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Set for rerating; drivers of FCF converging

After having doubled its gross debt on books during FY17-FY22, we believe Apollo Tyres (APTY) is now taking the right path, in terms of actively focusing on FCF generation. Having invested heavily in high growth but capital intensive TBR segment since FY16, APTY is now following the strategy of a steady consolidated capex budget every year against the current strategy of operating at 85% utilisation in domestic TBRs. EU is operating at ~14-15% EBITDA margin currently under the inflationary cost environment amidst steady replacement demand. With multiple headwinds to margin improvement across India and EU along with elevated capex, APTY saw major erosion in RoCE from >15% levels to sub-10% during FY17-FY22. We expect disciplined pricing strategy, recovering demand and controlled capex to augur well for APTY in coming years. This may help the company deliver FCF consistently with >15% RoCE levels. Maintain BUY with DCF-based price target of Rs329 (earlier: Rs306), implying ~14x FY24E earnings.

* Focused capital allocation to aid steady FCF generation: In FY17-FY22, APTY executed average consolidated capex of Rs24bn per annum against mean operating cashflow of Rs18bn per annum, resulting in gross debt almost doubling from ~Rs30bn to ~Rs60bn during this period. Pre-tax RoCE during FY17-FY22also declined from ~15% to ~7% as rising TBR capacity coincided with adverse profitability drivers. As a result, despite overall TBR capacity operating at ~85% utilisation, benign margin across this period, both in India and EU (barring FY21), has been hurting APTY improve its RoCE. APTY is now taking its capex policy prudently and would not club capex plans across segments together in order to keep annual capex budget steady. With scope to grow TBR volume by ~20% on its existing capacity (Andhra phase-1 included), APTY is not envisaging any incremental capacity addition in this space in the current upcycle. In EU, APTY has no plans of doing any brownfield expansion in Hungary in FY23-FY24, with scope of growing ~20% on the current existing capacity.

* Focusing on profitable growth: In the past five quarters, RMC/kg increased ~25% for APTY as against EBITDA margin declining merely 100bps to ~9.5%, with gross profit/kg remaining flat. This level of profitability retention was possible on the back of cumulative price hikes of ~15-17% across various segments in the past five quarters to combat ~25% increase in RMC (~70% of revenue). Peers took price hikes of ~10- 12% cumulatively, resulting in larger margin erosion. APTY lost ~150bps market share in TBR replacement due to steeper price hikes.

* Cyclical aspects of business turning favourable for APTY: We believe FY23- FY25E is likely to be favourable for APTY, when strong demand coincides with improving margin and steady capex. Thus, we expect APTY to deliver average FCF of Rs15bn/year in FY23-FY25E vs negative mean FCF of Rs6bn during FY17-FY22. With focus on pricing discipline and capital allocation, we expect APTY to become gross debt free over the next 5 years as against ~Rs60bn gross debt on books in FY22.

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