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Limited triggers left for further upside

We visited the Andhra Pradesh facility of Apollo Tyres (APTY) and interacted with its management on business outlook and future plans. Following are the key takeaways: 1) Facility with ~350TPD capacity, making TBR and PCR with investment of Rs40bn for phase-1, is built on ~250acres of land and this land can take care of the brownfield expansion till ~1,000TPD; 2) the plant is well automated across stages of mixing, assembly, curing and material handling and requires less than 50% manpower per TPD of output compared to its Chennai plant; 3) it is running at full capacity across PCR/TBR even before a couple of years of it getting operational as profitability is superior here vs APTY India running at ~80% of its overall PCR/TBR capacities; 4) in FY24, APTY is looking for ~10% India business revenue growth vs flattish outlook for EU, with Q4FY23 consolidated margin levels of ~16% set to sustain in the foreseeable future, assuming commodity prices remain unchanged. Consolidated capex is also set to remain at ~Rs10bn, with PCR being the sole segment to see expansion, if needed. We are enhancing FY24E and FY25E EBITDAM by ~50bps each resulting in 6% increase in earnings for both the years and enhancing DCF-based target price to Rs450 (earlier Rs424). We downgrade APTY to ADD from Buy (limited upside post ~30% upmove in the past 6 months), with target price implying 15x FY25E earnings.

Key aspects discussed with the management and our views:

* APTY is focused on attaining ~15% RoCE and reduce debt: Rather than focusing on growth and market share like some of its peers, APTY is focused on achieving ~15% RoCE and reducing debt on its books. We are building in ~15% RoCE with net debt/equity at ~0.1x in our estimates for FY25E. With India operations operating at higher end of EBITDAM at ~15% for FY24-25E along with capex limited to ~Rs10bn p.a., we expect APTY to generate consolidated FCF of Rs22bn on an average in the next couple of years. APTY has been passing on commodity inflation to the replacement market in a disciplined manner in order to focus on margin.

* Industry gross profit/kg already above one standard deviation from long-term mean: Post remaining subdued until H1FY23, gross profit/kg (GP/Kg) for domestic automotive tyre makers jumped up to one standard deviation (SD) level above long- term mean levels. In the past 12 years, this is the third occasion when GP/kg has breached the 1-SD level above the mean and it lasts for a period of 2-3 quarters. We believe a major decline in commodity prices followed by a period of no cut in replacement market prices, may result in a sharp jump in GP/kg and EBITDAM. Thus, we do not expect 15% plus EBITDAM levels to sustain beyond FY24E.

* Limited capex needs on the back of ~80% utilisation in TBRs currently: We expect APTY to announce its next TBR brownfield capex sometime in FY25E, by the time it reaches 90%+ utilisation in capital intensive space. Until then, sub-Rs12bn capex/year would help APTY reach ~15% RoCE amidst steady state India EBITDAM of ~14%.

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