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Apollo Tyres: Is topline the issue? - Views on News from Equitymaster
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Apollo Tyres: Is topline the issue?
Jul 6, 2005

Apollo Tyres announced its results for FY05 and 4QFY05 last month. For the full year, though the topline grew by 17% YoY, the bottomline saw a fall of 4% YoY. This dismal performance was primarily due to drastic rise in raw material cost and also on account of higher depreciation charge. Had it not been a fall in the effective tax rate, the earnings would have fallen at much faster clip. For FY05, the topline grew by 22% YoY and the bottomline, aided some fall in the rubber prices, managed to grow by 7% YoY.

What is company’s business?
Apollo Tyres is one of India’s leading manufacturers of tyres with presence in the commercial vehicle OEM segment (as a supplier to Telco and the like). It has market leadership in the truck tyre replacement segment. The company also supplies to car and tractor OEM majors (original equipment manufacturers). It has entered into a JV with Michelin, the world’s largest tyre maker, for manufacturing of truck and bus radial tyres.

Performance snapshot
Rs m) 4QFY04 4QFY05 Change FY04 FY05 Change
Net sales 5,182 6,351 22.6% 19,108 22,255 16.5%
Expenditure 4,785 5,943 24.2% 17,492 20,607 17.8%
Operating profit (EBDITA) 397 408 2.8% 1,616 1,648 2.0%
Operating profit margin (%) 7.7% 6.4%   8.5% 7.4%  
Other income 40 19 -52.5% 60 198 230.2%
Interest 37 103 179.2% 186 429 130.9%
Depreciation 122 146 19.8% 437 568 30.0%
Profit before tax 278 178 -36.2% 1,053 849 -19.4%
Tax 90 (24) -127.0% 348 173 -50.3%
Profit after tax/(loss) 188 202 7.3% 705 676 -4.1%
Net profit margin (%) 3.6% 3.2%   3.7% 3.0%  
No. of shares (m) 38.3 38.3   38.3 38.3  
Diluted earnings per share (Rs)* 19.6 21.1   18.4 17.7  
P/E (x)         13.8  
(* annualised)            

What has driven the performance for FY05?
Topline growth traces the auto sector:  The performance of the company, as an ancillary supplier, hinges on automobile demand. In FY05, commercial vehicles and car demand grew by 30% and 17% respectively. Apart from this, motorcycle demand grew by 20%. The company’s performance has to be viewed in this perspective. Infact, the company appears to have under performed the auto sector growth having regards to its strong presence in the commercial vehicles segment and the price increases made during the year.

We believe that going forward, demand for tyres is likely to be influenced by the passenger cars and motorcycle segments. The CV segment is expected to grow at 7% to 8% in next two to three years. This should augur well, as the company is aiming to strengthen its position in two-wheeler segment (currently its presence is comparatively weaker in this segment) and also trying to increase its share of pie in the passenger car segment. Apart from this, Apollo Tyres is the leader in the replacement market. Given the sharp rise in demand for automobiles in the last three years, we believe that replacement demand is likely to be strong going forward (replacement is generally with a lag of two to three years).

Cost breakup
Rs m) 4QFY04 4QFY05 Change FY04 FY05 Change
Raw materials 3,230 3,897 20.6% 11,553 14,254 23.4%
% sales 62.3% 61.4%   60.5% 64.0%  
Staff cost 337 343 1.8% 1,375 1,434 4.3%
% sales 6.5% 5.4%   7.2% 6.4%  
Other expenses 1,219 1,280 5.0% 4,564 4,745 4.0%
% sales 23.5% 20.1%   23.9% 21.3%  

Raw material blues continue:  The company’s problems on the raw material front is evident from the fact that the input cost has increased by 450 basis points in FY05 as compared to last year. The company had to face brunt on two accounts. Rise in rubber prices is the first factor (rubber accounts for around 45% of the operating cost). Secondly, rising exports of rubber from India had led to supply issues. Apart from rubber, firmness in steel and carbon black prices also have exercised upward pressure on raw material costs.

The impact of rising raw material has completely over shadowed the company’s efforts to control its costs, as is reflected by lower other expenses and staff cost as a percentage of sales.

The views on rubber prices remain mixed. The World Bank expects rubber prices to soften by around 10% to 15% going forward. However, Michelin, one of the largest tyre manufacturers in the world, has an upward bias on rubber prices owing to supply constraints in the international markets, notably South East Asia (in its latest annual report). But if rubber prices were to soften, it will be beneficial for Apollo Tyres. Even if rubber prices do not soften, we expect some solace from lower steel and carbon black prices in the next two to three years for the company.

Other income saves the day:  Though the company has been burdened by 131% increase in tax outgo coupled with an increase in depreciation charge, a 230% increase in other income coupled with a 50% fall in tax outgo enabled the company to contain the adverse impact.

What to expect?
At Rs 243, the stock is trading at a price to earnings multiple of 13.8 times FY05 earnings. Given the company’s strong presence in the replacement market and its new joint venture with Michelin, we do not foresee volume growth as a big issue. Apart from this, in the next two to three years, we feel that the demand for radial tyres will increase with improving road infrastructure (thereby no need of extra load tyres) and the government’s initiative to control overloading. However, the pressure on the raw material side, on an overall basis, is unlikely to recede. Secondly, as India moves towards WTO norms, import duty is likely to fall, which would reduce the competitiveness of Indian manufacturers. To conclude, investors should have a positive outlook on the volumes front. But this is likely to be partly negated by lower margins.

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