Structural changes in tyre companies under-appreciated by the street: IIFL Capital Services

1 Sep 2022 , 07:30 AM

Strong volume growth in FY22; exports also contributing

After seeing secular growth for two decades, the tyre industry saw weakness in FY20/FY21 (COVID impact). The industry got back on the growth path in FY22, with volumes up 14% YoY. In addition to strength in domestic OE and replacement segments, the industry also benefited from healthy growth in exports. Analysts at IIFL Capital Services expect volume growth to stay strong at 9-10% in FY23.

Input cost inflation hurt, but pricing discipline improving

Industry margin came off in FY22 due to rising input costs. It is quite normal to see margin compression when input costs rise. However, if the industry increases prices (even with a lag), margins should bounce back when input costs stabilize (even if at a higher level). The tyre industry has implemented periodic price hikes in the past 6-8 quarters. If input costs stabilize at current high level, analysts at IIFL Capital Services expect industry margins to start improving from Q3FY23.

Sharp rise in industry ASP after staying flat for 10 years

Tyre realizations (ASP) stayed flat over FY12-20. This suppressed EBITDA/MT (as company managements focused on % margins) and return ratios (as capex/MT continued to rise). Realizations have increased sharply in recent times, up 24% over FY20-23. Tyre-makers continue to focus on getting back to normalized margins (rather than EBITDA/MT) and are walking the talk with periodic price hikes. As a result, analysts at IIFL Capital Services expect Ebitda/MT to settle at higher levels, mirroring increase in realizations. Moreover, capex intensity measured as ‘% of revenue’ should come off.

MRF’s revenue/margin lead over peers receding; positive for industry pricing

Historically, MRF enjoyed significant margin advantage versus peers due to higher exposure to 2 wheelers and dominance in TBB (bias) segment. However, MRF’s 2 wheeler margins and market-share have come off. MRF has not been able to replicate TBB dominance in TBR (radial). As a result, its revenue/margin lead versus peers has shrunk considerably. Analysts at IIFL Capital Services believe this bodes well for industry pricing.

Apollo — Structural change in FCF profile

Due to sharp turnaround in its EU operations, analysts at IIFL Capital Services expect Apollo’s normalized consolidated EBITDA margin and ‘OCF as % of revenue’ to improve to 14-15% and 11-12% levels, respectively. With this, Apollo would be in a position to consistently generate FCFF, despite capex (7-8% of revenue).

Downgrade MRF to Reduce; Apollo is the preferred pick

MRF is trading at a significant premium to peers, ignoring the deterioration in its relative positioning versus peers. Analysts at IIFL Capital Services downgrade MRF from Add to Reduce. Their preferred pick in the space is Apollo Tyres. They believe that the structural changes in the industry and Apollo are underappreciated by the street. They see significant room for re-rating.