MORNING INSIGHT

March 20, 2012

INITIATING COVERAGE
Arun Agarwal arun.agarwal@kotak.com +91 22 6621 6143

APOLLO TYRES (APTY)

PRICE : RS.80 TARGET PRICE : RS.92 RECOMMENDATION : ACCUMULATE FY13E P/E: 7.2X

Sharp increase in rubber prices coupled with slowing demand has kept APTY's earnings under pressure in FY11 and 1HFY12. However rubber prices have corrected from its highs and have remained relatively stable in the recent months. Going ahead; expected pick-up in economic activity will lead to steady improvement in tyre demand. After two consecutive years of earnings de-growth, we expect APTY's net profit to grow by 50% in FY13. We expect the company to turn FCF positive from FY13 and use the cash to reduce its debt which in our view has peaked out for the near to medium term. On the back of stable natural rubber prices, positive outlook on APTY's earnings and improving balance sheet, we initiate coverage on the stock with a ACCUMULATE rating and a price target of Rs.92. Despite various positive triggers, we rate the stock as ACCUMULATE due to recent run-up in the stock price.
Stock details
BSE code NSE code Market cap (Rs mn) Free float (%) 52 wk Hi/Lo (Rs) Avg daily volume (mn nos) Shares (o/s) (mn) : 500,877 : APOLLOTYRE : 40,328 : 54 : 87/51 : 32 : 504

Key Investment Rationale

q Capacity in place for the next round of growth. Over the past couple of years, the company has been investing towards enhancing capacities in order to cater to the next wave of demand. APTY's new greenfield plant in Chennai is expected to get fully completed in FY13, even though production has already started since 4QFY10. With full production levels at the Chennai plant, the company's standalone capacity will increase from around 850MTPD in FY10 to around ~1400MTPD in FY13. Even though the current demand scenario is slightly slack, we expect the same to gather pace with expected improvement in the domestic economy. We believe the capacity after the completion of Chennai plant to be sufficient enough to take care of the domestic demand for the next 2-3 years. q Operating margins to improve going ahead. EBITDA margin of tyre manufacturers has been under pressure over the past few quarters led by steep jump in input cost. APTY's margin declined from 14.5% in FY10 to 11% in FY11. Margins continued to remain under pressure in FY12 with 2QFY12 margins standing at 8%. We believe the company's margins have bottomed out and expect recovery going forward. Correction in natural rubber prices, full impact of price hikes, improved capacity utilization of the Chennai plant and expected improved performance from the South African operations are positive triggers for the margins, going forward. While there are adequate levers present to propel the company's EBITDA margins in FY13, we have been a bit conservative in our assumptions. We expect the company's EBITDA margin in FY12 and FY13 at 9.2% and 10.0% respectively. q Current investment cycle over, debt to start coming down going forward. Over the past couple of years (FY10 and FY11), APTY invested Rs46bn towards capex that included capacity enhancement at various location and investment in its greenfield capacity at Chennai. With the current round of investment cycle expected to come to an end by FY12, we expect debt levels to stabilize and come down gradually for APTY. Reduction in debt levels will reduce the interest burden that is on a rise over the past few years. With majority of the capex getting over in FY12, we expect the company's free cash flow to turn positive in FY13. Further the company has not chalked out any major capex for FY13 and we expect the company to use this cash to lower its debt levels.

Summary table
(Rs mn) FY11 FY12E FY13E

Sales 88,677 120,782 135,981 Growth (%) 9 36 13 EBITDA 9,780 11,126 13,595 EBITDA margin (%) 11.0 9.2 10.0 PBT 5,471 5,153 7,751 Net profit 4,402 3,754 5,638 Reported EPS (Rs) 8.7 7.4 11.2 Growth (%) (32.6) (14.7) 50.2 CEPS (Rs) 14.1 13.8 18.3 Book value (Rs/share) 48 55 65 Dividend / share (Rs) 0.5 0.5 0.5 ROE (%) 20.1 15.3 18.6 ROCE (%) 15.7 14.1 17.5 Net cash (debt) (22,856) (23,890) (18,596) NW Capital (Days) 30.8 31.1 30.5 P/E (x) 9.2 10.7 7.2 P/BV (x) 1.7 1.5 1.2 EV/Sales (x) 0.7 0.5 0.4 EV/EBITDA (x) 6.5 5.8 4.3 Source: Company, Kotak Securities - Private Client Research

Kotak Securities - Private Client Research

Please see the disclaimer on the last page

For Private Circulation

MORNING INSIGHT

March 20, 2012

q De-risked business model and strong brands are APTY's key strengths. APTY operations are spread across three different geographies and have presence in most of the product segments within the tyre industry. Such a spread out revenue model provides cushion to the revenues and profits of the company during difficult times. APTY has created strong brands in each of its operational zones. For APTY, 'Apollo', 'Dunlop' and 'Vredestein' are the key brands in Indian, South African and European markets respectively. Company's other brands line Regal, Kaizen and Maloya support their more established counterparts. APTY sells its product through a strong distribution network across all the three geographies.

Valuation
q At the CMP of Rs.80, the stock trades at a PE of 10.7x and 7.2x its estimated FY12 and FY13 earnings respectively. On EV/EBITDA, the stock trades at 5.8x and 4.3x its FY12 and FY13 estimates respectively. After going through a difficult phase in the past 2 years, we expect macro situation for the tyre industry to improve. At the company level, both margin improvement and debt reduction will be positive for APTY in FY13. We initiate coverage on the stock with a ACCUMULATE rating and a price target of Rs.92. We value the stock at its historical average one year forward PE multiple of 8.2x.

We initiate coverage with ACCUMULATE recommendation on Apollo Tyres with a price target of Rs.92

Kotak Securities - Private Client Research

Please see the disclaimer on the last page

For Private Circulation