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Targets 12-15% in RoCE by FY26 through asset sweating

Lays down a prudent capex roadmap with eye on debt

APTY’s senior management team showcased (click here for the presentation) its roadmap for the future, revenue growth strategy, and capex at their Corporate Day CY22. It plans to maintain financial discipline by controlling capex and working capital with aim to improve return ratios and control debt. While it is trying to attain price leadership in the Indian market, exports has emerged as additional avenue to deploy capacity. Lastly, the management is very clear that it wouldn’t bunch large growth capex in order to avoid impact on cashflows.

Targets a RoCE of 12-15% by FY26 (v/s 5.5% in FY22)

* A large part of the targeted improvement needs to accrue from India, led by demand revival, margin recovery and full utilization of capacity. A large part of its greenfield AP capacity was being commissioned in FY22 and didn’t contribute to P&L in FY22.

* Europe operations will contribute via an increase in capacity utilization and mix improvement, as margins are at reasonable levels (except for transitory impact of RM prices).

* Unlike in the past, it now with three channels to sweat its assets (OEM, replacement, and exports).

No immediate growth capex; future capex to be considerate of FCFF

* APTY has currently assigned capex only for completion of AP capacity, debottlenecking and maintenance activities. Considering uncertain macro environment, it is not planning any growth capex. Debottlenecking can enhance its current capacity by 5-8%. Its annual maintenance capex, including sustainability and digitalization initiatives, would be at INR4b/EUR30-35m in India/EU.

* Growth capex strategy would avoid bunching of large capex to ensure consistent free cash flow to the firm. The first expansion may be required in PCR, but not in the foreseeable future.

* Capacity utilization in India stands at 80% (lower in TBR, but higher in PCR; this includes only part of the AP capacity) and at mid-80% in the EU.  Light truck steel radials (1,700 tyre/day) at its Chennai plant have been near full utilization over the last few months . It can debottleneck capacity to meet growth for next 1.5 years.

Leading the price hikes in the industry to pass on RM cost inflation

* RM cost inflation, which was seen as transitory, has turned into structural pressures due to exogenous factors. However, it is now seeing a peaking of commodity prices including crude prices.

* Price leadership in the Indian market: APTY has been the front-runner in raising prices, in terms of both quantum and frequency, during the current commodity inflation cycle. From Dec’20 onwards, it raised prices by 3% every 45 days (v/s 2% every quarter earlier). It is now raising prices by 4%.

* Recent price hikes: It raised domestic prices by 3-4% in 1QFY23 and by doubledigits in the EU. It indicated another price hike in the EU soon.

* Margin pressure: Based on current RM prices, it expects margin pressures to remain in 1QFY23 and a tad higher QoQ in 2QFY23.

India demand to remain modest in the near term; strong EU recovery

* India demand has seen a modest recovery, driven by OEMs. Replacement demand is holding up. While all macro parameters are pointing towards a modest recovery from 4QFY22 onwards, the management is bullish on the longterm India growth story.

* Bus tyres, in a normal scenario, account for 15% of CV tyres. Demand had crashed in the last two years, but is now returning back.

* Europe demand has seen a strong recovery after two-to-three years as PCR grew 15%, TBR clocked double-digit growth, and OHT grew 3%. APTY’s market share in PCR has been stabilizing, while gaining market share in UHP tyres. In all season tyres, its biggest market was traditionally Germany (10-12m p.a), but France and Italy are now growing. The current order wallet is the highest ever for winter tyre during this season.

Exports: Additional avenue to deploy capacities

* Exports have emerged has an additional avenue to deploy capacities and thereby sweat assets.

* It has developed products for its targeted markets of the EU, US, and South America. After BKT and Alliance Tire, it is way ahead of others in terms of product offerings. Two years back, it was at the bottom of the list.

* TBR export volumes have significantly risen and constitute a significant portion of its export basket. It is immune to a removal of ADD on imports, which will be reviewed in Dec’22.

Valuation and view

APTY is all geared for the next leg of growth, with sufficient capacity to cater to demand from India and Europe. With capex for Phase II of the AP plant concluding in FY23, increase in capacity utilization will generate higher cash flows and further deleverage its Balance Sheet. As compared to its peers, APTY offers the best blend of earnings growth and cheap valuations. The stock trades at 13.6x/8.7x FY23E/FY24E consolidated EPS. We value the stock at 12x Jun’24E EPS (v/s a five/10 year average P/E multiple of ~16x/12x). We maintain our Buy rating with a TP of INR265/share.

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