,521.4 Capital WIP Total Fixed Assets 3, ,16.9 5, ,671.4 Investments Inventory ,32.4 1,24.2 1,249.2 Debtors 1,42.7 1, ,84. 1,873.9 Loans and Advances Other current assets Cash Total Current Assets 2, ,6.3 3,8.3 4,22.5 Creditors , , ,249.2 Provisions Other current liabilities Total Current Liabilities 1, ,6.8 2,99.3 2,249.2 Net Current Assets 1,6.7 1, ,71. 1,773.3 Others Application of Funds 5,37.8 8,63.8 8,98.6 8,11.1 ; Key ratios (Year-end March) FY16 FY17 FY18E FY19E Per share data ( ) EPS Cash EPS BV DPS Cash Per Share Operating Ratios (%) EBITDA Margin PBIT / Net sales PAT Margin Inventory days Debtor days Creditor days Return Ratios (%) RoE RoCE RoIC Valuation Ratios (x) P/E EV / EBITDA EV / Net Sales Market Cap / Sales Price to Book Value Solvency Ratios Debt/Equity Current Ratio Quick Ratio ;. ICICI Securities Ltd Retail Equity Research Page 1

11 ICICIdirect.com coverage universe (Auto & Auto Ancillary) CMP M Cap EPS ( ) P/E (x) EV/EBITDA (x) RoCE (%) RoE (%) Sector / Company ( ) TP( ) Rating ( Cr) FY17 FY18E FY19E FY17 FY18E FY19E FY17 FY18E FY19E FY17 FY18E FY19E FY17 FY18E FY19E Amara Raja (AMARAJ) Hold Apollo Tyre (APOTYR) Buy Ashok Leyland (ASHLEY) Buy Bajaj Auto (BAAUTO) Hold Balkrishna Ind. (BALIND) Buy Bharat Forge (BHAFOR) Buy Bosch (MICO) Hold Eicher Motors (EICMOT) Buy Exide Industries (EXIIND) Buy Hero Moto (HERHON) Buy JK Tyre & Ind (JKIND) Hold M&M (MAHMAH) Buy Mahindra CIE (MAHAUT) Buy Maruti Suzuki (MARUTI) Buy Motherson (MOTSUM) Hold Tata Motors (TELCO) Buy Wabco India (WABTVS) Buy ICICI Securities Ltd Retail Equity Research Page 11

12 RATING RATIONALE ICICIdirect.com endeavours to provide objective opinions and recommendations. ICICIdirect.com assigns ratings to its stocks according to their notional target price vs. current market price and then categorises them as Strong Buy, Buy, Hold and Sell. The performance horizon is two years unless specified and the notional target price is defined as the analysts' valuation for a stock. Strong Buy: >15%/2% for large caps/midcaps, respectively, with high conviction; Buy: >1%/15% for large caps/midcaps, respectively; Hold: Up to +/-1%; Sell: -1% or more; Pankaj Pandey Head Research pankaj.pandey@icicisecurities.com ICICIdirect.com Research Desk, ICICI Securities Limited, 1st Floor, Akruti Trade Centre, Road No 7, MIDC, Andheri (East) Mumbai 4 93 research@icicidirect.com ICICI Securities Ltd Retail Equity Research Page 12

13 ANALYST CERTIFICATION We /I, Nishit Zota, MBA & Vidrum Mehta, MBA Research Analyst, authors and the names subscribed to this report, hereby certify that all of the views expressed in this research report accurately reflect our views about the subject issuer(s) or securities. We also certify that no part of our compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report. Terms & conditions and other disclosures: ICICI Securities Limited (ICICI Securities) is a full-service, integrated investment banking and is, inter alia, engaged in the business of stock brokering and distribution of financial products. ICICI Securities Limited is a Sebi registered Research Analyst with Sebi Registration Number INH99. 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