Apollo Tyres - Acquisition benefits likely back-ended - Standard Chartered Securities

OUTPERFORM, APTY IN, CMP INR 63, Price Target INR 76

- Apollo Tyres is acquiring Cooper Tire (an entity 2x its size) for USD 2.5bn, valuing it at 4.4x trailing 12m EV/EBITDA.

- Post the announcement, the stock fell a sharp 34% on concerns over leverage and expensive acquisition value.

- IER believes Cooper Tire is a strategic fit for Apollo given a complementary mix, in terms of products and geography.

- IER believes risk-reward now appears favourable post the recent correction. It maintains Outperform, but lowered its price target to INR 76 – valuing it at 5x FY15E EPS.

- The stock is likely to remain range bound in the near term as returns are likely to be back-ended (post integration).

Apollo Tyres, the seventh-largest global player. Apollo's Cooper Tire acquisition will make it the seventh-largest tyre manufacturer in the world, in line with management's stated objective to become a top 10 global player.

Synergies in place. IER believes the acquisition is a strategic fit. The combined entity will have a well-diversified mix, in terms of product and geography. It could cross-sell brands by leveraging existing distribution networks. Furthermore, it will benefit from joint sourcing. Bain Capital estimates synergistic benefits worth USD 80-100mn over three years, which could be conservative.

High leverage a key concern. Apollo funded the entire USD 2.5bn acquisition through debt. The result: 3.8x net debt /EBITDA with even standalone D/E rising to 2x. Such high leverage for a cyclical business has not gone down well with investors – the stock fell sharply by 34% in just five days.

Scenario analysis. To highlight the risks driven by higher leverage, IER conducted a scenario analysis (including Cooper estimates). It reveals a price target range of INR 34-172, with IER base case PT at INR 87.

Risk-reward looks favourable. IER have not factored in Cooper in its estimates as the deal has yet to be concluded. Post the recent correction, the stock is attractively valued at 4.2x FY15E EPS and 2.8x FY15E EV/EBITDA. IER values Apollo at 5x one-year-forward earnings (40% discount to historical average of 8x) given higher risk. Its target multiple is also the average of its bear cycle valuation. Its revised PT of INR 76 (from INR 102) implies potential 19% upside. The stock is likely to remain range bound in the near term as returns are likely to be back-ended (post integration of Cooper).

Source : Equity Bulls

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