Apollo Tires Rating: Buy- Company is ready for the next stage of growth

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APTY’s management team presented its roadmap for the future, revenue growth strategy and capital expenditure during its Corporate Day CY22. It plans to maintain financial discipline by controlling investments and working capital with the aim of improving yield ratios and controlling debt. As it attempts to achieve price leadership in the Indian market, exports have emerged as an additional avenue to deploy capacity. Finally, management is very clear that it would not bundle large growth investments in order to avoid an impact on cash flow.

Target RoCE of 12-15% by FY26 (v/s 5.5% in FY22)
Much of the targeted improvement must come from India, driven by reviving demand, recovering margins and full capacity utilization. Much of its UKTN greenfield capacity was commissioned in FY22 and did not contribute to FY22 P&L. Operations in Europe will contribute via increased capacity utilization and improved mix, as margins are at reasonable levels (excluding the transitory impact of RM prices).

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No immediate growth investment
APTY currently only allocates capital expenditure to the completion of UKTN capacity, debottlenecking and maintenance activities. Debottlenecking can improve its current capacity by 5-8%. Its annual maintenance investments including sustainability and digitization initiatives are said to be Rs 4 billion/30-35 million in India/EU. The growth capex strategy would avoid the aggregation of large capex to ensure constant free cash flow to the business. Capacity utilization in India is 80% (lower in TBR, but higher in PCR; this only includes part of the UKTN capacity) and around 80% in the EU.

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Lead industry price increases to pass on RM cost inflation
RM’s cost inflation, which was considered transitory, turned into structural pressures due to exogenous factors. However, it is currently witnessing a spike in commodity prices, including crude prices. APTY has been at the forefront of price increases, both in quantity and frequency, during the current cycle of commodity inflation. Starting in December 2020, it increased prices by 3% every 45 days (compared to 2% quarterly earlier). It boosted domestic prices by 3-4% in Q1FY23 and double digits in the EU. He indicated another price hike in the EU soon. Based on current RM prices, he expects margin pressures to hold in Q1FY23 and be a bit higher qoq in Q2FY23.

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Estimate and view
APTY is ready for the next phase of growth, with enough capacity to meet demand from India and Europe. With capital expenditures for Phase II of the UKTN Plant ending in FY23, increased capacity utilization will generate higher cash flow and further reduce its balance sheet. Compared to its peers, APTY offers the best mix of earnings growth and cheap valuations. The stock is trading at 13.6x/8.7x consolidated EPS FY23E/FY24E. We value the stock at 12x EPS June 24th (v/s five/10 year average P/E multiple of around 16x/12x). We maintain our buy rating with a TP of Rs 265/share.

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