Any slowdown in truck-tyre volumes to be compensated by high-margin car tyre sales
We have tweaked our PAT estimates led by lower tax rate (29% versus 33% earlier). Our new estimate of PAT in FY2013e and FY2014e is R5.4 billion and R6.5 bn, versus R5.2 bn and R6.2 bn earlier, respectively. We maintain Buy with a target price of R95 (at 8.5x one-year forward EPS).
Some investors have expressed concerns on increasing radialisation in truck tyres. The concerns are radial tyres last 1.7 times longer versus bias tyres which would mean subdued volume growth in future. Further, radialisation (truck/bus) in OE is much higher at 50% versus replacement market at 15%. Hence, margins could be under pressure as OE (original equipment) margins are lower and opens up market to foreign competition (Michelin etc.) which was earlier excluded due to different product specification.
We chose to differ as Ebitda per kg for Apollo tyres increased from R10 (three-year average in FY04-06) to R20 (average in FY10-12) despite radialisation (truck/bus) increasing from 3% in FY2005 to 21% in FY2012.
Needless to say, even as margins are lower in radial tyres (higher OE mix), the impact of improving product mix (in favour of non-truck tyres) has been overpowering. In our view, the industry is already past the point of worst product mix (OE:replacement) in truck/bus radials. Mix should improve from here, and as increasing radialisation leads to an adverse product mix (in radials only), it also leads to a favourable product mix in bias tyres as OE revenues decline as a proportion of sales, thereby cushioning margins impact of adverse mix in radial tyres.
Our calculations show that product mix will only improve from here. Further, the replacement/OE mix should start improving from year-2 onwards. Indian truck/bus radial market has already gone past the point of worst mix. Also, as OE ratio in radial (truck/bus) tyres increases, it decreases in bias tyres and hence, volume mix for bias tyres improves, lending a cushion to margins in the business.
We agree that increasing radialisation could slow down volume growth. In our view, it will have a positive impact as the mix would improve in favour of non-truck tyres which are more profitable. Truck/bus tyre is the least profitable business for the industry in which it hardly recovers its cost of capital. Hence, slowing truck tyre volumes are not that bad.
Radialisation in light truck tyres increased from 11% in FY2005 to 25% in FY2012. The impact of improving volume mix in favour of non-truck tyres has been overpowering and despite margin pressure in radial tyres (on account of high proportion of OE sales initially), margin (Ebitda per kg) has trended higher.