Apollo Tyres shares get 'buy' rating FE BUREAU

As per media reports, tyremaker Michelin announced a 12% increase in truck tyre prices in Africa and India. Apollo Tyres is present in both these geographies. As per an article in Rubber World, Yokohama Tire raised truck tyre prices by 8%. We believe this sets the stage for price increases by other tyre manufacturers and bodes well for the fundamentals of the tyre industry.

Over the past two weeks, natural rubber prices in India have declined from R240/kg to R220/kg. Natural rubber costs are 30% of revenues for Apollo Tyres. We assume a natural rubber cost of R225/kg for Apollo Tyres over FY11. We have also analysed the potential for substitution of natural rubber usage in the glove industry and believe that higher rubber prices would lead to substitution of natural rubber by synthetic rubber in that industry.

We derive our price target from our sum-of-the-parts valuation. We value the company’s India business at 4.5x (times) the average of FY12-13e (September 2012e) EV/Ebitda (enterprise value/earnings before interest, taxes, depreciation and amortisation) and its international business at 5.5x. Apollo Tyres share is trading at 7.2x March 2012e PE (price-to-earnings).

We believe that price increases implemented by Michelin and Yokohama, as well as the marginal decline in natural rubber prices point to improving fundamentals for the tyre industry. As per Rubber World, natural rubber is 43% of the global rubber consumption and synthetic rubber is 57%. Tyre is 63% of the rubber consumption, while gloves contribute a majority of the remaining rubber consumption.

While tyre manufacturers are not able to flexibly shift between usage of natural vs synthetic rubber, glove manufacturers can shift the usage more flexibly. As per our conversation with Top Glove, natural rubber-based gloves (powder-free gloves) are 27% more expensive than synthetic rubber (nitrile)-based gloves; the same time last year, natural rubber-based gloves were 9% cheaper than synthetic rubber-based gloves.

Nitrile gloves are used in the USA and EU and contribute to 25% of global consumption of gloves. We believe the industry can shift marginally towards nitrile gloves as long as the pricing difference between nitrile and powder-free gloves lasts.

Substitution of natural rubber with synthetic rubber will likely improve the supply-demand dynamics of the natural rubber industry and help moderate natural rubber prices.

We believe the key risks are, a sustained industrial slowdown, continued increase in raw material prices, Further production interruptions, and any ruling against Apollo Tyres (and other tyre companies) by the Competition Tribunal in South Africa.

(Source: http://www.financialexpress.com/news/apollo-tyres-shares-get-buy-rating/765037/0)