Introduction
Established in 1977 by Raunaq Singh, Apollo Tyres Ltd. is a prominent Indian tire manufacturer that adheres to the core principles of delivering shareholder value through product reliability and maintaining dependable relationships with stakeholders. The company provides a diversified range of tires for heavy, light, and passenger vehicles.
The company operates a total of four manufacturing units in India, as well as two manufacturing units each in South Africa and Zimbabwe following its acquisition of Dunlop Tires, South Africa. This report includes a concise analysis of the company’s strategy, an evaluation of its financial performance between 2004 and 2006, and a brief comparison with leading US tire manufacturer Goodyear. Lastly, we provide our perspective on the financial prospects of the company.
Strategy Analysis
Analysis of the Industry
The Indian tyre market is valued at around Rs. 14,500 crore and has consistently grown by 11% in volume from 2002-2006. The dominant players in this market are Apollo Tyre, JK Tyre, Ceat, and MRF, who together make up 78% of total revenue. Commercial vehicles such as trucks, buses, and light commercial vehicles (LCVs) contribute to 70% of the industry’s earnings. However, the passenger car segment is growing at a faster rate with a Compound Annual Growth Rate (CAGR) of 16%, surpassing heavy commercial vehicles (HCVs), LCVs, and the farm segment. Despite this growth, it is unlikely that there will be a significant shift towards a global structure where passenger cars and light trucks make up 88% by volume and 63% by sales within the next 3-5 years.
There are several crucial factors that impact the industry:
- Health Of The Economy: GDP growth rate of 8% plus and stable growth forecast for next 5 years implies continued growth for the tyre industry. Increased economic activity will boost road transportation industry which handles 60% of goods and 80% of passengers in India.
- Interest Rates affect tyre industry directly by increasing the cost of financing. Indirectly, customers like OEM (vehicle sales through financing) and general economic activity get hit. Hence, upswing in the interest rates is detrimental to the tyre industry.
- Infrastructure Development Projects like Golden Quadrilateral and NSEW corridor project would boost passenger movement & transportation of goods.
- OEM Demand (commercial and passenger vehicles manufacturers): Commercial vehicles sales grew at about 33 per cent with multi-axle trucks segment posting 112 per cent growth in the year 2006-07. Light vehicles growth forecast for 2007 is 11. 2 percent. Passenger vehicles sales are likely to grow at 14. 9 per cent till 2010.
- Replacement Demand – Replacement demand of tyres was 59% of total sales in 2003 (HCV, LCV, Farm, passenger vehicles and two wheelers) of which HCV and LCV formed 22%. It is relatively high in India because of poor road conditions and over loading. Radial tyres cut down replacement but form only 2% in HCV and LCV (which forms 70% of revenue). Hence replacement market would be a force to reckon with.
- Auto Export Industry: With several OEMs seeking to build a future production base for potential exports from India, it is being seen as a sourcing hub for worldwide sales by the auto industry. Production in 2007 is expected to outpace sales by 8 percent. Tyre exports in 2006 was $516 million, an increase of 27% over previous year and hence, is an important source for demand
- Cost Pressures: The industry is highly raw material intensive which form 70% of the production cost. Natural rubber prices increased by approximately 24% compared to 2005-06. Hike in carbon black due increased crude oil prices pressured the margins.
Company Analysis
Technology and Advantages
The company partners with polymer and design institutes in India (IIT’s) and Europe for research and development (R&D) purposes.
Apollo partners with global leaders for sourcing and developing raw materials for its products. The products undergo rigorous testing at test track facilities in Europe and the USA. They also adhere to quality certifications in India, Africa, Europe, the US, and other major global markets. This is exemplified by Apollo Acelere winning the Overdrive Automotive Product of the Year 2005 and Apollo Aspire being named the NDTV Profit Car India Automotive Product of the Year in 2007; these achievements have earned customer trust. Notable HCV/LCV customers include Tata Motors, Ashok Leyland, Eicher, Tatra, Force Motors, Swaraj Mazda, and Mahindra.
Customers under the Farm vehicles category include Mahindra, TAFE, New Holland Tractors, Punjab Tractors, etc. As for Passenger vehicles, customers range from Maruti Udyog Ltd, Tata Motors, Mahindra, and General Motors. The company holds a dominant position in various product categories with a market share of 27% in the key HCV segment and 23% in the LCV segment. It also commands a 16% market share in the growth segment of small passenger vehicles and 23% in the Farm sector. One noteworthy development is the company’s acquisition of Dunlop Tyres International Ltd., South Africa on April 21st, 2006, marking its first international buyout.
DTIPL operates two plants with a combined annual capacity of 50,000 MT. Through the acquisition, the company gained control over DTIPL’s subsidiaries in Zimbabwe, which also operate plants. These plants have a complimentary range of products and technology. As a result, Apollo now conducts business in 60 countries. There were no significant alterations to the accounting policies during the specified period.
Financial Analysis Of Apollo Tyres Ltd.
DuPont Analysis
The DuPont Analysis is attributed to the rise in ROI as it breaks down Return on Investment into Profit Margin and Asset Turnover Ratio, offering a more transparent understanding of the company’s performance.
The Net Profit Margin has remained stable during the study period. However, further examination reveals significant fluctuations in the year-on-year change in operating profit and non-operating income. In 2004, there was a 61% decrease in operating profits compared to the previous year due to increased raw material costs. These cost increases were caused by international price hikes in natural rubber, higher prices of petro-based raw materials due to rising oil prices, and the imposition of an anti-dumping duty on imported inputs from China. On the other hand, non-operating income experienced a staggering 424% increase in 2004, representing 128% of the profits after tax.
Upon analysis of the schedules, it can be concluded that the rise in non-operating income was a direct result of selling fixed assets. Consequently, the company concealed a significant decrease in operating profits by boosting their non-operating income. The Return on Net Assets (using NOPAT) was only 3.32% in 2004 due to the substantial decline in operating profits. Nevertheless, this percentage has improved and reached 14.9% in 2006. In 2005, sales growth exceeded the increase in operating expenses primarily because of improvements made to the distribution network, stronger partnerships established with key automakers, introduction of new products, and implementation of specific marketing initiatives.
The operating profit has increased both in absolute terms and as a percentage of sales due to various factors. One factor is the rise in inventory, which is evident from the decrease in the inventory turnover ratio. This decrease helps distribute fixed operating expenses across different periods. However, it should be noted that the non-operating income in 2004 was an isolated event and resulted in a lower non-operating income for 2005. As a percentage of profit after tax (PAT), it decreased significantly from 128% to 26%. On a positive note, there was a healthy growth rate of 66% for operating profit in 2006. Furthermore, the inventory turnover ratio improved and there was only a minimal increase in non-operating income.
In 2006, the operating profit margin rose to 7.29% from its previous level of 5.5% in 2005 due to aggressive marketing strategies, improved operational and financial efficiencies, and offsetting increased input costs by raising tyre prices. Consequently, while the ratio of profit after tax to sales stayed within the range of 3-3.5%, there were variations in profit composition and influencing factors.
Asset Turnover Ratio
The Asset Turnover ratio has consistently improved, from 1.6 in 2004 to 1.54 in 2006, indicating better utilization of total assets. During this period, net sales experienced a faster growth rate compared to total assets, leading to an enhancement in this ratio. Furthermore, the composition of total assets reveals a declining proportion of fixed assets within the overall asset mix, decreasing from 46% in 2004 to 41% in 2006.
In 2005, the proportion of current assets, particularly cash, in the total assets rose. However, in 2006, the proportion of other assets increased due to significant investment in Apollo (Mauritius) Holdings Pvt Ltd. (AMHPL), a new subsidiary. This suggests that Apollo was preparing to acquire Dunlop Tyres, South Africa, in an all-cash deal early in 2006. AMHPL established Apollo (South Africa) Pvt. Ltd., which acquired Dunlop Tyres and its subsidiaries.
Since the analysis is being conducted on unconsolidated accounts, the asset turnover ratio for assets responsible for sales creation is likely to be higher. This is evident in the greater increase in the Fixed Asset Turnover Ratio compared to the total asset turnover. The FATOR increased by 14.7% while the Total Asset Turnover Ratio only increased by 5.6%. Therefore, it can be inferred that the company is utilizing its fixed assets more effectively than in the past and is considering inorganic growth as a future growth strategy. In conclusion, with a consistent increase in both PAT/Sales and Asset Turnover ratio, the Return on Investment has steadily improved.
Changing Capital Composition
In 2005, Apollo had a debt equity ratio that was over 100%, indicating a high level of leverage in their capital structure. This increase was due to a significant rise in short term borrowings, which may have been used for bridge loans to acquire Dunlop Tyres. In 2006, the company raised more equity capital from qualified institutional bidders at a premium price. This capital was used to repay the bridge loans taken for the Dunlop Tyres acquisition and for general business needs. As a result, net worth increased and both long term and short term borrowings decreased. This caused the debt equity ratio to decrease by almost half from 118.4% to 63.98%. The interest coverage ratio has consistently improved as EBIT increased. Additionally, in 2005, the return on capital employed rose from 8.71% to 9.54%, with both PAT and capital employed experiencing growth.
The growth in net worth drove the increase in capital employed, resulting from an increase in the general reserve. This shows that profits were reinvested into the business. The return on equity also increased, although not as much as the return on capital employed (ROCE), due to the increase in equity component. In 2006, ROCE rose from 9.54% in 2005 to 11.39%. Additionally, there was a significant 45% increase in PAT. While long-term debt decreased compared to 2005, net worth experienced a significant rise due to a new equity issue. Consequently, the return on equity also increased (from 12.92% in 2005 to 14.7% in 2006), albeit not as much as ROCE.
Moving forward with working capital management, Apollo Tyres currently has a current ratio below 1. Although the current ratio increased from 0.86 in 2004 to 0.89 in 2005, it then declined further and reached only0 .82in2 .006 This suggests that Apollo is using current liabilities for financing its long-term assets. During this period, the industry average current ratio stood at approximately1 .14(Source: Capitaline). Henceforth , even though the industry’s current ratio is low,Apollo’s falls below this industry average and raises particular concern due to being less than1 .
To gain a better understanding of the company’s liquidity position, it is crucial to analyze the quick ratio. In 2006, this ratio was only 0.38, indicating that inventory makes up a significant portion of the company’s current assets (over 50% in that year). Consequently, the company’s liquidity is lower than indicated by the current ratio. The majority of its current liabilities consist of creditors, short-term borrowings, and long-term borrowings that will be settled within one year.
Hence, Apollo Tyres urgently needs to improve its liquidity. The share of Inventory in Current Assets in 2006 was 47%, while Quick Assets were 53%. High debtor and inventory turnover ratios can help manage liquidity better. Apollo has a high debtor turnover ratio (17.37 in 2006) compared to the industry average (8.87 in 2006, Source: Capitaline). However, its inventory turnover ratio (6.99 in 2006) is sluggish compared to the industry average (8.77 in 2006, Source: Capitaline).
The company’s working capital management needs improvement, as indicated by the high proportion of inventory in current assets and the below industry average inventory turnover ratio.
Cash Situation
The company’s cash position shows a strong cash from operations situation. Cash from operations saw a significant increase in 2006, which can be attributed to an increase in creditors and acceptances. This suggests not only an increase in the purchase of goods but also a longer period in which creditors hold the company’s funds. The percentage of cash flow from operations to operating profit before working capital changes (such as an increase in creditors) rose from 36% in 2005 to 114% in 2006.
Investing activities have led to a cash outflow in all years, as a result of purchasing fixed assets and, in 2006, investing in a subsidiary company created for acquiring Dunlop Tyres. Financing activities resulted in cash inflows in 2004 and 2005 due to increased borrowings. However, in 2006, despite the equity issue, there was a net outflow due to repayment of short and long term borrowings.
A good measure of the company’s cash availability to meet short term obligations is the percentage of opening cash and cash flow from operations in relation to current liabilities. This ratio increased from 19.65% in 2005 to 56.53% in 2006 thanks to a significant rise in cash from operations. Nonetheless, considering that a substantial amount of cash is being spent on investing and financing activities and the current ratio is low, the company’s liquidity position remains a matter of concern.
Market Ratios
Despite the increase in EPS over this time period, the market has shown less faith in the company as reflected by the steady decline in the Price Earnings ratio and the Price to Book ratio.
Comparison with Goodyear Tires
The return on investment in Goodyear is only 1.49%, while Apollo Tyres has experienced a higher ROI ranging from 4.4% to 5.3%. Additionally, other measures of return such as RONA and PAT/Sales are also lower for Goodyear compared to Apollo. However, the Operating Profit Margin of Goodyear is similar to that of Apollo. The lower PAT in Goodyear can be attributed to a high non-operating loss.
Apollo and Goodyear both have healthy liquidity positions. Goodyear’s current ratio is 1.75 and its quick ratio is 1.16. Cash Flow from Operations is also good and comparable to Apollo’s ratios. While the inventory turnover ratios are similar, Apollo has a better Debtor Turnover ratio than Goodyear, resulting in a shorter debtors holding period. The fixed asset turnover ratios are similar for both companies. The ratios involving net worth have not been calculated due to the unavailability of net worth value without considering comprehensive loss.
The capital structure of Goodyear shows a significantly high level of debt compared to Apollo, which has successfully reduced its debt equity ratio. The benchmark year for Goodyear is 2005, as the company experienced a loss in 2006. The analysis is based on consolidated accounts.
Prospective Analysis
The current price-to-earnings ratio (PE) for Apollo Tyres is 17.30, which is a significant improvement compared to the 11.75 PE at the end of the last fiscal year. This increase reflects the progress made since then and the market’s expectations for Apollo Tyres. However, Apollo’s profit margins are still influenced by fluctuations in natural rubber and oil prices. Fortunately, in the current fiscal year, the price hike in raw materials has stabilized.
The rise in tire prices influenced by Apollo in the previous fiscal year, along with a significant demand for replacements, suggests that Apollo will experience improved margins this year. The acquisition of Dunlop Tires in South Africa will also contribute to increased returns. Experts in the industry predict that inorganic growth will play a crucial role in driving industry expansion, and it is possible that Apollo will pursue further acquisitions in the future. With a reduced debt equity ratio, Apollo will have the capability to secure loans for leveraged buyouts.
