Apollo Tyres Ltd Focus back on core business; robust margin to drive cash flows We recommend BUY with a PT of Rs255 based on 11.45x FY15E EPS. We have increased our FY15E EPS by 22% led by healthier margin visibility amid weak demand. We maintain our target earnings multiple at 8x vs 10x for global peers. We have increased our EBITDA margin assumption by ~160bp for both FY14E & FY15E led by visibility of subdued raw material basket (RMB) prices & steady pricing discipline. We expect deleveraging to continue even after factoring resumption of capex cycle from FY15E on back of robust cash flows amid weak demand. With favourable district court judgment, we don t expect any liability from Cooper deal call off. Robust margin and demand recovery in EU to result in strong cash flow generation: Internationalisation has its benefits The company expects a) strong performance in Europe (38% of EBITDA) aided by market recovery and marketshare gains, b) below-trend demand scenario in India (60% of EBITDA) until 1HFY15, c) overall margins to be maintained at current levels (c13%) in the medium term driven by stable raw material prices and a virtually dormant pricing environment. In the medium to long term, the company expects to drive growth from capacity expansion in Europe and expanding its sales presence in South-East Asia, Latin America and the Middle East. Standalone business to operate ~80-85% capacity in FY15E; capex in the key markets to be back soon: With Vredestein running at optimal utilisation and India operations running at ~75-80% utlisation, the capex cycle is expected to resume from FY15E to take care of the next level of growth in FY16-17E. As a matter of financial prudency, a APTY may adopt the organic capex route for the next business cycle by re-initiating plans of green field capacities in east Europe & Thailand. Standalone capacity is presently around 1,500 TPD with FY14E expected sales at ~75% of it. Now with the uncertainity over the Cooper done with; we do not expect any exit penalty for APTY: With APTY getting an exit from the Cooper merger deal, the only element of uncertainty remaining will be the quantum of exit penalty. It can be safely assumed that with APTY getting favorable judgement from local legal authority, chances of any substantial cash outflow from APTY seems slim. However, one cannot rule out PTY s intention of entering any such large ticket deal in future, but apparently at least for the near term till FY16E, APTY will aim to grow through the organic capex led route and thus initiate its capex cycle aggressively from FY15E post a gap of a couple of years. BUY Rs 197 Reuters: APLO.BO Bloomberg: APTY IN 12-month price target Rs 255 Chandraveer Singh chandraveer.singh@kslindia.com +91 22 4076 7373 Pranav Khandwala pranavk@kslindia.com +91 22 4076 7373 Market cap Rs 10236.74Cr 52 week high/low Rs 206.65/54.60 Share o/s: 504 mn Share o/s (fully diluted) : 504 mn Avg daily trading vol (3m) : 9,375 ('000) Source: Bloomberg KHANDWALA vs Consensus (Rs) PT EPS (FY14) Mean 133.25 17.10 High 211.90 19.40 Low 54.60 13.62 KHANDWALA 255 18.3 Buy(s) Hold(s) Sell(s) Nos 16 6 6 Source: Bloomberg Shareholding pattern (%) Sep 13 Jun 13 Mar 13 Promoters 43.5 43.4 43.4 FIIs 34.5 28.94 33.48 MF/s/FIs/Banks 7.86 9.21 8.04 Others 14.14 18.35 14.98 Source: BSE Price movement (Rs) vs the Sensex Valuation: We put a BUY on APTY with a PT of Rs255 from the current Rs203. We have increased our FY15E EPS by 22%, and we maintain our target earnings multiple at 11.45x, with similar global peers trading at ~14x forward earnings. Risks: Higher than expected RMB price, continued weak demand in India/EU, fresh acquisition plans & larger penalty/legal expenses for Cooper deal call off are risks to our call & estimates. Source: Bloomberg Exhibit 1: Consolidated financials and valuation Year Ended (Cr's) 12-Mar 13-Mar 14-Mar 15-Mar (E) 16-Mar (E) Revenue 12153.29 127946.3 133103.3 142928 159636 EBITDA 15571.9 20664.6 18756 19291 21327 EBITDA growth (%) 12.81 16.15 14.1 13.50 13.36 Net Income 412.12 613.8 1005.06 10168 11316 EPS 8.18 12.15 19.94 19.1 21.3 P/E 21.65 14.53 8.88 13.35 11.97 Adj PAT 11,662 14,569 10,521 18,517 32,590 PAT margin 9.6 11.4 7.8 13 20.41 1 P a g e 1 7 J u n e 2 0 1 4
E E Apollo Tyres: focus back on core business; robust margin to drive cash flows 2 P a g e 1 7 J u n e 2 0 1 4
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Key financials Apollo Tyres: focus back on core business; robust margin to drive cash flows 4 P a g e 1 7 J u n e 2 0 1 4
Apollo Tyres: focus back on core business; robust margin to drive cash flows Rating history - Apollo Tyres Future prospects Apollo Tyres is planning to expand its capacity at its Chennai facility. Moreover, the company is also in the process of setting up a R&D centre in the same complex. The new Centre will take up R&D works related to commercial vehicles for all the Apollo plants, across the World. At present, the Chennai plant manufacture radial tyres for truck and capacity of the plant is 6,000 trucks tyres and 15,000 passenger car tyres a day and the capacity utilisation of around 70-75%. The facility caters to both domestic and export markets. Apollo Tyres produces the entire range of automotive tyres for ultra and high speed passenger cars, truck and bus, farm, off-the-road, industrial and specialty applications like mining, retreaded tyres and retreading material. These are produced across Apollo s eight manufacturing locations in India, Netherlands and Southern Africa. As of Jun 06, 2014, the consensus forecast amongst 44 polled investment analysts covering Apollo Tyres Ltd advises that the company will outperform the market. This has been the consensus forecast since the sentiment of investment analysts improved on February 16, 2014. The previous consensus forecast advised investors to hold their position in Apollo Tyres Ltd. NOW, Sectors having high EVF should benefit the most during a recovery We use fixed costs/pbt ratios of bear and bull cycles to arrive at an Earnings Volatility Factor (EVF). Sectors with high operating leverage, inability to control fixed costs during downcycles, and low margins have typically witnessed high EVF. Typically, sectors having EVF above 1.4x demonstrate this characteristic. This implies that if one has an outlook of an improving business cycle, operating leverage for sectors/stocks with high EVF should improve materially. These sectors should thus witness the highest improvement in earnings with improving business cycles. However, we believe even in the event of a recovery, stock performance will vary. We prefer stocks that meet two criteria: high EVF (Earnings Volatility Factor), to identify stocks that would witness high earnings recovery, and high ECS (Early Cycle Score) to identify stocks that would respond fastest to a recovery. Apollo tyres fits both the criteria. We prefer early cyclicals. As per our analysis, companies with high ECS respond quickly to even short cycles of an economic recovery: stocks within durables, commercial vehicles (CV), four-wheelers (4W) stand out, while investment cycle-driven sectors recover with a lag, indicating that the full negative impact of their operating leverage may not have played out as yet. We prefer stocks with high fixed costs. We note that companies with high fixed costs, inability to control them during downcycles and low margins witness a disproportionate increase in earnings during upcycles. We measure this through EVF. Sectors with high EVF: CVs, 4Ws, Durables, Cement, Retailing, Construction and Industrial Products stand out on this parameter. Likely winners and losers. Assuming India is at the cusp of an economic recovery, we would invest in stocks with high ECS and high EVF. We screen companies with ECS>5x and EVF>1.4x; Apollo Tyres should be a key beneficiary of a potential economic recovery. 5 P a g e 1 7 J u n e 2 0 1 4
Ratings and other definitions Institutional Equities Research coverage universe - distribution of ratings Stock rating system BUY. We expect the stock to deliver >15% absolute returns. ACCUMULATE. We expect the stock to deliver 6-15% absolute returns. REDUCE. We expect the stock to deliver +5% to -5% absolute returns. SELL. We expect the stock to deliver negative absolute returns of >5%. Not Rated (NR). We have no investment opinion on the stock. Sector rating system Overweight. We expect the sector to relatively outperform the Sensex. Underweight. We expect the sector to relatively underperform the Sensex. Neutral. We expect the sector to relatively perform in line with the Sensex. Analyst certification We, Chandraveer Singh and Pranav Khandwala, hereby certify all of the views expressed in this report accurately reflect our personal views about the subject company or companies and its or their securities. We also certify that no part of our compensation was, is or will be, directly/indirectly, related to the specific recommendations or views expressed in this report." 6 P a g e 1 7 J u n e 2 0 1 4
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