Apollo Tyres return ratios may inch up as margin improves; demand recovery vital
PremiumWhile demand from original equipment manufacturers has improved across categories, replacement demand has been a mixed bag
Apollo Tyres Ltd. is a key beneficiary of softening prices of commodities such as natural rubber and crude-based derivatives. This eases margin pressures which will aid earnings growth. However, it remains to be seen if the tyre maker can improve its return ratios, which have been a sore point over the last few years.
During FY2017-22, Apollo Tyres’ average consolidated capital expenditure (capex) was higher than the mean operating cashflow, resulting in gross debt almost doubling to ₹6,000 crore during the period, according to analysts at ICICI Securities. As such, pre-tax return on capital employed (RoCE) declined to 7% during FY17-22 from about 15% as rising truck and bus radial (TBR) capacity coincided with adverse profitability drivers, they added.
Several margin headwinds across regions impacted its RoCE despite adequate capacity utilisation. But going ahead, declining input costs coupled with price hikes would lead to margin expansion. The benefit of moderation in commodity costs would be reflected in the December quarter (Q3FY23) financials as the effect comes with a lag.
Also, continued focus on free cash flow generation on the back of a better capex policy augurs well for the improvement in return ratios. But, recovery in demand environment is crucial.
While demand from original equipment manufacturers has improved across categories, replacement demand has been a mixed bag. “Replacement demand is holding-up well for the passenger car radial and two-wheeler segment. However, replacement demand is relatively weak for truck and bus (T&B) and tractors," said analysts at Motilal Oswal Financial Services in a report on 13 September. T&B demand is expected to pick-up Q3 onwards as the noise around inflation tapers off, they added.
Meanwhile, shares of Apollo Tyres have risen nearly 26% in the past one year, while the Nifty 500 index has gained 4.5%. The stock is currently flirting with its 52-week high of ₹285.40. Hereon, any meaningful upside would depend on margin improvement and the pace of recovery in demand.
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“We believe FY23- FY25E is likely to be favourable for Apollo Tyres, when strong demand coincides with improving margin and steady capex. Thus, we expect Apollo Tyres to deliver average free cash flow of Rs1500 crore per year in FY23-FY25E versus negative mean free cash flow of Rs600 crore during FY17-FY22," said ICICI Securities analysts in a report dated 14 September.
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