Apollo Tyres' Q2FY19 results (Neutral) - Weak performance; compensation rejig a positive

Q2FY19 results

• Consolidated Adj PAT below estimates: Apollo Tyres reported consolidated Adj PAT at Rs1.9bn (+33% yoy) below consensus expectations. There was an exceptional item of Rs 400 mn on account of provisioning on default of inter corporate deposits of Rs 2bn from IL&FS. Operational performance too was below expectations. The management cut Mr. Neeraj Kanwar’s compensation by ~30%.
• Europe weak; domestic volumes strong: On a consolidated basis, APTY's revenues grew to Rs42.6bn (+22% yoy) with India sales rising 25% yoy driven largely by volumes. Consolidated EBITDA margins came in at 11% (down 130 bps qoq,+50 bps yoy). Revenue growth was below estimates on account of while EBITDA too was below estimates due to weak operating leverage. Standalone: The Indian revenues registered an increase of 25% yoy (to Rs32bn) led by strong volume growth across all segments (Truck and Buses +35%;PVs +17%; 2Ws+ 60%; Farm tyres +17%). EBITDA margins though declined to 12% (-150bp qoq) on account of higher RM basket on crude linked derivatives inflation. Europe: The European revenues grew by 15% yoy to Euro 122m led by strong volume growth and improvement in product mix. Consequently EBITDA margins were at 8% (v/s 9.1% in 1QFY19; 6.2% in 2QFY18). Reifencom revenues were at Eur 27mn (flat revenues yoy) while EBITDA margins were negative on account of seasonal quarter.
• Concall highlights: (a) Management expects RM costs to increase by ~5% in 3QFY18. It has taken a price hike of 2.5% in the TBR segment in 2QFY19 and is expected to take another price hike of 3% in November on all categories to counter increase in RM costs. (b)It expects the current decline in crude prices to start reflecting from 4QFY19 as it carries an average inventory of 3-4 weeks.(c) Total capex over the next 3 years( till FY21) is expected to be Rs65 bn (Rs55bn for India operations). The company spent Rs 5 bn in 1HFY19 in the domestic business.(d)Post default from IL&FS, the company has changed its policy and plans to keep short term funds in liquid assets while long term funds in select banks.

Key positives: Continued domestic volume growth

Key negatives: Higher RM costs; weak European performance

Change in estimates: We cut our FY19/20 estimates by 7%/3% respectively

Valuations & view

While APTY is well placed in the domestic commercial vehicle space where it is gaining market share, However, this is tempered by the fact that FCF will likely remain negative as capex continues to remain high with the company expanding capacities in Europe and India. Also, APTY’s pricing power in the increasingly important European market will be tested. Maintain Neutral with a TP of Rs. 235 (11XFY20E EPS).