Sector Update Sector View Overweight What s changed? Target Prices ( ) JK Tyres Apollo Tyres Balkrishna Industries Old New 285 477 240 270 800 870 Stocks Performance (Returns as on Sept 09, 2014) Return (%) Company 1 month 3 months 1 year BSE Sensex 7 7 47 BSE Auto 13 16 72 JK Tyres 19 32 337 Apollo Tyres 25 4 225 Balkrishna Industries 5 14 228 Ceat 50 68 678 MRF Tyres 27 26 123 Goodyear India 9 39 113 Natural Rubber price trend ( /Kg) 240 220 200 180 160 140 120 Jun-11 222 Dec-11 Rubber prices have been on a continuous decline over the past 1 year Jun-12 Dec-12 Prices of natural rubber is of RSS-4 grade Jun-13 192 Dec-13 Jun-14 133 Natural Rubber estimates ( /kg) Old Revised Old Revised JK Tyres 160 153 161 155 Apollo Tyres 148 143 149 143 Balkrishna Industries 144 136 145 137 Standalone: Apollo Tyres, JK Tyres EBIDTA margins movement (%) Q2FY14 Q3FY14 Q4FY14 Q1FY14 JK Tyres 11.1 10.8 10.0 10.3 Apollo Tyres 13.2 14.0 14.3 13.2 Balkrishna Industries 24.1 25.9 25.8 24.8 Analyst Nishant Vass nishant.vass@icicisecurities.com Venil Shah venil.shah@icicisecurities.com Tyre Sector Rubber prices slide globally! Stocks get re-rated In the recent past, global rubber prices have gone into a downward spiral with increasing concerns on demand-supply mismatch. The benchmark Bangkok RSS-4 rubber prices have declined from $2.2/kg in March to ~$1.7 levels. These are five-year low prices. Recent news flow of sale of 200,000 MT of rubber stocks by the Thailand government has caused more panic in the existing market. On the demand side, global studies and major manufacturers commentary suggests automotive tyre demand will grow ~4-5% in volume terms. This would be split with demand rising well in the North American region while Europe and Japan would remain sluggish. Emerging markets like India and China are expected to see a moderate recovery. From an Indian perspective, domestic tyre manufacturers saw another quarter of favourable raw material prices mostly as natural rubber (NR) prices saw a decline to 132/kg from 148/kg in March in the domestic market. Domestic rubber supplies would have ebbed in the monsoon season, however, due to lower tapping. However, in the coming periods, as tapping increases prices could remain under pressure as supply increases domestically. The recent crude price decline (~9% QoQ) may cause a lag decline in crude linked derivatives like synthetic rubber and nylon tyre cord. Rubber contributes ~50% in volume terms and ~55% of the total raw material cost for tyre companies, depending on the product mix. Crude-linked derivatives constitute another 20-25% of the raw material basket for tyre companies. Thus, tyre makers are in a unique sweet spot as commodity prices, unlike historically, are reducing without a demand collapse. Hence, this is providing companies opportunities to focus more on bottomline growth vis-à-vis pace of topline growth. Sector outlook Raw material outlook: Rubber price fall in a traditionally weak quarter (Q1) augurs well for OEMs as risk of price increases come down significantly for the rest of. The increase in domestic tapping from the Kerala region and increase in global supplies as Thailand inventory comes into the market may keep prices under control. Going ahead, we believe RSS-4 prices would continue to remain at ~$1.8/kg (Bangkok), ~ 135/kg in the domestic market. On the crude linked derivatives side, like synthetic rubber/carbon black prices are also expected to witness declines albeit in a lagged manner owing to the recent fall in Brent crude prices to below $100/bbl. Pricing discipline: On the pricing front, so far, even with the slowdown and natural rubber price corrections, the pricing discipline shown by the tyre industry in the replacement market has been strong. On the OEM side, the pricing contracts are on a quarterly or bi-annual basis, thereby resulting in price reductions in the OEM segment as the benefit of favourable raw material prices gets passed on. Thus, the increase in OEM demand would have led to higher utilisation levels but would be offset by a decline in terms of pricing. Demand outlook: Demand recovery is showing some green shoots of revival with the M&HCV, PV (-4%, ~3% YoY YTD growth) OEM sales showing sings of revival even as the 2-W segment continues to remain strong (~16% YTD YoY growth). This augurs well for,. The pick-up in tyre demand from OEs may be more pronounced from H2 onwards. We expect the overall auto industry to grow 9-11% for. Replacement demand has mitigated the overall weakness in OE demand in FY14E. We believe overall industry share of replacement, OEM would move to 65%, 35% from ~70%, 30%, respectively.
Exhibit 1: Sensitivity Analysis NR* price change ( /Kg) EBITDA margin change (%) EPS impact (%) JK Tyres` Apollo Tyres` Balkrishna Industries JK Tyres` Apollo Tyres` Balkrishna Industries 20-4 -4-2 -60-40 -13 10-2 -2-1 (30) (20) (7) 0 0 0 0 0 0 0-10 2 2 1 30 20 7-20 4 4 2 60 40 13 `standalone As per our analysis, for every 10 change in natural rubber prices (other things remaining constant), EBITDA margins could likely change in varying degrees from 100 bps to 400 bps, clearly showing that Balkrishna Industries would benefit the least from a rubber price fall. On the earnings front, JK Tyres is expected to see ~30% change on every 10 change in natural rubber prices. Exhibit 2: World natural rubber production and consumption trends Rubber production (000's MT) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Natural rubber 6,811 6,913 7,317 7,986 8,726 8,921 9,850 10,057 10,098 9,723 10,393 11,230 11,603 12,036 Synthetic rubber 10,870 10,483 10,906 11,414 11,979 12,025 12,700 13,367 12,738 12,393 14,115 15,073 15,142 15,495 Total rubber 17,681 17,396 18,223 19,400 20,705 20,946 22,550 23,424 22,836 22,116 24,508 26,303 26,745 27,531 Rubber consumption (000's MT) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Natural rubber 7,108 7,039 7,515 7,797 8,562 9,049 9,513 10,133 10,181 9,361 10,773 11,007 11,027 11,322 Synthetic rubber 10,830 10,253 10,679 11,177 11,693 11,731 12,434 13,087 12,517 12,129 13,984 14,803 14,925 15,483 Total rubber 17,938 17,292 18,194 18,974 20,255 20,780 21,947 23,220 22,698 21,490 24,757 25,810 25,952 26,805 Supply demand surplus/deficit 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Natural rubber -297-126 -198 189 164-128 337-76 -83 362-380 223 576 714 Synthetic rubber 40 230 227 237 286 294 266 280 221 264 131 270 217 12 Total rubber -257 104 29 426 450 166 603 204 138 626-249 493 793 726 Source: International Rubber Study Group (IRSG), ICICIdirect.com Research As per the study conducted by the International Rubber Study Group, natural rubber production has doubled from the levels in year 2000. In the past 14 years, rubber production has been surplus for six years. However, the supply demand surplus has not exceeded two years until the year 2013, which has seen increasing surpluses. Also, in 2014, the same situation is likely to persist. Furthermore, for the next 15-18 months, natural rubber prices are likely to remain muted as supply outstrips demand. Key financials Crore FY13 FY14 Net Sales 6,949 7,599 7,682 8,667 EBITDA 618.0 871.3 1,001.7 1,181.2 Net Profit 203.3 263.0 387.2 496.1 FDEPS ( ) 44.8 58.0 85.4 109.4 Valuation matrix FY13 FY14 P/E (Dil.) (x) 8.2 6.3 4.3 3.4 EV/EBITDA (x) 6.3 4.3 4.0 3.4 Tar. EV/EBITDA (x 7.0 4.8 4.4 4.0 P/B (x) 1.7 1.4 1.0 0.8 RoNW (%) 22.4 24.0 25.9 25.4 RoCE (%) 14.1 19.2 20.0 21.8 JK Tyres Changed from Hold to Buy Strong market share in TBR segment, favourable rubber prices aid margins! The performance of JK Tyres and Industries (JKTIL) in FY14 has been driven mainly by earnings upgrades as tyre makers have held pricing discipline even as raw material prices have witnessed declines. The replacement demand has remained steady in mid-single digits while OEM demand looks set to improve in, as the hitherto underperforming M&HCV segment looks set for a recovery. JK holds ~35% share in the TBR segment, which is growing faster than the overall industry as the trend of radialisation continues. The company has also laid out plans on new capital expenditure plans of ~ 1,400 crore in the wake of high utilisation (~80-90%) in existing facilities in the TBR segment. The performance of Mexican subsidiary, JK Tornel, however has been disappointing in the past two quarters as the bias capacity is increasing becoming redundant in the wake of the faster radialisation trend in the industry. Page 2
Exhibit 3: Revised estimates ( Crore) Old New % Change Old New % Change Comments Revenue 7,773 7,737-0.5 8,779 8,724-0.6 Largely unchanged estimates EBITDA 898 1,002 11.6 1,092 1,181 8.1 EBITDA Margin (% 11.5 12.9 140 bps 12.4 13.5 109 bps Margin profile to remain on an uptrend as raw material prices decline PAT 317 387 22.2 413 496 20.2 Higher margins to lead to an increase in bottomline FDEPS ( ) 69.9 85.4 22.2 91.0 109.4 20.2 Key changes in forecasts In,, we believe rubber prices will continue to remain favourable while a recovery in the M&HCV segment is likely to lead to higher utilisation and push operating margins to ~13.7% in. We have, thus, increased the PAT estimate by ~17% to ~ 480 crore With earnings likely to hold their course, we have raised our multiple slightly in tandem with the re-rating of the tyre industry. Thus, we have raised our target multiple by ~15% to 4x EV/EBITDA. Consequently, we raise our target price to 477 and recommend BUY Key financials Crore FY13 FY14 Net Sales 12,795 13,311 13,804 15,006 EBITDA 1,456.7 1,876.2 2,022.8 2,204.1 Net Profit 612.6 1,005.8 1,099.7 1,237.4 EPS ( ) 12.2 20.0 21.8 24.5 Valuation matrix FY13 FY14 P/E (x) 17.6 10.7 9.8 8.7 Tgt P/E (x) 22.2 13.5 12.4 11.0 EV/EBITDA (x) 9.0 6.3 6.0 5.4 P/BV (x) 3.2 2.4 1.9 1.6 RoNW (%) 18.0 22.0 19.6 18.2 RoCE (%) 17.5 23.7 20.2 19.1 Apollo Tyres Unique combo of domestic & global tyre play... Unchanged While the Cooper deal failed to materialise, ATL s focus on geographically de-risking the business augurs well for the future. With the radialisation trend in the T&B segment likely to improve radial volumes, a revival in economic demand augurs well for domestic capacity utilisation levels, which stand at ~75%. The European business Vredestein has continued to perform strongly with the ~30% RoCE business operating at ~90% capacity utilisation levels. With little scope to expand, the board s decision to set up a greenfield plant in Eastern Europe at an estimated spend of 500 million is on track to fatten ATL s bottomline even further. In the domestic business, with raw material prices (especially rubber that represents >60% of total raw material cost for ATL) remaining favourable, ATL s margin profile is likely to remain stable. We also expect the pricing discipline shown by the industry to continue, going forward, thus helping sustain profitability. Our stance on ATL continues to be positive from the core existing business perspective. We believe valuations would rise ahead of other strong domestic, global peers like MRF, Michelin, etc. Page 3
Exhibit 4: Revised estimates ( Crore) Old New % Change Old New % Change Comments Revenue 13,898 13,853-0.3 15,304 15,054-1.6 Largely unchanged estimates EBITDA 1,945 2,023 4.0 2,082 2,204 5.9 EBITDA Margin (% 14.0 14.6 61 bps 13.6 14.6 104 bps Margins expectation increased owing to lower raw mateiral costs PAT 1,035 1,100 6.2 1,101 1,237 12.3 Higher margins to lead to an increase in bottomline EPS ( ) 20.5 21.8 6.2 21.8 24.5 12.3 Key changes in forecasts Our earnings estimates have increased ~6%, ~12% as a domestic recovery coupled with favourable raw material prices aids margins in,, respectively. is expected to witness a stronger margin performance from the South Africa subsidiary and higher product mix from the European business post capacity expansion. ATL s core business continues to be attractively placed with geographically diversified revenue streams. We believe it remains an attractive bet considering its strong business position and comfortable B/S situation. We value ATL at 11x EPS to arrive at a target price of 270. We continue to recommend BUY Key financials Crore FY13 FY14 Net Sales 3,173 3,536 3,892 4,527 EBITDA 664.4 893.9 1,054.8 1,239.8 Net Profit 355.9 488.4 530.1 647.2 EPS ( ) 36.8 50.5 54.8 67.0 Valuation matrix FY13 FY14 P/E (x) 21.2 15.4 14.2 11.6 Tgt P/E (x) 23.6 17.2 15.9 13.0 EV/EBITDA (x) 14.1 11.0 9.1 7.1 P/BV (x) 5.3 4.0 3.2 2.5 RoNW (%) 25.1 25.9 22.2 21.5 RoCE (%) 16.0 17.2 17.1 19.7 Balkrishna Industries Changed from Hold to Buy Huge capacity likely to find utilisation as growth revives in US, Europe! BIL is a focussed off-highway tyre (OHT) manufacturer with contribution of agricultural and OTR segments at 63% and 37%, respectively. With the OHT segment forming only 10-15% of revenues for global players like Bridgestone and Michelin, BIL s focus on this niche segment augurs well for the company as it currently enjoys only 4.5% market share in a ~$15 billion global market. Despite selling at ~30% discount to the industry leader, BIL enjoys strong margins as its products are competitive due to lower labour costs in India, compared to significantly higher wage and benefits/entitlement structure present in European facilities. BIL is setting up a plant at Bhuj with a capacity of 140,000 MT, which is expected to be fully commissioned by the end of in a phased manner. This would take BIL s total capacity to 300,000 MT in. It would cater mainly to the OTR segment (which forms only 37% of revenues) where BIL s presence was constrained by lack of capacity. The new capacity will also facilitate entry into markets like CIS and Russia where the management expects strong offtake in the coming years. On the raw material front, BIL imports natural rubber and has very little exposure to domestic rubber price fluctuations. Thus, margins have remained strong. BIL s huge capex plan had raised fears it would lead to deteriorating earnings and return ratios over the next two years. However, with a European recovery aiding a strong volume pick-up and raw material prices aiding profitability, we believe BIL may clock volumes of ~185,000 MT, at ~15% CAGR in FY14-16E. Page 4
Exhibit 5: Revised estimates ( Crore) Old New % Change Old New % Change Comments Revenue 3,955 3,934-0.5 4,656 4,576-1.7 Largely unchanged estimates EBITDA 1,006 1,055 4.9 1,161 1,240 6.8 EBITDA Margin (% 25.4 26.8 138 bps 24.9 27.1 216 bps Margin expectation increased on the back of favourable raw material prices PAT 499 530 6.1 595 647 8.8 Increase in margins to flow to the bottomline EPS ( ) 51.7 54.8 6.1 61.5 67.0 8.8 Key changes in forecasts With a strong margin performance in FY14E and favourable rubber price outlook, we have cut our NR cost estimates. Thus, we have upgraded our earnings estimates for, by ~6%, ~9%, respectively BIL has a strong business case, being in a niche segment supplying from a low-cost production centre. We have valued BIL at 13x P/E EPS to arrive at a target price of 870 and change our stance from HOLD to BUY. Page 5
ICICIdirect.com Research Universe (Auto) CMP M Cap EPS ( ) P/E (x) EV/EBITDA (x) RoCE (%) RoE (%) Sector / Company ( ) TP( ) Rating ( Cr) FY14E FY14E FY14E FY14E FY14E Amara Raja (AMARAJ) 590 590 Buy 10,074 21.5 25.4 33.7 27.4 23.2 17.5 15.6 12.1 9.0 34.3 33.1 33.9 27.0 25.3 26.1 Apollo Tyre (APOTYR) 214 270 Buy 10,808 20.0 21.8 24.5 10.7 9.8 8.7 6.3 6.0 5.4 23.7 20.2 19.1 22.0 19.6 18.2 Ashok Leyland (ASHLEY) 41 32 Hold 11,611 0.1 0.2 1.5 371.8 175.4 28.2 84.5 19.7 10.6 NM 2.7 8.7 0.7 1.3 7.6 Bajaj Auto (BAAUTO) 2,324 2,400 Buy 67,235 112.1 124.1 153.3 20.7 18.7 15.2 12.8 11.4 8.8 40.6 37.8 40.1 33.8 32.2 33.5 Balkrishna Ind. (BALIND) 790 870 Buy 7,635 50.5 54.8 67.0 15.4 14.2 11.6 11.0 9.1 7.1 17.2 17.1 19.7 25.9 17.2 17.1 Bosch (MICO) 14,991 15,450 Hold 47,071 281.8 366.3 492.2 48.6 37.4 27.9 31.4 25.2 18.4 14.1 16.0 18.2 14.1 15.8 19.5 Eicher Motors (EICMOT)` 11,121 13,000 Buy 30,038 145.9 262.9 384.0 76.2 42.3 29.0 46.1 21.7 14.3 18.3 25.1 29.7 19.2 26.9 29.5 Escorts (ESCORT)* 139 103 Sell 1,659 20.5 11.9 17.1 5.7 9.9 6.8 4.1 5.9 4.4 13.7 8.3 10.7 13.4 7.3 9.7 Exide Industries (EXIIND) 162 148 Hold 13,732 5.7 7.9 9.5 28.2 20.4 16.9 16.0 12.3 10.2 18.5 22.3 23.2 13.1 16.1 17.1 Hero Mototcorp (HERHON) 2,761 2,600 Hold 55,137 105.6 136.4 173.3 26.1 20.2 15.9 13.0 14.6 13.5 43.4 49.2 53.6 37.7 40.8 43.0 JK Tyre & Ind (JKIND) 381 477 Buy 1,564 58.0 85.4 109.4 6.6 4.5 3.5 4.3 4.0 3.4 19.2 20.0 21.8 24.0 25.9 25.4 M&M (MAHMAH) 1,402 1,322 Hold 82,733 56.5 67.8 72.7 24.8 20.7 19.3 15.5 12.3 11.0 18.5 20.4 19.8 22.1 20.2 18.6 Mahindra CIE (MAHAUT)* 200 175 Buy 6,500 1.5 6.4 10.1 137.6 31.1 19.8 14.0 10.1 8.0 2.0 8.2 12.6 4.7 8.0 11.7 Maruti Suzuki (MARUTI) 2,911 2,450 Hold 87,963 92.1 105.1 144.1 31.6 27.7 20.2 13.4 11.8 8.8 13.3 13.5 16.9 13.3 13.4 15.9 Motherson (MOTSUM) 394 360 Hold 34,729 8.7 14.6 22.2 45.4 26.9 17.7 12.6 9.3 6.9 24.2 32.1 36.4 25.9 36.5 40.3 Tata Motors (TELCO) 515 560 Buy 159,234 43.3 61.6 73.5 10.3 7.3 6.1 4.6 4.0 3.4 21.7 23.2 23.2 21.3 23.7 22.5 Wabco India (WABTVS) 3,815 3,700 Hold 7,249 62.0 79.2 137.0 61.6 48.2 27.8 36.4 27.0 16.8 15.6 16.9 23.0 17.7 20.7 27.6 Source: ICICIdirect.com Research `Calendar Year ending *Mahindra CIE Auto financial numbers incorporate merger assumption completed Page 6
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. Sector view: Over weight compared to index Equal weight compared to index Under weight compared to index Index here refers to BSE 500 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 400 093 research@icicidirect.com ANALYST CERTIFICATION We /I, Nishant Vass (MBAFINANCE) Venil Shah MBA research analysts, authors and the names subscribed to this report, hereby certify that all of the views expressed in this research report accurately reflect our personal views about any and all of 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. Analysts aren't registered as research analysts by FINRA and might not be an associated person of the ICICI Securities Inc. 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