Tyre Sector Sept07

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India Research

Tyre SectorTread gains...!!!Navin Matta Research Analyst +9122 4096 9752 navin@dolatcapital.com Harshal Patil Research Associate +9122 4096 9725 harshal@dolatcapital.com

September 2007

DOLAT CAPITALThe tyre industry has witnessed an evident upturn since the beginning of the current year. The primary reason being, the softening of natural rubber prices (42% of total raw material cost). Furthermore, the high capacity utilizations by most of the leading players and small additions in bias capacities in the next 2 to 3 years would result in a better pricing power scenario. The demand environment continues to look positive with high growth expected from the Replacement and Exports segments.

Buoyant capacity utilizations to render pricing powerThe Indian tyre industry has been operating at a capacity utilization rate of around 90% in the last 3-4 years. Currently almost 70-80% of the vehicles (in terms of weight) in India are on bias tyres. The eventual shift in preference from bias to radial tyres is deterring any player to put up major bias capacities. Going forward for the next 2-3 years, we expect small capacity additions in the bias segment only by way of de-bottlenecking. Therefore, the tight demand supply situation would ensure a better pricing power scenario.

Radialisation in the Truck & bus segment to gather paceThough radial tyres have several benefits such as better fuel efficiency, longer life and better road grip, the higher upfront cost (around 25%) has limited radial penetration in the T&B segment to 4%. Governments focus on development of road infrastructure would encourage the use of radial tyres. We expect radial penetration in the T&B segment to reach at least 12% by 2010, based on which the revenues from T&B radials would increase by 55% CAGR over 2007-10

Natural Rubber prices slipping to comfort zoneThe tyre industry is highly raw material intensive with natural rubber accounting for 42% of the total raw material cost. In the last three years, NR prices have been on an unabated up trend, from a yearly average price of Rs 47 per kg in 2003 to Rs 89 per kg in 2007. This was mainly on account of tight demand supply dynamics and depleting stock levels in the domestic market. However, the strong linkage of international and domestic rubber prices would suggest stable NR prices on the back of higher stock levels, both domestically and internationally.

Improving financials healthThe recent price hikes by most players, coupled with softer raw material cost has enabled the industry to post better financial numbers in the past 2-3 quarters. The average operating profit margins have improved to almost 10% from a low of 6.6% in the previous year while the PAT margins are at 4% from a low of 1.50%. The improving financial health of the sector would partially fund the capex plans, which have been announced by most of the large players. Strong financial health coupled with a well thought out growth stratergy makes Apollo Tyres Ltd ( ATL) our top pick amongst its peers. We initiate coverage on ATL with a BUY recommendation and a 12 months price target of Rs 49 based on 12xFY09E fully diluted earnings. The consistent financial performance, coupled with a extensive product portfolio in the niche OHT segment makes Balkrishna Ltd an interesting play. We expect the stock to be a re-rating candidate on the back of continued high earnings growth coupled with the recent de-merger of the non tyre businesses into separate companies. We initiate coverage on the stock with a BUY recommendation and a 12 months price target of Rs 840 based on 12xFY09E fully diluted earnings.

Valuations matrixParticulars Rs in Mn Apollo Tyres J K tyres* Ceat Balkrishna Industries * Fig for Sep07 & Sep08 CMP Rs. 38 127 164 598 17,633 3,911 7,488 11,580 MCAP Net Sales FY08E 47,928 29,151 23,503 10,851 OPM-% FY09E 10.0 8.4 7.8 20.7 Net Profit FY08E 1575 510 704 1124 FY09E 1926 607 817 1462 EPS (Rs) FY08E 3.1 12.4 15.4 51.3 FY09E 4.1 14.8 17.9 70.0 PER (X) FY08E 12.2 10.5 11.0 11.7 FY09E 9.4 8.8 9.2 8.6 ROE-% FY08E 15.0 7.6 17.2 23.4 FY09E 17.1 7.9 17.5 26.0 ROCE-% FY08E 16.2 10.3 18.2 20.9 FY09E 18.0 10.6 18.5 25.0 FY09E FY08E 54,203 31,175 25,456 13,800 9.4 8.1 7.5 21.6

26 September, 2007


DOLAT CAPITALPorters Five forces Model:Barriers to Entry: Highly capital intensive Long payback period

Supplier Power: Possibility of substituting NR with SR is minimal Supply concerns weigh on NR prices. Crude based raw materials subject to high price volatility.

Inter firm Rivalry Low value added product with high competition 75% of market share with top 4 players Consolidation expected as the industry nearing maturity.

Buyers Power: Pricing power with OEM on account of low switching cost Low brand loyalty observed as the Replacement markets offers wide brand choice at comparable price points in each product segment

Threat of substitutes: Import of Chinese tyres. Retreading option to postpone repurchase.

26 September, 2007


DOLAT CAPITALBuoyant capacity utilizations to render pricing powerThe Indian tyre industry is operating at high capacity utilization rates of around 90-95% in the past 3-4 years. Excluding the passenger vehicles segment, a significant proportion of vehicles (approx 75-80% in value terms) are still on bias tyres. Majority of the players operating bias capacities are running at near peak capacity (principally in the T&B bias segment). Furthermore, none of the tyre manufacturers are willing to undertake major capacity expansions in bias tyre facilities, owing to the eventual shift in preference from bias to radial tyres. Going forward for the next 2-3 years, small capacity additions in bias tyres segment, if any, would be primarily through brown-field expansions or de-bottlenecking route.Meanwhile radial pentration is expected to increase only upto 12% from the current 4%.

Production and Capacity Utilization Trend80 75 70 65 60 55 50 45 40 35 30 25 20 2002 2003 2004 2005 Production-LHSSource: ATMA, Cris Infac, Dolat Research

100% 85% 70% 55% 40% 25% 10% 2006 2007 2008E 2009E 2010E

NOS in Mn

Cap Utilisation-RHS

We expect a steady demand for bias tyres, mainly in the T&B segment to continue for the next 2 to 3 years. Supply growth being diminutive in the following years, we anticipate a favorable pricing scenario for bias tyres.

Radialisation in Truck & Bus segment expected to gather paceCurrently the radial penetration in the T&B segment is barely 4%. Although, there are several benefits of using radial tyres, such as better fuel economy, longer life and better road grip, the higher upfront cost compared to bias tyres is the main deterrent . T&B radial tyres cost approximately 25% higher as compared to bias tyres. Radial tyres have softer sidewalls because of which they are prone to damage on poor road conditions existing in India.

Radial Penetration trend100 90 80 70 per cent 60 50 40 30 20 10 0 2002Source: ATMA, Dolat Research

Passenger Car


Truck & Bus






26 September, 2007


DOLAT CAPITALThe increased emphasis on building road infrastructure and ban on overloading is expected to trigger a higher radial penetration in the T&B segment. The NHDP has estimated infrastructure spent on roads at Rs 2474 Cr by the year end 2012. This would be dedicated towards building of 45,974 kms of road.

Radial tyre sales from Truck & Bus (T&B) Segment:Particulars Tyre Volume (mn nos) T & B tyre volume ( mn nos) Share of T & B tyres in Total Tyre production Radial Tyres in Truck & Bus segment-(mn nos) Truck & bus Radialisation penetration* Avg wt(Kg)-Radial tyre Total Wt.-Radial Tyre(Tons) Avg realisation for radial tyre* Sales from T & B radial tyres (Rs Bn)* Dolat Research Estimates, Cris Infac, ATMA *- realization for radial tyres assumed 25% higher than bias tyres.

2005 60.10 11.00 18% 0.22 2% 60 13,200 145 1.91

2006 65.93 11.90 18% 0.24 2% 60 14,280 145 2.07

2007 71.58 12.17 17% 0.49 4% 60 29,205 165 4.82

2008E 74.76 12.71 17% 0.76 6% 60 45,755 165 7.55

2009E 81.41 13.84 17% 1.25 9% 60 74,735 165 12.33

2010E 88.67 15.07 17% 1.81 12% 60 108,531 165 17.91

We expect radial penetration in the T&B to increase to 12% by 2010 from the current levels of 4%. Our base estimates peg the demand for radial tyres to reach 1.81 mn tyres in the next 3 years. Based on the average weight and realization per kg of a radial tyre, we arrive at total sales from radial tyres of around Rs17.9 bn by 2010 (approx ~ 10% of total market share). This translates into a 55% CAGR over 2007-10.

Natural Rubber prices slipping to comfort zoneThe tyre industry is highly raw material intensive with natural rubber accounting for 42% of the total raw material cost. Consequently, the fortunes of the industry are largely linked to natural rubber prices. In the last three years, prices have been on an unabated up trend. This has caused a dent in the margins of the all the tyre manufacturers.

Raw Material profile (percentage in terms of cost)17%

3% 5% 42% 11%

22% Natu r al Ru b b e rSource: ATMA

Nylo n T yr e C o r d Fab r ic

C ar b o n Black



Oth e r s

26 September, 2007


DOLAT CAPITALDomestic NR production and consumption11,000 Production (LHS) Bangkok Intl prices - Rs/kg (RHS) Consumption (LHS) 100 80 60 7,000 40 5,000 20 2003Source: Rubber Board of India, Dolat Research

9,000 (in '000 MT)

3,000 2004 2005 2006 2007P

The past few years have seen a tight demand supply si