JK Tyres and Industries (JKTYRE) 116

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1 Result Update Rating matrix Rating : Buy Target : 145 Target Period : 12 months Potential Upside : 25% What s changed? Target Unchanged EPS FY17E Changed from 17.7 to 15.5 EPS FY18E Changed from 26.9 to 22.5 EPS FY19E Introduced at 29.1 Rating Unchanged Quarterly performance ( Crore) Q3FY17 Q3FY16 YoY Q2FY17 QoQ Revenues 1, , , EBITDA EBITDA (%) bps bps Reported PAT Key financials Crore FY16 FY17E FY18E FY19E Net Sales 6,953 7,458 8,28 9,318 EBITDA 1, , , ,514.9 Net Profit FDEPS ( ) Valuation summary FY16 FY17E 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 (FY16) ( Crore) 2,669.7 Cash & Investments (FY16) ( Crore) EV ( Crore) 5, week H/L ( ) 162/74 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 Radialisation to drive growth! February 16, 217 JK Tyres and Industries (JKTYRE) 116 On a consolidated basis, JK Tyres (JKTIL) revenues came in at 1,838 crore (up 14.6% YoY), which we believe would largely be volume driven. Gross revenues from India increased 25% YoY to 1,93 crore (accounting for ~87% of consolidated revenue) while revenue from Mexican operation grew 12% YoY to 279 crore EBITDA margins contracted 242 bps YoY & 57 bps QoQ to 14.4% below our estimate of 17%. Higher input cost (average natural rubber prices were up 14.2% YoY to 124/kg) impacted the gross margins of the company, down 14 bps YoY & 44 bps QoQ JKTIL posted an exceptional gain of 47.7 crore (mainly attributable to gain on sale of asset worth 6.4 crore, partly offset by unfavourable foreign exchange movement of 12.7 crore). Reported PAT declined 22.3% YoY to 86 crore vs. our estimate of 78 crore Demonetisation impacted 2W & 3W tyre sales in Q3FY17. According to the management, the unabated increase in natural rubber and other raw material price in the past continues to be an area of great concern and is likely to pass it on to consumers The resolution of GST, phasing out of the demonetisation effect, government s focus on infrastructure & cheaper financing option are likely to revive CV sales in the coming months, thus benefiting JKTIL 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 44% in FY16. Penetration in truck & bus radial tyres in the OEM space is 72% while in the replacement segment it is 33%. It enjoys 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%. The management is focusing on the radial segment and has expanded its TBR capacity from 4 lakh tyres to 12 lakh per annum (pa) and PCR capacity from 3 lakh pa to 45 lakh tyres pa. Its existing truck bus bias (TBB) segment (~4% of capacity) would be shifting to other segments and exports market. JKTIL s 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 remains intact for JKTIL. Higher input cost + other expense = results into lower margins! EBITDA margins of Q3FY17 contracted 242 bps YoY & 57 bps QoQ to 14.4%. This was mainly due to higher input cost (gross margins down 14 bps YoY & 44 bps QoQ) & higher other expense (up 188 bps YoY & 146 bps QoQ). We believe the volatility in NR prices will have a negative impact on margins. However, JKTIL is likely to pass on most of the rise in input cost to consumers going forward. Further, a better product mix (higher share of radial tyres) will also support margins. Thus, we expect margins to be 16.5% & 16.3% for FY18E & FY19E respectively. Growth to revive; maintain BUY! The expectation of a revival in the capex cycle makes us optimistic about the revenue/earnings growth possibilities. Its plans to explore the 2-W space and the new radial capacity would drive incremental growth, going forward. The domestic tyre industry indirectly benefited from demonetisation, as dealing in Chinese tyres was largely cash based in nature & was impacted. Any positive development on part of the government in terms of restricting import of Chinese tyres, going forward, will benefit JKTIL. Thus, we value JKTIL at 4x FY19E EV/EBITDA. We maintain our target price of 145 with a BUY rating on the stock. ICICI Securities Ltd Retail Equity Research

2 Variance analysis Q3FY17 Q3FY17E Q3FY16 YoY (%) Q2FY17 QoQ (%) Comments Total Operating Income 1,838 1,687 1, , Above our expectations largely supported by volume growth Raw Material Expenses 1, Higher input cost impacted the gross margin of the company, down 14 bps YoY & 44 bps QoQ. Average natural rubber prices were up 14.2% YoY to 124/kg. Prices of other crude derivatives were also higher during the quarter Employee Expenses Other expenses Other expense also increased sharply in Q3FY17 Operating Profit (EBITDA) EBITDA Margin (%) bps bps Lower gross margins & higher other expense impacted the operational performance Interest Post the CIL acquistion, interest outgo looks higher on a YoY basis Depreciation Assets of CIL have been clubbed with JKTIL's assets resulting in higher depreciation on YoY basis PBT before Exceptional Items Less: Exceptional Items Exceptional gain includes gain on sale of asset worth 6.4 crore partly offset by unfavourable foreign exchange movement of 12.7 crore PBT after Exceptional Items Total Tax Profit from Associates PAT Decline in margins impacted the profitability EPS Key Metrics Gorss Sales ( crore) India Strong revenue growth would have been largely supported by volumes. We believe JKTIL indirectly benefited from demonetisation, as dealing in Chinese tyres were largely cash based in nature & were impacted Mexico Reported decent growth on YoY basis Less : Inter segment Net Sales EBIT - India EBIT - Mexico EBIT Margins (%) - India bps bps Higher raw material cost impacted the company's margins EBIT Margins (%) - Mexico bps bps Change in estimates FY17E FY18E FY19E ( Crore) Old New % Change Old New % Change Introduced Comments Revenue 7,51 7, ,696 8, ,318 EBITDA 1,397 1, ,528 1, ,515 EBITDA Margin (%) bps bps 16.3 Post a sharp decline in Q3FY17, margins are expected to moderate, going forward, mainly due to a rise in input cost (NR) PAT Lower topline growth & margin moderations led to lower earnings FDEPS ( ) ; *We have considered acquisition of CIL & its impact in our estimate Assumptions Current Earlier Introduced Comments FY15 FY16 FY17E FY18E FY17E FY18E FY19E India Tonnage Sales (MT) 34,471 36, , ,19 336,17 376,339 42,89 Capacity addition of TBR & PCR will improve volume growth Average realizations ( /kg) Any delay in passing of prices may impact realisations Mexico Tonnage Sales (MT) 49,15 47,446 53,756 58,57 53,24 58,524 63,282 Capacity expansion of PCR to lead higher growth Average realizations ( /kg) ; *We have considered acquisition of CIL & its impact in our estimate ICICI Securities Ltd Retail Equity Research Page 2

3 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, the company has completed the expansion of its new capacity at its Chennai plant in addition to its leadership position in the TBR segment that is likely to drive its growth, going forward. The company has also created a slightly lower quality brand, which competes well against imported cheaper Chinese tyres. Apart from its regular quality tyres, JKTIL has launched the Challenger brand in the TBB segment. The company is soon going to launch in the TBR segment, which marginally compromises the quality and easily competes against Chinese tyres on the pricing front. The acquisition of Cavendish Industries (CIL) has 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 will be witnessing volume driven revenue CAGR of ~1% CAGR in FY16-19E. Exhibit 1: Revenue growth likely to recover! ( crore) (3.5) 6953 (5.8) (5) (%) 4 FY13 FY14 FY15 FY16 FY17E FY18E FY19E Total Operating Income Growth (1) ICICI Securities Ltd Retail Equity Research Page 3

4 Exhibit 2: JKTIL combined capacity (JKTIL + CIL + Tornel) Combined Capacity (Lacs. No.pa) Tornel Mexico Total India + Mexico Sr no Particulars JKTIL CIL Total India 1 Truck Bias Truck Radial Total Truck Passanger Radial W & 3-W Others (LCV, Farm, OTR) Total (Lacs no pa) Total Tonnes per day (TPD) Exhibit 3: Sales remain largely flat in domestic business Q4FY11 Q1FY12 Q2FY12 Q3FY12 Q4FY12 Q1FY13 Q2FY13 Q3FY13 Q4FY13 Q1FY14 Q2FY14 Q3FY14 Q4FY14 Q1FY15 Q2FY15 Q3FY15 Q4FY15 Q1FY16 Q2FY16 Q3FY16 Q4FY16 Q1FY17 Q2FY17 Q3FY17 ( crore) EBITDA margins to remain >16%! Natural rubber (NR) prices declined to < 1/kg in Q4FY16 from highs of ~ 25/kg. NR accounts for ~4% of total raw material costs, thus swinging gross, operating margins. Crude prices have also fallen significantly, resulting in lower prices of its derivatives (carbon black, synthetic rubber, fabric) that are key materials for companies. This has led to an increase in profitability for the overall industry. Tyre manufacturers in India have passed on bare minimum of these benefits to consumers in the past, thus resulting in elevated margins for companies. JKTIL posted highest ever margins for Q2FY17, which was at 2.1% mainly attributable to lower input cost, better product mix and due to favourable impact of operating leverage as radial capacity utilisation levels are >9%. However, NR prices have been volatile in the last year and are largely inching northwards (currently at ~ 16/kg). The impact of higher NR prices impacted Q3FY17 EBITDA margins, which declined 242 bps YoY & 57 bps QoQ to 14.4%. Apart from NR prices, crude prices have also moved up in the recent past. This would further create pressure on tyre manufacturers. However, JKTIL is likely to pass on most of the rise in input cost to consumers, going forward. Further, a better product mix (higher share of radial tyres) will also support margins. Thus, we expect margins to be 16.5% & 16.3% for FY18E & FY19E respectively. ICICI Securities Ltd Retail Equity Research Page 4

5 Exhibit 4: Margins to moderate, going forward ( crore) (%) FY13 FY14 FY15 FY16 FY17E FY18E FY19E EBITDA EBITDA Margins (%) - Exhibit 5: Natural rubber price has increased sharply over last year Aug-11 Nov-11 Feb-12 May-12 Aug-12 Nov-12 Feb-13 May-13 Aug-13 Nov-13 Feb-14 May-14 Aug-14 Nov-14 Feb-15 May-15 Aug-15 Nov-15 Feb-16 ( /Kg) May-16 Aug-16 Nov-16 Feb-17 Exhibit 6: Net raw material expense trend of domestic business 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 (%) ICICI Securities Ltd Retail Equity Research Page 5

6 Moderation in margins to impact profitability JKTIL s FY17 profits look muted mainly due to higher depreciation charges of the newly acquired CIL. A gradual improvement in the demand environment was further offset by modest de-growth in margins that will impact the overall profitability. We expect profits to increase at ~11% CAGR in FY16-19E to 66 crore. Subsequently, PAT margins are likely to touch ~7%, going forward. Exhibit 7: Lower margins likely to offset higher revenue impacting profitability ( crore) (%) FY13 FY14 FY15 FY16 FY17E 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 3,624 crore in FY17E. In the past, the management has guided that debt levels have peaked out and no major capex would be done over the next year or two. Exhibit 8: CIL acquisition perks up debt! ( crore) ,624. 3,28.2 2,833. 2,59.8 2, , ,47. 1, , ,91.5 FY14 FY15 FY16 FY17E FY18E FY19E ( crore) Capex CFO Net Debt (RHS) ICICI Securities Ltd Retail Equity Research Page 6

7 Exhibit 9: CIL assets temporary drag asset turnover; to recover in FY18E (%) (x) FY13 FY14 FY15 FY16 FY17E FY18E FY19E RoCE RoE Asset turnover 1. Exhibit 1: Strong CFO/EBITDA indicates good working capital management ,49.5 1,46.7 1,91.5 FY14 FY15 FY16 FY17E FY18E FY19E 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 44% in FY16. 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. With the expectation of a revival in capex cycle, we are optimistic about the revenue/earnings growth possibilities for JKTIL the leader and pioneer in the TBR segment. The capacity constraint in the TBR segment is largely over as the new capacity is already in place and the new CIL acquisition has further provided additional capacity of 1.2 million tyres/per annum. Any positive development on part of the government in terms of restricting imports of Chinese tyres, going forward, will benefit JKTIL. Thus, we value JKTIL at 4x FY19E EV/EBITDA to arrive at a target of 145. We maintain our BUY recommendation on the stock. Exhibit 11: Valuations Sales Growth EPS (Diluted) Growth PE EV/EBITDA RoNW RoCE ( cr) (%) ( ) (%) (x) (x) (%) (%) FY16 6,953.1 (5.8) FY17E 7, FY18E 8, FY19E 9, ; *We have considered acquisition of CIL & its impact in our estimate ICICI Securities Ltd Retail Equity Research Page 8

9 Recommended history vs. consensus ( ) Jan-15 Mar-15 Jun-15 Aug-15 Nov-15 Jan-16 Mar-16 Jun-16 Aug-16 Nov Jan-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 Shareholding Pattern Name Latest Filing Date % O/S Position (m) Change (m) JK Organisation 3-Sep Edgefield Securities, Ltd. 3-Sep Dimensional Fund Advisors, L.P. 3-Nov Tasha Investment Advisors Pvt. Ltd. 3-Sep LSV Asset Management 3-Sep Acadian Asset Management LLC 31-Dec Schroder Investment Management Ltd. (SIM) 3-Sep Van Eck Associates Corporation 31-Dec Mellon Capital Management Corporation 31-Jan APG Asset Management 31-Dec Source: Reuters, ICICIdirect.com Research (in %) Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Promoter FII DII Others Recent Activity Buys Sells Investor name Value Shares Investor name Value Shares Tasha Investment Advisors Pvt. Ltd Fidelity Management & Research (Hong Kong) Limited Schroder Investment Management Ltd. (SIM) LIC Mutual Fund Asset Management Company Ltd UTI International (Singapore) Pvt. Ltd Van Eck Associates Corporation Mellon Capital Management Corporation.4.2 Goldman Sachs Asset Management (India) Private Ltd... BlackRock Advisors (UK) Limited.3.2 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 FY17E FY18E FY19E Total operating Income 6, , ,28.3 9,317.9 Growth (%) Raw Material Expenses 3, ,15.5 4,65.6 5,322.9 Employee Expenses ,44.6 Other Expenses 1, , ,3.1 1,435.6 Total Operating Expenditure 5, , , ,83. EBITDA 1, , , ,514.9 Growth (%) Depreciation Interest Other Income Exceptional Items PBT Total Tax PAT Growth (%) FDEPS ( ) ; *We have considered acquisition of CIL & its impact in our estimate Cash flow statement Crore (Year-end March) FY16 FY17E 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 Net Cash flow Opening Cash Closing Cash ; *We have considered acquisition of CIL & its impact in our estimate Balance sheet Crore (Year-end March) FY16 FY17E FY18E FY19E Liabilities Equity Capital Reserve and Surplus 1,73.1 1, , ,973.2 Total Shareholders funds 1, ,26.8 2,457. 3,18.6 Total Debt 2, , , ,969.7 Deferred Tax Liability Other non-current liabilities Minority Interest Total Liabilities 5, , ,59.1 7,874.2 Assets Gross Block 6,51.4 8, , ,177.1 Less: Acc Depreciation 2, , , ,115.5 Net Block 3,753. 5, , ,61.6 Capital WIP Total Fixed Assets 3, ,37.5 6,72.5 6,111.6 Investments Inventory ,43.5 1,199.8 Debtors 1,42.7 1, , ,838.1 Loans and Advances Other current assets Cash Total Current Assets 3,5.6 3, , ,11.8 Creditors ,21.7 1, ,25.9 Provisions Other current liabilities Total Current Liabilities 2,15.6 2, ,52.7 2,779.9 Net Current Assets ,28.8 1,232. Others Application of Funds 5, , ,59.1 7,874.2 ; *We have considered acquisition of CIL & its impact in our estimate. Key ratios (Year-end March) FY16 FY17E 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 ; *We have considered acquisition of CIL & its impact in our estimate 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) FY16 FY17E FY18E FY16 FY17E FY18E FY16 FY17E FY18E FY16 FY17E FY18E FY16 FY17E FY18E 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) Buy Eicher Motors (EICMOT) Buy Escorts (ESCORT) Hold Exide Industries (EXIIND) Buy Hero Mototcorp (HERHON) Buy JK Tyre & Ind (JKIND) 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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