Rolling ahead

POUND WISE

A focus on product development, expansion plans and greater international presence make Apollo Tyres a good investment.

Compared to the exhilarating 47 per cent Sensex return in 2006, India's number two tyre maker had quite a tepid sojourn at the bourses as the stock moved up a modest 27 per cent. Financial performance has been mixed too.

In the first half of FY07 while the top line recorded a robust 27 per cent y-o-y growth, operating profit margins have seen considerable erosion. From 9.4 per cent in H1 FY06 margins have fallen to 7.6 per cent in the first half of this year.

While cost pressures proved to be the problems of 2006, the prospects for the company appear positive in the near as also the long term.

"Softening of raw material prices would in my view result in an improvement of 50 basis points in Q3 margins," says Girish Solanki, senior research analyst (mid-cap), Angel Broking.

"And in the longer term a 100 basis points improvement in FY08 looks quite possible," he adds.

Moreover, with a well thought-out blue print for expansion and innovative forays into new products, Apollo looks in line to meet its revenue target of $2 billion by 2010. Overall most analysts concur that within the tyre space, Apollo remains a good investment and many retain a "buy" recommendation on the stock.

Pricing its power
"We expect tyre demand growth of 10-12 per cent over the next five years driven by strong truck and bus replacement demand and rising proportion of radials," says Rishab Bageria, research analyst, Pioneer Research. Apollo Tyres is on a strong wicket in all these growth drivers.

Apollo's overall dependence on the replacement segment at 69 per cent of revenues remains higher than the industry's aggregate, thus enabling considerably more pricing flexibility.

In sales to manufacturers, tyre makers have less bargaining power. Moreover, it remains the leader in the commercial vehicle replacement segment with a 29 per cent market share.

Given that this segment constitutes 46 per cent of the domestic tyre industry's turnover, Apollo stands well placed to take advantage of the robust estimated CAGR in commercial vehicles at 13-15 per cent in the next three years.

A strong distribution backbone comprising 4,000 dealers, has also underlined the company's significant presence in the replacement segment. The nascent tie-up with Tata Motors for exclusively selling Apollo Tyres at Tata Motors service outlets could also yield rich dividends.

There are also indications that Apollo's bargaining position with OEMs has been improving in the past few years. This is most significantly evident in the truck and LCV segment. The price differential between the OEM and replacement markets, which was in the range 15 to 20 per cent two years ago today stands at about 5-7 per cent. 
 

FINANCIALS
Apollo Tyres	FY06	FY07E	FY08E
Sales	25783.00	34829.50	39680.50
Operating profit	2215.00	3505.00	4210.00
EPS	18.80	20.95	28.30
P/E	18.40	16.43	12.20
Source :Bloomberg

In fact, with capacity utilisation edging past 90 per cent for the company, the pricing power shows all indications of improving in the near term.

The radial drive
Apollo, the third largest player in the passenger car radial replacement market, is planning an ambitious foray in the truck and bus radial segment.

As a first step, it is setting up a pilot project in Gujarat, for 10,000 truck and bus radial tyres per month capacity. It is also setting up a greenfield plant in Tamil Nadu for exclusive radial capacities across segments.

This project, with a first phase investment of Rs 300 crore over three years, is expected to be operational by 2008 and could reflect significantly in revenues from FY09. Analysts estimate that radial tyres will account for 10 per cent by 2010 from the current 2 per cent in trucks and buses.

Given that radial tyres command a premium of 10 to 15 per cent over bias tyres, this focus should stand Apollo in good stead. Apollo is also planning an aggressive expansion in its car radial capacity this year. By March 2007 its capacity will increase from 7,000 to 10,000 tyres per day.

Overseas forays
Strong benefits would also accrue from Dunlop International, South Africa, which it acquired in April 2006. The company is in the process of a debt restructuring to reduce the cost of debt from 11 per cent to 9.5 per cent.

"Besides technological synergies, the access to Dunlop's global distribution network would be a key upside for the company," comments an analyst tracking the sector. With two plants in South Africa and one in Zimbabwe, the company would automatically become a major player in both these countries.

Moreover, an access to Dunlop's European distribution channel will provide export leverage. In exports, where it has been the largest exporter of car radials, could also contribute more to revenues. Analysts expect exports to increase from 9 per cent of sales in FY06 to around 15 per cent by FY09.

The company's product development strategies also seem to be synergised with a view on overseas markets.

As Sunam Sarkar, chief-corporate strategy and marketing, Apollo Tyres, puts it, "We see this trend (exports in car radials) continuing with a focus on the European market. Towards this end, we have recently launched two ultra-high performance products--the V-rated Apollo Acelere Sportz and the W-rated Aspire."

The cost rub
By all accounts 2006 was a rough year on the costs side. Natural rubber prices, which comprise nearly 45 per cent of revenues, increased by nearly 33 per cent y-o-y. But the outlook for rubber remains positive at least for the near term.

"We would expect rubber prices to stabilise around the Rs 85-90 per kg levels in the next six months," says Bageria.

Moreover, the increasing focus on radials could also reap rich dividends. This is because the proportion of natural rubber costs to net sales would come down to as low as 25 to 30 per cent in radial tyres.

Some other vital raw material components like SBR and carbon black, as well as synthetic rubber, a key element in radial costs are linked to Crude prices. Crude prices, which ended 2006 about 20 per cent below the peak level in mid-August of $78 per barrel, are now down to $55.

Building stamina
Apollo's forays into the retreading segment with a focus on the cold process segment could stand it in good stead especially as it could draw from the experience of Dunlop, South Africa. The company is also looking at strengthening its overseas distribution network.

As Apollo's Sarkar says, "We are in the process of building a robust dealer-distribution network internationally to enable our products to reach customers more efficiently."

With an impressive product line-up, global synergies and focus on radials, Apollo Tyres remains a good investment bet.