Higher competition, falling demand could squeeze margins of Apollo tyres

The company's stock jumped 3% on Friday after CLSA Mauritius hiked its stake in the company to 5%

Apollo Tyres stock jumped 3% on Friday after CLSA Mauritius hiked its stake in the company to 5%. CLSA’s stake increase in the company follows the go ahead by RBI on February 14 to Apollo Tyres to increase its FII limit under the portfolio investment scheme to 40%. The company’s Indian operations, which account for over 60% of consolidated revenues, have been under pressure given the slowdown in auto space especially the commercial vehicle space which accounts for two thirds of its revenues.

FY13 year-to-date, while car sales are down 1.3%, the commercial vehicle space has seen a steep fall of 21%. Apollo management in a recent concall too has indicated that sales to manufacturers had declined by 40% y-o-y and it was the replacement segment which was supporting overall growth.  In addition to demand woes, increasing competition from MNC majors could lead to pricing pressures for the tyre maker.

Given the muted demand environment, the stock is trading at cheap valuations. At the current price (market sell off over the last couple of sessions has  seen the stock shed 4.5% to close at Rs 85 on Tuesday), it is available at 7 times its FY13 earnings per share estimates while the same for FY14 is 6 times.

Margin respite shortlived?

While revenue growth for the December quarter was flat due to falling demand , margins were boosted by lower raw material prices.  However, analysts say that this could be short lived given higher competition. Say Jatin Chawla and Akshay Saxena of Credit Suisse in a recent report. “A continued weak demand scenario along with extra competition (Bridgestone and Michelin starting their India plants) may force pricing indiscipline, which combined with declining capacity utilisations, can put further pressure on margins.” The research firm believes that margins in FY14 are likely to fall by 67 bps over the current fiscal. While there have been no pricing cuts in recent months, the management despite increasing competition believes that there will not be any undercutting in the current environment.

Fund raising, expansion overhang

On the back of falling rubber prices and reasonable valuations, the stock over the last one year has outperformed the BSE Auto as well as the broader Sensex. On the back of an expected recovery in auto sales in FY14, Apollo’s diversified revenue pie and higher capacity utilization most analysts have a target price in the range of Rs 95-Rs 100. What is pegging back the stock in the short term is muted demand environment and a lack of clarity on the company fund raising (delay due to unfavourable market conditions) and expansion activities. Say Emkay Global analysts, "Plan for fund raising is likely to remain an overhang for the stock given lack in clarity on the quantum, timelines and exact usage of funds."