Apollo Tyres Ltd. is a leading Indian tyre manufacturer which commenced its production in 1977 under the leadership of Raunaq Singh. It is built around the core principles of creating shareholder value through reliability in its products and dependability in its relationships with stakeholders. The company offers a range of tyres to consumers in heavy, light and passenger vehicles category.
The company has four manufacturing units in India and through its recent acquisition of Dunlop Tires, South Africa, now possesses two manufacturing units each in South Africa and Zimbabwe. In this report we are presenting a brief strategy analysis of the company, an analysis of the financial performance of the company over the last three fiscal years (2004 to 2006) and a brief financial comparison of the company with the US tire manufacturer Goodyear. We conclude with our views on the financial prospects of the company.
Analysis of the Industry
Indian tyre market is estimated to be a Rs. 14,500 crore industry with CAGR of 11% in terms of volume in last 5 years (2002-06). It is concentrated as the top four companies Apollo Tyre, JK Tyre, Ceat and MRF control 78% of the total revenue. 70% of the industry revenues are contributed by commercial vehicles (Truck, Bus & LCV)i Passenger car segment is growing faster (CAGR 16%) than HCV, LCV and farm segment, a drastic shift towards a global structure where passenger cars and light trucks constitute 88% by volume and 63% by sales is not expected in the next 3-5 years.
Key Factors affecting industry are:
- 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.
Technology and Advantages
The company has tie-ups with polymer and design institutes in India (IIT’s) and Europe for R&D.
It partners with global leaders for strategic sourcing and development of raw materials. The products undergo vigorous testing at world class test track facilities in Europe and USA. Its products adhere to quality certifications in India, Africa, Europe, the US and other key global markets. This manifests with Apollo Acelere winning the Overdrive Automotive Product of the Year 2005 and Apollo Aspire the NDTV Profit Car India Automotive Product of the Year in 2007 and customers pose faith in its products. Main Customers HCV/LCV customers include Tata Motors, Ashok Leyland, Eicher, Tatra, Force Motors, Swaraj Mazda and Mahindra.
Under Farm vehicles customers are Mahindra, TAFE, New Holland Tractors, Punjab Tractors etc. Passenger vehicles customers are Maruti Udyog Ltd, Tata Motors, Mahindra and General Motors Market Share The company is a dominant player in different product categories. Its market share in the key HCV is 27%, and 23% in LCV segment. It holds 16% in the growth segment of small passenger vehicles and has 23% market share in the Farm sector. Key Development- Buyout of Dunlop Tyres, South Africa The company’s first international acquisition was of Dunlop Tyres International Ltd. , South Africa on 21st April 2006.
DTIPL has two plants with a total capacity of 50,000 MT p. a. With the acquisition of DTIPL, the company got control over subsidiaries of DTIPL, having plants in Zimbabwe. It has a complementary set of products and technology and now Apollo deals in 60 countries. No major changes in accounting policies were made during the period.
Financial Analysis Of Apollo Tyres Ltd.
ROI is Rising. But, Why? Under the DuPont Analysis, the Return on Investment is broken down into Profit Margin and Asset Turnover Ratio to understand better the performance of the company.
The Net Profit Margin has remained steady across the period of study. However, further analysis reveals high fluctuations in year-on-year change in operating profit and non operating income. In 2004, the operating profits fell 61% from 2003 levels due to increase in raw material costs. Natural rubber prices increased internationally, petro-based raw materials became more expensive due to increase in oil prices and an anti-dumping duty on imported inputs from China caused the raw material costs to escalate. In 2004, non operating income increased a whopping 424%, and as a percentage of profits after tax was 128%.
Analysis of schedules reveals that this increase in non operating income was a result of sale of fixed assets. Hence, the company camouflaged a sharp drop in operating profits by increasing non operating income. The Return on Net Assets (using NOPAT) was only 3. 32% in 2004, as the operating profits declined significantly, but increased since then to reach 14. 9% in 2006. In 2005, the sales grew faster than operating expenses mainly due to improved distribution network, better relationships with key automakers, introduction of new products and some marketing initiatives.
This led to an increase in operating profit both in absolute terms and as a percentage of sales. The increase may also be partly attributed to an increase in inventory as seen by the decreased inventory turnover ratio which helps pass fixed operating expenses of the period to the next period. Since non-operating income in 2004 was a non recurring occurrence, the non operating income in 2005 was relatively much lower and as a percentage of PAT it reduced from 128% to 26%. In 2006, operating profit increased at a healthy rate of 66%, inventory turnover ratio improved, and there was very small increase in non operating income.
The operating profit margin was 7. 29% in 2006 as compared to 5. 5% in 2005. The company attributes this to aggressive marketing initiatives, better operational and financial efficiencies despite rising input costs and passing on part of the cost increases to the customer in the form of increased prices for tyres. Thus, though the PAT/Sales ratio remained in the 3-3. 5% range, the composition of profits and the factors contributing to it varied.
Asset Turnover Ratio
Better Than Expected The Asset Turnover ratio has steadily increased (from 1. 6 in 2004 to 1. 54 in 2006) indicating better utilization of total assets. Net sales grew more rapidly than total assets which results in an improvement in this ratio. The pattern in composition of total assets indicates a decreasing share of fixed assets in total assets (from 46% in 2004 to 41% in 2006).
In 2005, the share of current assets, especially cash, in total assets increased while in 2006, the share of other assets increased due to the substantial investment in its new subsidiary, Apollo (Mauritius) Holdings Pvt Ltd. (AMHPL). This can be interpreted as an indication of Apollo’s preparation for acquiring Dunlop Tyres, South Africa in an all cash deal in early 2006. AMHPL formed a subsidiary, Apollo (South Africa) Pvt. Ltd. which acquired Dunlop Tyres and its subsidiaries.
Since the analysis is being performed on unconsolidated accounts, the asset turnover ratio of assets responsible for creation of sales is likely to be even higher. This is seen in the higher increase in Fixed Asset Turnover Ratio than in total asset turnover: a 14. 7% increase in FATOR vs. a 5. 6% increase in Total Asset Turnover Ratio. Hence, it can be concluded that the company is using its fixed assets better than in the past and is also looking at inorganic growth as a future growth strategy. Conclusion: Thus, with steady increase in both PAT/Sales and Asset Turnover ratio, Return on Investment has increased steadily.
Changing Capital Composition
In 2005, the debt equity ratio (which includes short term debt) was greater than 100% indicating high use of leverage in Apollo’s capital structure. It increased in 2005 (from 94. 35% to 118. 4%) because of a high increase in short term borrowings which may partly be due to bridge loans for acquiring Dunlop Tyres. In 2006, the company raised additional equity capital at a premium from qualified institutional bidders for repayment of bridge loans raised for the acquisition of Dunlop Tyres, South Africa and to meet normal capital expenditure and other general business needs of the Company. This led to an increase in net worth and a simultaneous decrease in long term and short term borrowings and hence, to almost halving of the debt equity ratio as it dropped from 118. 4% to 63. 98%. The interest coverage ratio has improved steadily with rising EBIT. In 2005, the return on capital employed increased from 8. 71% to 9. 54%. While PAT had grown at 15. 6%, the capital employed also increased.
The major source of increase in capital employed was a growth in net worth due to increase in general reserve, an indicator of ploughing back of profits into the business. The return on equity also increased from 11. 8% to 12. 9% but the increase wasn’t as high as in the case of ROCE as the equity component had increased. In 2006, ROCE increased from 9. 54% in 2005 to 11. 39%. PAT had increased 45%. Long term debt decreased compared to 2005 while Net Worth increased sharply due to the new equity issue as explained above. Hence, again, Return on Equity increased (from 12. 92% in 2005 to 14. 7% in 2006) but not as much as ROCE did. Working Capital Management: On Verge of Liquidity Crisis? Apollo Tyres has a current ratio of less than 1. Apollo’s current ratio increased from 0. 86 in 2004 to 0. 89 in 2005 and then fell to 0. 82 in 2006. This indicates that Apollo is financing its long term assets with current liabilities. The industry average was approximately 1. 14 during this time period (Source: Capitaline). Hence, though the current ratio in the industry is low, the below industry average current ratio of Apollo and specially a ratio of less than 1 is a cause of concern.
o understand the liquidity position of the company better, the quick ratio needs to be studied. The quick ratio is only 0. 38 in 2006 indicating that inventory forms a dominant part of the current assets of the company (over 50% in 2006) and hence, the liquidity is even lesser than what the current ratio indicates. The bulk of current liabilities are comprised of creditors and short term borrowings as well as long term borrowings repayable in one year.
Hence, Apollo Tyres needs to improve its liquidity urgently. Share of Inventory in Current Assets in 2006 47% 53% Inventory Quick Assets High debtor and inventory turnover ratios can help manage liquidity better. Apollo has 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 high proportion of inventory in current assets and the below industry average inventory turnover ratio are an area of improvement in the working capital management of the company.
The cash position of the company indicates healthy cash from operations position. Cash from operations increased significantly in 2006 as the creditors and acceptances increased implying, besides increased purchase of goods, an increase in the holding period of creditors. Cash flow from operations as a percentage of operating profit before working capital changes (such as increase in creditors) increased from 36% in 2005 to 114% in 2006.
Investing activities have resulted in a net outflow of cash in all the years due to purchase of fixed assets and in 2006, also due to the investment in the subsidiary company formed to acquire Dunlop Tyres. Financing activities resulted in cash inflows in 2004 and 2005 ue to increase in borrowings while 2006, despite the equity issue, resulted in a net outflow due to repayment of short and long term borrowings. Opening cash and cash flow from operations as a percentage of current liabilities is a good test of the availability of cash with the company to meet short term obligations. This ratio increased from 19. 65% in 2005 to 56. 53% in 2006 due to a major increase in cash from operations. However, since significant amount of cash is being spent on investing and financing activities and the current ratio is low, the liquidity position of the company is still a matter of concern.
The Price Earnings ratio and the Price to Book ratio have steadily declined even though the EPS has increased over this time period implying that the market has less faith in the company.
Comparison with Goodyear Tires
The return on investment in Goodyear is only 1. 49% while Apollo Tyres has witnessed a ROI of 4. 4 to 5. 3%. Similarly other measures of return for Goodyear such as RONA and PAT/Sales are lower than these measures for Apollo. However, the Operating Profit Margin of Goodyear is comparable to the operating profit margin of Apollo. The lower PAT arises due to a high non operating loss in the case of Goodyear.
Unlike Apollo, Goodyear has a healthy liquidity position. It has a current ratio of 1. 7 5 and a quick ratio of 1. 16. Cash Flow from Operations are also healthy and comparable to Apollo’s ratios. While the inventory turnover ratios are comparable, Apollo has a much better Debtor Turnover ratio than Goodyear and hence, a much lower debtors holding period. The fixed asset turnover ratios are similar for both the companies. The ratios involving net worth have not been calculated because the net worth value without considering comprehensive loss is not available.
However, figures indicate a very high presence of debt in the capital structure as opposed to Apollo which has reduced its debt equity ratio. The Goodyear figures for 2005 have been used as benchmark as the company made a loss in 2006. Consolidated accounts have been considered.
The PE at latest price is 17. 30, a marked improvement over the 11. 75 level at the last fiscal year end. This is an indicator of the development since then and of the expectations of the market from Apollo Tyres. Apollo’s margins are vulnerable to natural rubber and oil prices. In the current fiscal, the price rise in inputs has stabilized.
The increase in price of tyres affected by Apollo in the previous fiscal coupled with high level of replacement demand witnessed implies better margins for Apollo this year. The synergies derived from acquisition of Dunlop Tires, South Africa will further boost returns. Industry observers believe that inorganic growth is going to be an important driver of growth in the industry. In future, we might witness Apollo making more acquisitions. This would be facilitated by the reduced debt equity ratio enabling Apollo to raise loans for leveraged buyouts in the future.