Apollo Tyres - Top-line disappoints, margin surprises - Ambit

Results overview: Apollo Tyres' 3QFY13 results were a mixed bag. Consolidated revenue was lower than our expectations by 7% largely due to standalone revenues falling short of our expectations by 10%. The raw material cost as a percentage of net sales for the quarter declined by 368bps QoQ (against of our expectation of 30bps decline), resulting in a gross margin surprise of 338bps. However, the benefit of lower-than-expected raw material costs was offset to a significant extent by higher-than-expected 'other expenses' (which were 208bps ahead of our expectations) and employee expenses (which were 60bps ahead of our expectations). EBITDA margin was 70bps ahead of our expectations. Absolute EBITDA fell short of our expectations by only 1%. 'Other income' was nearly 5x our expectations due to one-off items such as proceeds from insurance claims and forex gains. As a result, PBT and PAT was ahead of our expectations by 6% and 12%, respectively.

Key takeaways from the conference call:

a) Indian business: Standalone revenue declined by 3% YoY driven mainly by decline in volumes. Whilst the truck-bus OEM segment's revenue declined by 40% YoY, the truck-bus replacement segment saw double-digit growth. The capacity utilisation was around 75% for the quarter (including the Chennai radial tyre facility). Gross margin improved by 364bps QoQ as against our expectation of a 166bps QoQ improvement. However, 'other expenses' increased by 12% QoQ (275bps as a percentage of sales) and were 220bps ahead of our expectations. Thus, EBITDA margin fell short of our expectations by 54bps. The spike in 'other expenses' was mainly led by the corporate campaign launched by the company.

In the near term, the company would continue to record a revenue slowdown in the OEM segment (though QoQ OEM volumes should improve due to seasonal factors). The replacement segment continues to perform better than the OEM segment by recording positive growth. The company expects rubber prices to remain stable or decline. The company does not plan to undertake any price correction in the replacement tyre market at present. The corporate campaign is likely to sustain for some time though the intensity may vary depending upon the market conditions.

b) Vredestein: Vredestein's revenue for the quarter was flat YoY (in Euro terms, revenue was down 2% YoY, implying currency translation gains of 2% YoY in INR terms). Demand in Europe remains challenging, which led to an overall 13% YoY decline in volumes at the industry level and a ~18% YoY decline in winter tyre volumes. Winter tyre sales were affected by the late onset of winter and by dealers carrying inventory from previous periods. Vredestein operated at 80% capacity utilisation during the quarter. EBIT margin for Vredestein at 17.2% expanded 147bps YoY and 300bps QoQ due to the softening in raw material prices as well as a favourable product mix (winter tyres).

c) South Africa business: The South African operations continue to face the challenges of low capacity utilisation emanating from slow economic growth, high Chinese imports, and labour issues. Revenues expanded by 6% YoY and 4% QoQ. The margin performance was better QoQ, with EBIT margin of 1.2%, an improvement of nearly 900bps YoY and 225bps QoQ.

Capex plans: The company is planning has two major capex plans in the next 2-3 years: (i) expansion of capacity at Vredestein by 20% from around 6mn tyres annually to around 7mn tyres annually. The capex is likely to start from FY14 and is likely to be complete by FY15. The capex is not likely to exceed 50mn Euros; and (ii) setting up of a Greenfield facility in the ASEAN region. The company is in the process of land acquisition for this project, after which environmental, regulatory and other clearances will need to be obtained. Construction is likely to commence from 2HCY13. The capex for this project has not yet been finalised.

e) Financing: The company had a net debt of Rs27bn as at end-December 2012 vs Rs29.5bn as at end-September 2012 and Rs30bn as at end-December 2011. The reduction in the debt level is due to the reduction in working capital. The management has not made any firm decision with respect to the timing of the Qualified Institutional Placement (QIP); the QIP is not likely at least until the announcement of the annual results for FY13. The company has made a preferential allotment of 5mn warrants (1% of the O/S shares) at a conversion price of Rs86.20 during the quarter and received 25% of the price as upfront payment.

Where do we go from here?

Whilst Apollo Tyres' revenue for the quarter was below our expectations, higherthan-expected margin performance made up for the revenue shortfall at the absolute EBITDA level. With rubber prices remaining benign (domestic natural rubber price has averaged Rs161/kg so far in 4QFY13 vs Rs173/kg in 3QFY13), we expect margins to continue benefiting from the moderation in raw material prices. We do not expect any significant changes to our FY13 EBITDA and net earnings estimates (some downgrades at the revenue level should be offset by upgrade to margin estimate). In FY14, we expect volume growth of 6% YoY and EBITDA margin of 10.2% at the standalone level (vs 10.1% in 3QFY13). We expect revenue growth of 5% YoY and EBITDA margin of 16.0% for Vredestein. We do not envisage any significant changes to our FY14 earnings estimates. The stock is currently trading at 6.6x FY14 net earnings. We retain our BUY stance on the stock.

Source : Equity Bulls

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