LKP. Buy. Apollo Tyres. Weathering headwinds. Valuation. Risks and concerns. February 24, 2011

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1 February 24, 2011 Buy Apollo Tyres LKP Since 1948 Industry: Auto and Auto Components Industry View: Overweight Initiating Coverage Weathering headwinds Apollo Tyres(Apollo) promoted by the Gurgaon based Kanwar family is India s leading automotive tyre manufacturing company with a capacity to manufacture 950MT of tyres per day. Apollo is in an expansion mode and is increasing capacity by more than 50% through a Greenfield plant at Chennai. Apollo derives 65% of its revenues from the replacement markets, 24% from OEMs and the rest from exports. It has a 27% market share in the CV segment and 21% share in the PV segment. Internationally, Apollo has operations in Europe through its recent acquisition of Vredestein Banden BV and in South Africa through the Dunlop assets bought out in Given its market leadership in CV tyres and strong foothold in PV tyres, the rapid recovery in the OEM and replacement CV demand post the blip observed following emission norms gives us confidence that the CV cycle is still intact and on the up-move which should benefit Apollo. With its domestic capacities operating at 100% utilization rates the company has gained back the lost market share post the two month lockout at its Perambra plant. This is expected to offer Apollo pricing power in both OEM as well as replacement markets.increasing dependence on radial tyres through the Chennai plant expansion will support margin performance. Despite surging natural rubber prices, we believe Apollo would have enough pricing power and operating leverage through its volume expansion led by capacity growth. Even after factoring an average FY 12E Natural Rubber price of `235, we derive a 27% consolidated earnings growth in FY 12E over FY 11E. Apollo s International operations would also in our view provide the required support as both the European and South African auto industries are growing and the company is increasing its capacity in Europe and capacity utilization rate in South Africa. Valuation With Apollo gaining back its lost market share and attempting to arrest margin decline due to rising input costs through better pricing and capacity expansion we believe that the stock price factors most of the negatives and initiate coverage with a BUY rating. We rate Apollo as a BUY with a target price of `72 based on 8.5xFY 12E EPS of `8.5 (8.5x being the 5 year average trailing multiple) which translates into an upside of 29%. Risks and concerns The key risk faced by Apollo and the entire tyre industry is surging rubber prices. Stock Data Current Market Price (`) Month Target Price (`) 72 Potential upside (%) 29 Reuters APLO.BO Bloomberg APTY IN Key Data Market Cap (`.bn ) Week Range(`) 89 / 44 Avg. Daily Trading Value (`mn) 42 Promoters (%) 40 FII Holding (%) 25 DII Holding (%) 11 Public & Others Holding (%) 24 Y/E March FY 09 FY 10 FY 11E FY 12E Revenues (` mn) 49,841 81,207 83, ,385 EBITDA (%) PAT (%) EPS (`) EPS growth (%) P/E (x) P/B(x) EV/EBITDA (x) ROCE(%) ROE(%) Dividend yield (%) Relative price performance Feb-10 May-10 Aug-10 Nov-10 Feb-11 Apollo Tyresr) BSE Sensex Slower than expected ramp up at its Chennai plant. Labour issues keeping in view the recent lockouts at Kerala and South Africa Weakening auto OEM and replacement demand. One Year Indexed ( % ) 1 Month 3 Months 12 Months Absolute 2 (7) 0.3 BSE Relative 6 2 (12.4) Ashwin Patil ashwin_patil@lkpsec.com Disclaimer: The information in this document has been printed on the basis of publicly available information, internal data and other reliable sources believed to be true and is for general guidance only. While every effort is made to ensure the accuracy and completeness of information contained, the company makes no guarantee and assumes no liability for any errors or omissions of the information. No one can use the information as the basis for any claim, demand or cause of action. LKP Securities Ltd., and affiliates, including the analyst who have issued this report, may, on the date of this report, and from time to time, have long or short positions in, and buy or sell the securities of the companies mentioned herein or engage in any other transaction involving such securities and earn brokerage or compensation or act as advisor or have other potential conflict of interest with respect to company/ies mentioned herein or inconsistent with any recommendation and related information and opinions. LKP Securities Ltd., and affiliates may seek to provide or have engaged in providing corporate finance, investment banking or other advisory services in a merger or specific transaction to the companies referred to in this report, as on the date of this report or in the past.

2 Investment Argument Strong demand in the auto industry to drive tyre volumes Auto industry in India has been growing at a robust pace since the downturn happened in FY The auto demand is buoyant on the improvement in economy, increase in per capita income, lower penetration levels, increase in exports, 9% GDP growth, increased consumption and rapidly developing rural markets. Tyre demand has moved in tandem with the auto industry and has hence grown at 18.5% in FY 10 out of which the OEM tyre segment grew at 29.9% yoy and the overall auto segment growing at 26%. The overall tyre demand is expected to grow at 16-17% in FY 11E and 12-14% in FY 12E on an increasing base (Source- CRISIL) when the auto demand is expected to remain between 15-18% (Source SIAM) in FY 11-12E. OEM demand is expected to grow at 23-25% in FY 11E and 11-13% in FY 11-12E, while the replacement demand is anticipated to grow at 14-16% in FY 11E and 13-15% in FY 12E. Apollo being one of the leading players in the Truck & Bus (T&B segment M.S. of 27% at the end of January 2011) and Passenger cars segment (PCR M.S. of 21%) will benefit from the rising demand from the OEMs, new launches, the increasing gap between the supply and demand of tyres and the replacement market which works with a lag effect with the OEM demand cycle. Growth in the CVs, PVs and tyre segments (% yoy) CVs PVs and Uvs Tyre demand Tonnage growth across segments (%) FY 09 FY 10 FY11E FY12E Overall tyre demand OEM Replacement Exports Market leadership position in TBR and PCR segments to offer a competitive edge Apollo is one of the leading tyre making companies in India and has a significant market share in both CV and PV segments. At the end of FY 10, Apollo had a 28% market share in the CV segment and about 19% market share in the PV segment. Though the company has lost some market share in FY 11 due to a 2 month lockout at its Perambra plant in Kerala, it remains one of the leading market player in the tyre market. At the end of FY 10, Apollo s overall market share was at 21% 2

3 Overall Market shares - FY10 Apollo Tyres Others 19% Apollo Tyres 21% Falcon Tyres 3% TVS Srichakra 3% Goodyear 6% MRF 21% Ceat Tyres 11% JK Tyre and Industries 16% PV market share - FY10 CV segment - FY10 Bridgestone 23% Others 4% Apollo 19% Birla Tyres 19% Others 3% Apollo 28% MRF 19% Ceat 13% Goodyear 13% Ceat 3% JK Tyres 19% JK Tyres 18% MRF 19% Apollo s market share has fallen by 6% to 15.7% at the end of August and within the CV segment the market shares have dropped from 28% to about 23% in the first nine months of FY 11. In January, the market share in the CV segment was back to 27% while the PV market share has gone up to 21%. Now that the capacity at Perambra is functioning in full swing and new capacity buildup is happening at Chennai, we expect the company to win back its lost market share particularly in the CV segment as the Chennai capacity will be mainly catering to the TBR segment in tonnage terms. 3

4 Overall market share in April - August 2010 Companies % Market share Apollo Tyres Ltd Birla Tyres 12.0 Bridgestone India Pvt. Ltd. 2.5 Ceat Ltd Falcon Tyres Ltd. 2.6 Goodyear India Ltd. 5.4 JK Industries 17.2 MRF Ltd TVS Srichakra Ltd. 3.3 Others 7.7 Apollo s segmental market share in April-August 2010 (%) Truck and Bus Cars and Uvs LCV Tractors Replacement market to offer strong potential Post the emission norms establishment in October, the CV sales, mainly the replacement market demand softened during the months of November and December. However, January witnessed firming up of replacement demand thus indicating the continued strength of the demand in this market. Since most of the vehicle launches in the PCR segment (Volkswagen Polo, GM Beat, Ford Figo, Honda Jazz, Maruti Swift, Fiat Grande Punto, Hyundai i20. Mahindra Xylo) and Truck and Bus segment (Mahindra Gio and Maximo, Prima Trucks from Tata Motors) happened in the last years, the replacement sales for these models will start commissioning within a year or so as the replacement cycle of a tyre is of years. Also, with slightly reduced government spending on the country s infrastructure, mainly roads, the replacement cycle of tyres will get reduced thus leading to an added demand for tyres within our investment horizon. Replacement sales enjoy higher margins than OEM due to better pricing power and with Apollo deriving about 65% of its revenues from replacement markets, will witness an improvement in margin performance. 4

5 Replacement demand trend and % yoy growth % 0.00% E (mn tonnes) % yoy 20.00% 18.00% 16.00% 14.00% 12.00% 10.00% 8.00% 6.00% 4.00%, Chennai plant expansion to improve operating leverage and cater to the expanding demand Capacity constraints by the tyre manufacturers and increasing supply-demand gap in the tyre industry has led companies across the tyre industry to set up huge expansion plans and thus largely contribute to the auto juggernaut. In an attempt to do so, Apollo has set up a Greenfield plant at Chennai which will be completely functional by FY 13. The plant is producing 150 Tonnes Per Day (TPD) currently, which is expected to move up to 200 TPD by March 2011 end and 500 TPD by the beginning of FY 13E. For this project, the company is investing `23bn over a period of three years till completion of the plant. The Chennai plant at its full capacity will produce ~5mn PCR tyres and ~2mn TBR tyres annually. This expansion will not only cater to the topline and to the rising auto demand but will also help Apollo to improve its margin performance due to two reasons 1). Increase in the volumes of radialized tyres as the entire capacity will produce the high margin radial tyres and 2). Achieve economies of scale as the complete capacity will be utilized as and when it will be built and add volumes to the top-line significantly. Chennai capacity breakup by FY 13E in terms of tonnage per day PCR 24% TBR 76% Source: Company, 5

6 Chennai capacity breakup by FY 13E in terms of tyres per day TBR 27% PCR 73% Source: Company, Apollo Tyres capacity expansion estimates Production(TPD) FY 10 FY11E FY 12E FY 13E Limda, Baroda, Gujarat Bias Radial Perumbra, Cochin, Kerala (Bias) Kalamassarey, Cochin, Kerala (Bias) Chennai, Tamil Nadu (Radial) India Total Source: Company, Expansion plan at Maruti Suzuki to boost domestic business topline Maruti Suzuki, the leading car maker in India is set to expand its capacity by ~45% within the next one year. It will add 5 lakh units to its existing capacity of 1.2 mn. Apollo has a ~21% market share in the PCR segment and has been continuously expanding it. With the PCR tyre industry being divided into five main players MRF, Apollo, Bridgestone, JK and Goodyear in the descending order of their market shares, we believe the expansion at Maruti will offer Apollo with demand for at least 21% of the incremental capacity to be added by Maruti which translates into ~1 lakh units or ~5.25 lakh tyres, which will be about 5-6% of Apollo s expected PCR capacity of ~9.6mn tyres by beginning FY 13E. With Chennai plant expanding, Apollo can easily cater to the increasing demand from Maruti thus lifting its topline. This will be a very big opportunity for Apollo to improve its volumes and profitability. The impact of this order will be seen from H2 FY 12 and FY 13 will witness an even stronger impact from this avenue. Price hike to negate the impact of raw material cost increase In view of the spiraling domestic and international rubber prices due to several climatic adversities for natural rubber growing and tapping across the world, the entire tyre industry has faced severe margin pressures denting their profitabilities in the past 2 quarters. Natural rubber (NR) which contributed 56% of the total raw material costs of Apollo in FY10, has grown at 72% in the period between April to January 2011 on a yoy basis. In order to negate the impact of this on margins, the company has taken 14% price increase in FY 11, which shows that the company has pricing power. However, off late they have found it difficult to increase prices due to slight softening in the replacement markets in the last two months of CY 10, CV sales softening on establishment of new emission norms and the lockout at its Perambra plant in Q2 6

7 FY11 leading to 6% loss in CV market share. In January, the company has managed to gain its lost market share and is back to 27% increased their prices by 1-1.5%. As the replacement demand is seen firming up again, Apollo has got leeway to increase prices in this high margin business (margins higher by 10-15% than the OEMs) in the coming future. Also in the OEM business, with auto demand expected to remain buoyant, we believe the company can take price hikes but at a lesser extent than the replacement tyre market. The natural rubber scenario is not expected to get any respite in the coming 6 months according to the management of Apollo and is rather expected to firm up in the coming months. For FY 11, we have assumed the NR prices to average at `192 as the inventory on the books of `6.5bn will help to keep the blended costs of rubber at `210 per kg in Q4 FY11. For FY 12, in spite of assuming the prices to zoom up to average out at `235/kg, we believe the recovery in revenue growth (operating leverage) will significantly offset the increase in raw material prices. In such a scenario, still we have factored in consolidated EBITDA margin fall of 50 bps in FY 12E to 9.9% as the international operations will also provide support, mainly the European operations. On a standalone basis, we have factored in a 130 bps fall in EBITDA margins. RM Cost break up Others 7% Carbon Black 12% Fabric 17% Rubber 56% Chemicals 8% Source: Company, Rubber Price trend ` per 100 kg Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 July October January Source: Rubber Board, 7

8 Quarterly Standalone RM to sales (%) v/s EBITDA margins(%) 72.0% 70.0% 68.0% 66.0% 64.0% 62.0% 60.0% 58.0% 56.0% 54.0% 52.0% 16.5% 16.4% 15.5% 69.3% 67.8% 68.2% 67.1% 64.7% 14.1% 10.4% 10.4% 10.3% 60.1% 58.8% Q1 FY10 Q2 FY10 Q3 FY10 Q4 FY10 Q1 FY11 Q2 FY11 Q3 FY11 RM costs as a % of sales EBITDA margins (%) 18.0% 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% Source: Company, YearlyStandalone RM to sales (%) v/s EBITDA margins(%) 76.0% 74.0% 72.0% 70.0% 68.0% 66.0% 64.0% 62.0% 60.0% FY 06 FY 07 FY 08 FY 09 FY 10 FY 11E FY 12E 18.0% 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% RM costs as % of sales EBITDA margins(%) Source: Company, Higher content of radial tyres to protect margins Radial tyres have longer life cycle, superior quality and hence command a premium to bias tyres (20% better pricing) and have better margins to the tune of bps higher than bias tyres. Currently, in India, the proportion of radial tyres in the MHCV segment is as low as 8-9%. With improving infrastructure and expected higher government spending on roads, we expect a rapid shift towards radial tyres. In FY 10, Apollo had a radial capacity of 120 TPD (14% of total TPD) which has moved to 220TPD (23% of total TPD) currently and is expected to move to 370 TPD (32.5% of total TPD) in FY 12E and 570 TPD (42.5% of total TPD) by the end of FY 13E with the Chennai plant capacity (450 TPD of radial capacity) operating at full utilization. Due to this, we would witness improvement in margins in FY 13E from a small decline in FY 12E. Radialization composition % % % % FY 2010 FY 2011E FY 2012E FY 2013E Radial TPD Radial as a proportion of total TPD Source: Company, 45.0% 40.0% 35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% 8

9 Composition of a bias tyre Bead wires 4% Others 7% Rubber chemicals 7% Nylon fabric 9% Natural rubber 43% Carbon Black 24% Synthetic rubber 6% Source: Company, Composition of a radial tyre Others 9% Steel chords 12% Synthetic rubber 28% Bead wires 5% Rubber chemicals 9% Source: Company, Nylon fabric 1% Carbon Black 36% European operations to gain traction on increasing demand Apollo acquired Vredestein Branden B.V. (VBBV) a Netherlands based tyre company years back. Apollo earned about 25% of its FY 10 revenues and 23% of its PAT from European business. Europe is a sophisticated auto market and the tyre industry over there contributes 30% of the world tyre market. Apollo has been recording strong numbers from this market, as in FY 10, the company earned `20 bn from this business and reported EBITDA margins of 17.5%. October December and the January to March quarters are the best quarters due to increased demand for winter tyres (32% of volumes) thus reflecting seasonality. Apollo has a capacity of 150 TPD in Europe, which is expected to move up to 170 TPD by the end of FY 11 for a capex of Rs7bn. The capacities are functioning at a utilization rate close to 100%. With the European auto industry coming out of woods, we expect Apollo to win higher market share with increasing capacities and a better distribution network. We expect these operations to report 14.5% revenue CAGR growth in between FY 10-12E. Due to cost pressures from higher international NR prices, we expect margins to fall close to 14% in FY 11 and remain at a similar level in FY 12E. 9

10 Revenue composition of European business OEM 9% Others 16% Passenger car - Winter tyres 32% Other PC tyres 24% Replacement 91% Source: Company, Passenger car - Summer tyres 28% South African business is back in the black and is expected to improve hereon Apollo has been struggling in this geography (13% of consolidated revenues and 12% of consolidated PAT in FY 10) since it acquired the South African business of Dunlop in Issues like competition, labor unrest and low demand offtake took their toll on Apollo s profitability over there; these operations have been constantly oscillating in loss to minimum profit zone. In FY 2009, the company reported profits of `316mn which grew handsomely by 260% in FY 10 to `1451mn. However, in FY 11, the entire South African tyre industry faced labor unrest as a result of which Apollo s plants in South Africa (Durban and Ladysmith) were locked out for 33 days. This led to loss in market share in Q2 FY11 and a negative margin of 3% at the operating level. Now operations are running at full swing with a reported 3% operating margin in Q3 FY11 with a 3.4% yoy increase in revenues. In South Africa, Apollo has capacity of 180 TPD which is operating at 80% utilization rate. Apollo expects to increase it to 100% in the coming year, thus catering to the growing SA auto market. With improved operating leverage, we expect a 4% margin in FY11E and a 6% margin FY 12E from this business with revenues expected to grow at CAGR of 12.6% in the period between FY 09-FY 12E. Revenue composition of South African business Exports 20% Domestic 80% Source: Company, 10

11 Segmental markets share of Apollo in South Africa 25% 22% 20% 15% 16% 18.50% 10% 5% 0% Passenger cars LCV Trucks and Buses Source: Company, Sensitivity Analysis Sensitivity analysis(fy 12E) Base case % impact NR prices(`) Conso EBITDA margins 9.9% 0 Conso EPS(`) Target price(`) 72 0 Bull case NR prices (`) Conso EBITDA margins 11.40% 150 bps Conso EPS (`) Target price (`) Bear case NR prices (`) Conso EBITDA margins 8.40% (150bps) Conso EPS (`) Target price (`)

12 Industry background Apollo Tyres Indian tyre industry is an oligopolistic market with 36 players, though the top 10 contribute more than 90% of the market. The leading tyre companies are MRF (21.8% market share), Apollo Tyres (21.7%), JK Tyres (15.7%) and Ceat (10.9%). Overall mkt share trend Apollo Tyres MRF JK Tyre and Industries Ceat Tyres Goodyear TVS Srichakra Falcon Tyres Others Segmental Market shares in April-August 2010 (in % terms) Truck and Bus Cars and Uvs LCV Tractors 2/3 wheelers Apollo tyres Ltd Birla tyres Bridgestone India Pvt. Ltd Ceat Ltd Falcon Tyres Ltd Goodyear India Ltd JK tyres MRF Ltd TVS Srichakra Ltd Others In value terms, tyre companies mainly cater to the CV segment (69%) followed by PVs (13%), while the two wheelers, three wheelers, exports and other segments such as OTR, tractors, construction equipments etc collectively comprise 18% of total volumes. Industry dynamics (Value terms) Others 18% Cars and UVS 13% LCV 7% MHCV 62% 12

13 In tonnage terms, MHCV contributes 55% of total market, while cars and UVs contribute 11.5%. Industry dynamics (Tonnage terms) Others 26% MHCV 56% Cars and UVS 11% LCV 7% The domestic tyre industry is expected to grow at a CAGR of 14-16% in tonnage terms in the period between to and is expected to cross `400 bn in value terms mainly driven by OEM demand which is expected to grow at 17-18% and replacement and exports are expected to grow at 14-15% in the same period. In the long term (FY to 2014E-2015E), the overall tyre industry is expected to grow at 10-11%(Source CRISIL). Industry Composition Exports 8% OEM 21% Replacement 71% 13

14 Industry Growth (% CAGR) OEM Replecament Total to to E The domestic tyre off-take has increased at a CAGR of 10.5% in the period between FY to FY in line with the buoyant growth in the automobile industry. OEM demand was strong, along with replacement demand which generally functions with a lag effect to the OEM demand. Domestic tyre offtake trend (000 s units) Vs % YoY Growth % 20% 15% 10% 5% 0% M&HCV has been the leading driver in the higher tyre offtake as the content per tyre in MHCV is significantly higher than any other tyre, also an MHCV requires 7 tyres per truck (2 front, 4 rear and 1 spare). Segment wise demand break-up(tyres) E E Million tonnes ` bn Million tonnes ` bn Million tonnes ` bn Million tonnes ` bn MHCV LCV Cars and Uvs Others Total Growth % yoy 17.9% 24.6% 17.5% 24.9% 12.6% 18.4% 14

15 In the year FY 11, the production of tyres was robust mainly in the PV segment as purchasing power of the consumers became stronger on modification in tax slabs, new launches, better consumer sentiments etc. On account of this, the growth in production has shown strength every month as PV tyre production has grown 20-30% in the recent month. Monthly PV Tyres Production (000 s units) April May June July August September October November December January February March However, CV production showed some contraction in the last two months of CY 10 on new emission norms, keeping customers away for some time from buying the higher priced vehicles. However, the resilience showed by freight rates and economic improvement along with upbeat OEM industry and recovery in replacement demand resulted in improvement in January CV sales thus reflecting higher CV tyre production (January CV tyre production figure not known, only direction is known). Monthly CV Tyres Production (000 s units) April May June July August September October November December January February March Within the tyre segment, radial tyres are recording a strong demand uptick though it will take some time to make a foothold in the CV segment. Expected added emphasis on road infrastructure by the government would lead to a stronger demand for radial tyres considering its better quality and higher price. In India, radlalization has been seen only in PV segment (98%), while MHCV has 8.6% of their tyres radialized. Globally, radialization in M&HCV tyres averages at 60%, while in geographies like North America, Europe etc, it is as high as 95%. 15

16 Redialization (%) Western Europe North America Central Europe Africa/Middle East Asia South America Asia Eastern Europe India World Radialization attracts higher capex and margins. Level of radialization in M&HCV is expected to move rapidly upto 22-23% by FY E (source CRISIL) on most of the tyre players expanding their radial capacities going forward. Segment wise radialization ( %) in India Segment E MHCV LCV Passenger cars and Uvs With the surge in auto demand, most of the leading tyre companies are taking significant capacity increases, mainly in the TBR segments, which will improve the proportion of TBR within the total tyre market. Tyre Industry Capex layout Company name Current capacity Capacity Timeline Capex (mn tyres p.a.) expansion (%) (` bn) Ceat 4.7 ~40 FY ~7 Apollo(TBR) 13.1 ~33 FY11-13 ~23 JK Tyres(TBR) 9.1 ~30 FY12 ~15 MRF(TBR) 28.4 ~22 FY11-13 ~30 Source: Company, Along with these domestic companies, global players like Bridgestone and Michelin have also plans to expand their capacities for an investment of `66bn collectively to leverage India s automotive growth story. Capacity utilization trend suggests that all the tyre players are functioning at >90% capacity utilization rates thus signifying the strong demand for automobiles. Most of these expansions are happening in the TBR segment thus indicating a latent increase in the industry profitability and also the per tonne capex which is almost double in case of radial tyres as compared to bias tyres. China has been a threat to the Indian tyre industry (imports of 6-7%), however with huge domestic capacities in the offing this threat will no longer exist. 16

17 Capacity utilization trend in tyre industry E A major threat for the tyre sector has been higher raw material prices mainly emanating from higher rubber prices. Basically Thailand, Indonesia, Malaysia and India account for 83.5% of world s rubber production. Global Production Break-up Vietnam 9% China 7% Others 1% Thailand 34% India 10% Malaysia 10% Indonesia 29% Globally, supply of natural rubber is expected to be low on the shortage of NR from the major rubber producing nations like Thailand, Malaysia and India (collectively 55% of global production) due to unfavorable weather conditions. Owing to this the prices of rubber are unusually firming up. On the other hand, the demand is very strong across the globe for auto industry which is further putting an upward pressure on the rubber prices in the short to medium term. Global Production v/s Consumption of natural rubber (000 tonnes) E Consumption Growth (%) 0.5% -7.6% Production Growth(%) 2.1% -3.8% Surplus/deficit (319.00) (158.00) 237 ( ) ( ) 17

18 However, the significant area which was brought under cultivation in India and China in CY 2005 will start yielding rubber by CY 2012 as it takes 6-7 years for plantation to mature, thus resulting in a sizeable increase in tapped area. Also improving yield in India is adding to the positive expectations about reducing the gap between supply and demand and calming down of rubber prices. Global tyre industry Since Apollo has international operations, it is important to track the international tyre markets where Goodyear, Michelin, Continental and Bridgestone are the main players deriving major revenues from the PCR and LCVs segment. Global Tyre market shares Global Tyre Industry composition Others 34% Bridgestone 17% 2 wheelers 4% Agricultural 2% Aircraft 1% Earth movers 6% Yokohoma 3% Michelin 17% Trucks and buses 27% Passenger cars and LCVs 60% Sumitomo 3% Pirelli 4% Continental 6% Goodyear 16% 18

19 Company Background Apollo Tyres Apollo is one of India s leading tyre manufacturer based at Gurgaon, Haryana with operations across Asia, Africa and Europe. Apollo has eight manufacturing facilities across these three geographies. Recently the company has started operations from its Chennai facility and is expecting to reach full production of 500 TPD by FY 13E by then. Apollo s topline is contributed mainly by the T&B segment (75%) while cars contribute 14% of revenues. At the same time, replacement is the biggest revenue segment for Apollo. Revenue composition Tractors 7% Exports 11% LCV 4% Cars 14% OEM 24% T&B 75% Replacement 65% Source: Company, The company currently produces 960TPD of tyres from the domestic operations. Apollo had acquired the South African operations of Dunlop in CY 06, with which it had acquired 3 manufacturing units in South Africa, a retreading unit in South Africa and Zimbabwe each and brand rights for 32 African countries. In May 2009, Apolllo acquired Vredestein Banden B. V. based at Netherlands which is a manufacturer of niche high end passenger car and specialty tyres with strong distribution network across Europe. The company has 3 production units in India Limda in Gujarat and Kalamassery and Perambra in Kerala who collectively produce 850 TPD of tyres, Chennai is in ramp up stage with 150TPD capacity at this point of time, while South Africa and Europe produce 180TPD and 150TPD of tyres respectively. FY 10 sales contribution FY 10 EBIT contribution South Africa 13% South Africa 10% Europe 21% Europe 25% India 62% India 69% Source: Company, 19

20 Outlook and Valuation Apollo has faced the heat of rising commodity prices, softening replacement demand and labor unrest in the recent past. In the coming future, in the domestic markets, we believe the replacement market has firmed up again after a temporary blip following the establishment of emission norms. OEM demand is strong and will continue to be stronger and demand from the OEM CV segment will be driven by the improvement in the economy and increasing freight rates which will offset the increase in interest rates. In the PCR segment, the company will leverage its dominant position through gaining important orders like the one associated with the expansion of Maruti s capacities. The capacity expansion at Apollo s Chennai plant is on schedule and will significantly increase the radial capacity of the company thus leading to a significant margin improvement in the latter half of FY 12E thus negating the impact of raw material cost hike upto a great extent and also contributing to a strong revenue growth. The company had lost its pricing power in the second quarter of FY 11 due to lockouts at its various plants, however, with the tyre demand remaining strong and Apollo once again gaining its lost market share in the CV business back to 27% has gained its market leadership position, thus winning the pricing power. Even after factoring average FY 12E NR price at `235 and a 50 bps fall in EBITDA margins, we derive a 27% consolidated earnings growth in FY 12E over FY 11E. One of the main contributors to this growth is the European business which is expected to report stronger growth on recovery in European auto industry and the company s niche position in the winter tyres segment considering the stronger winters in Q3 and Q4 in Europe. Expansion of capacities in Europe will also accommodate the rising auto demand over there. In South Africa, we expect a stable growth in revenues and improvement in margins going forward on expected increase in utilization rates (currently ~80%). Thus we believe that despite raw material prices zooming up, Apollo has the pricing power and scale of operations with expanding capacities to protect its margins and at the same time increasing its market share. International operations will provide the required support as compared to other tyre companies which are purely dependent on the vulnerable domestic operations. At CMP of `56, the stock trades at 6.6x times its FY 12E EPS of `8.5. We have assigned its trailing 5 year average multiple of 8.5x to value this stock at `72, which gives an upside of 29%. We initiate coverage on Apollo with a BUY rating. PE band x 8x 6x 4x 2x 0 Date 31-Jan Nov Oct Aug Jun May-10 Source: Bloomberg 20

21 Risks and concerns The major risk which we see for the company and the entire tyre industry is the higher than expected hike in the RM prices. Among the RM, natural rubber prices are the biggest risk. If production constraints do not get resolved globally in the near future, we may see immense pressure on the margins. Synthetic rubber prices may also increase on increasing in crude prices Slower than expected ramp up at the Chennai plant may not provide the necessary jump in volumes Labour issues remain a concern keeping in view the recent lockouts at Kerala and South Africa Weakening of auto OEM and replacement demand due to rising interest rates and lower freight rates Reduction in pricing power on account of production constraints and competition may hamper margins 21

22 Financial Summary (Consolidated) Income statement YE Mar (`mn) FY 09 FY 10 FY 11E FY 12E Total Revenues 49,841 81,207 83, ,385 Raw Material Cost 34,003 45,808 47,420 62,923 Employee Cost 4,015 10,481 12,798 15,119 Other Exp 6,691 11,547 12,809 15,474 EBITDA 4,090 11,685 8,676 10,485 EBITDA Margin(%) 8.2% 14.4% 10.4% 9.9% Other income Depreciation 1,285 2,542 3,048 3,834 Interest PBT 2,134 8,266 4,675 5,787 PBT Margin(%) 4.3% 10.2% 5.6% 5.4% Tax 742 2,607 1,315 1,511 Adj PAT 1,391 5,660 3,359 4,276 Adj PAT Margins (%) 2.8% 7.0% 4.0% 4.0% Exceptional items PAT PAT Margin (%) 2.8% 8.0% 4.0% 4.0% Key Ratios YE Mar FY 09 FY 10 FY 11E FY 12E Per Share Data (`) Adj. EPS CEPS BVPS DPS Growth Ratios(%) Total revenues EBITDA PAT EPS Growth Valuation Ratios (x) PE P/CEPS P/BV EV/Sales EV/EBITDA Operating Ratios (Days) Inventory Recievable Payables Net Debt/Equity (x) Profitability Ratios (%) ROCE ROE Dividend payout Dividend yield Balance sheet YE Mar (`mn) FY 09 FY 10 FY 11E FY 12E SOURCES OF FUNDS Equity Share Capital Reserves & Surplus 12,992 19,174 23,166 27,225 Total Networth 13,496 19,678 23,671 27,729 Total debt 8,907 17,072 26,072 25,072 Net Deferred Tax Liability Total Liabilities 22,404 36,750 49,742 52,801 APPLICATION OF FUNDS Net block 14,254 25,600 34,552 37,718 Capital WIP 2,814 5,360 5,860 6,360 Investments Current Assets Cash and Bank 3,621 3,490 4,811 6,184 Inventories 6,302 9,929 10,523 13,791 Sundry Debtors 2,247 7,869 9,175 10,201 Loan, Advances & others 5,895 8,275 9,175 9,618 Current Liab & Prov Current liabilities 5,860 13,122 13,584 16,894 Provisions 4,982 8,239 8,315 11,723 Net Current Assets 7,228 8,245 11,785 11,178 Def. tax assets(liab.) -1,942-2,514-2,514-2,514 Total Assets 22,404 36,750 49,742 52,801 Cash Flow YE Mar (`mn) FY 09 FY 10 FY 11E FY 12E PBT 2,134 9,140 4,675 5,787 Depreciation 1,285 2,542 3,048 3,834 Interest 1,098 1,157 1,454 1,464 Chng in working capital 467 1,992 (2,263) 1,980 Tax paid (680) (1,764) (1,315) (1,511) Other operating activities (54) (3) CF from operations (a) 4,250 13,125 6,545 11,551 Capital expenditure (5,019) (10,444) (12,500) (7,500) Chng in investments 23 (2,441) 0 0 Other investing activities (225) CF from investing (b) (5,221) (12,142) (12,500) (7,500) Free cash flow (a+b) (971) 983 (5,955) 4,051 Inc/dec in borrowings 1, ,000 (1,000) Dividend paid (incl. tax) (290) (264) (168) (214) Other financing activities (704) (1,272) (1,454) (1,464) CF from financing (c) 671 (801) 7,378 (2,678) Net chng in cash (a+b+c) (300) 182 1,423 1,373 Foreign excg fluctutions Closing cash & cash equivts 2,941 3,388 4,811 6,184 Bank deposits with 3 mts tenr Adj. Closing cash & cash eqvts 3,621 3,490 4,811 6,184 Source: Company, 22

23 LKP Research Team S. Ranganathan Head of Research Pharmaceuticals, Agriculture Ashwin Patil Research Analyst Automobiles & Telecom Chaitra Bhat Research Analyst Banking & Financial Services Ami Shah Research Analyst Cement & Sugar Deepak Darisi Research Analyst Energy Dwaipayan Poddar Technical Analyst Institutional Equities Pratik Doshi Director pratik_doshi@lkpsec.com Hardik Mehta Sales hardik_mehta@lkpsec.com Varsha Jhaveri Sales varsha_jhaveri@lkpsec.com Hitesh Doshi Sales hitesh_doshi72@lkpsec.com Kalpesh Vakharia Dealing kalpesh_vakharia@lkpsec.com Gurdarshan Singh Dealing gurdarshan_singh@lkpsec.com LKP Securites Ltd,10th floor, Nariman Bhavan, Nariman Point, Mumbai Tel Fax