Lower input prices point to more gains for Apollo Tyres

Decline in rubber prices, cheap valuation are positives; demand still a concern

An intra-day gain of about three per cent was wiped off, with the Apollo Tyres stock closing 0.35 per cent lower on the BSE on Wednesday. Though analysts had expected pressure on sales due to weak demand in India and Europe, sales in the quarter ended December were significantly lower than estimates (eight to nine per cent growth). The company benefited from lower raw material costs. Therefore, margins improved. The trend is likely to continue, as the quarter ending March would see the company reaping the full benefits of low rubber prices.

Though demand-side pressures remain, with a reasonable valuation of 5.5 times the FY14 estimated earnings, analysts believe downside risks are limited for the stock (at Rs 85). However, the upside is also likely to remain capped until the business environment improves and clarity emerges on the company's equity dilution plans.

India revenue disappoints
Consolidated sales growth fell 0.33 per cent, as the company's India business reported a decline of 2.7 per cent in revenues, owing to a three per cent year-on-year fall in overall volumes, thanks to weakness in the truck original equipment manufacturers segment. European operations saw a marginal decline of 0.5 per cent in revenue, against the modest growth expected, owing to delay in the onset of winter there. South African operations, too, disappointed, with sales rising just 5.9 per cent, compared with a jump of 35 per cent in the first half of the financial year. Though analysts had expected pressure on revenue growth, the actual fall came as a surprise. Yaresh Kothari, analyst at Angel Broking, says, “Top line is below estimates across all geographies, due to low demand.”

However, a decline in raw material prices (natural rubber) rescued margins, which saw significant improvement, bettering analyst estimates. Consolidated operating profit margin improved 183 basis points to 11.9 per cent, thanks to a 381-basis point drop in raw material costs, as percentage to sales. Natural rubber prices (average) fell about 15 per cent year-on-year in the December quarter and 30 per cent from the peak level of Rs 242 in April 2011. The net profit margin also jumped 168 basis points to 5.6 per cent. The quarter saw a huge surge in other income at Rs 27 crore, compared with -Rs 2.4 crore (possibly due to foreign exchange losses) in the corresponding quarter of the previous year. Higher growth in other income further boosted the net profit.

While the India business disappointed on the revenue growth front, despite the ramp-up of the newly-commissioned Chennai plant, this business drove the improvement in profitability, as standalone operating profit and net profit jumped 21 per cent and 73 per cent year-on-year, respectively. Further gains were recorded in foreign operations. These operations also saw better margins, with South Africa reporting profit (against a loss in the year-ago period) and Europe reporting better profitability.

Outlook subdued
In early December, natural rubber prices touched a two-year low of Rs 161 a kg. Therefore, the current quarter would see the full benefit of this. Margins are expected to improve, despite the rupee's depreciation, analysts say. Production is generally higher in the second half of a financial year and, therefore, rubber prices could fall further. Also, low global demand would affect rubber prices. While continued improvement in profitability is a positive, this is unlikely to lead to an upside in the stock, which has underperformed the Sensex in the last three months, amid worries of revenue growth and possible equity dilution.

Replacement demand in the domestic market is not very impressive and would take time to pick up. Europe continues to face macroeconomic challenges and revenue from South Africa faces risks of Chinese imports, competition and slowdown in growth. The company had said it planned to raise capital in the September quarter through a $150-million qualified institutional placement. It had also announced it would issue $27.5 million of convertible warrants to promoters to cut debt. Setting up capacities and inorganic growth opportunities were also on the cards. Though the equity dilution plan has been postponed, the timing has not been decided yet. Analysts say the stock valuation is cheap. They see limited downside from current levels. Ashwin Patil, analyst at LKP Securities, sees positives for the stock. He feels replacement demand would pick up, margins would improve and the capex outlay would slow. He also forecasts delayed or no capital-raising, leading to an improvement in net debt-equity ratio and a fall in interest costs.