High valuation and margin concern may limit rally in Apollo Tyres

Healthy volume outlook, focus on debt reduction are key positives, say analysts

Shares of Apollo Tyres, India’s largest commercial vehicle (CV) tyre maker, jumped 12 per cent intra-day on Thursday after the company reported record quarterly revenue for Q3FY21.

Consistent demand momentum aided by the strong replacement market, recovery in the original equipment manufacturer (OEM) market, debt reduction, and market share gains were key triggers for the stock. 

Sales rose 17 per cent year-on-year (YoY) to Rs 5,154 crore, and came higher than the consensus estimate of Rs 4,743 crore. This was led by a healthy double-digit growth in volumes across all markets (OEM and replacement).

This helped Apollo Tyres increase its market share by 400 basis points (bps) in passenger car radial (PCR) tyres and by 300 bps in the truck and bus replacement segment. 

Net profit at Rs 449 crore was up sharply from Rs 174 crore a year ago, and ahead of estimates of Rs 200 crore.

With the CV cycle set for a reversal after two and a half years of downturn, analysts forecast sustainable volume growth, going forward. “We maintain our positive view thanks to the uptick in OEM volumes and continued replacement market growth. Further, restriction on import of PCR tyres is likely to lead to sustained recovery in operating profit,” said Abhishek Jain, research analyst, Dolat Capital. 

Apollo Tyres is also focused on expanding its distribution network. It has successfully added 450 new dealer touchpoints and had quadrupled its retail outlet reach from 1,350 at the start of FY21 to 5,330 as of December-end. 

With the capex cycle largely over, focus has shifted to reducing debt. So far this year, Apollo Tyres has generated free cash flows of Rs 1,200 crore, which helped reduce consolidated net debt to Rs 3,800 crore in Q3 from Rs 6,000 crore in March 2020; net debt-to-Ebitda ratio halved from 3.2x to 1.6x year-to-date. Restructuring of its European business is also a positive, say analysts.

Sustainability of margins, however, remains a key area of concern. Operating margins in Q3 expanded by 700 bps to over 19 per cent. With raw material prices increasing, some moderation is likely. 

“The raw material cost basket is expected to sharply increase by 7-9 per cent during Q4FY21, owing to increasing natural rubber and crude derivatives prices. At the end of December 2020, the firm undertook a price hike of 2-3 per cent to offset commodity cost inflation. Further price hikes are required to offset input cost increase,” Jain added.

While the outlook remains healthy, at 21x its FY22 estimated earnings, the stock is trading at a premium of nearly 70 per cent to its 5-year average of 12.3x. It is also quoting 20 per cent above consensus target price of analysts. 

Investors are, therefore, advised to await a healthy correction before accumulating on dips.