Deflated no more

It was the original India Shining story of last year — mid-size Indian manufacturer makes a ballsy bid on an American firm in a multi-billion dollar deal, disbelieving market notwithstanding. As it happens in most of the fairytales from the Grimm Brothers school of thought, this success story was just too good to be true. And so it came to be that Neeraj Kanwar’s grand ambitions of his company, Apollo Tyres, acquiring the US-based Cooper Tire & Rubber Company for $2.5 billion were thwarted by Cooper’s own Chinese subsidiary. At the time the deal was announced, this price tag was nearly thrice Apollo’s market value, potentially making the merged entity the seventh-largest tyre-selling entity in the world. At that time, a confident Kanwar had told Outlook Business that “the Apollo-Cooper combination is a fit from all angles — strategy, branding, product portfolio and geographies” and that the Indian entity wasn’t being exposed to inordinate risk and debt. As it turns out, investors didn’t really buy Kanwar’s argument; a third of Apollo’s market capitalisation was wiped out and its stock price hit a low of ₹68 on June 12, 2013, from ₹92 the previous day. By December 2013, the deal had been called off. 

Schadenfreude can be a powerfully motivating emotion, as the Indian stock market proved in the aftermath of the doomed deal. Apollo’s stock rose to ₹100 first and is now trading at ₹235 after hitting an all-time high of ₹240. What explains this extraordinary performance? To understand that, says Kanwar, we would have to travel back in time and track the positive steps the company has taken since the recession of 2008-09. “Banks were panicking, investors had cold feet. At a time when everyone was calling off their expansion projects, we went ahead with our proposed Chennai greenfield facility for passenger car tyres and truck-bus radials, with an investment of ₹2,100 crore in 2009. This gave us a nearly 24-month lead over our competitors, and despite being late starters in the truck-bus radial tyres space, we became the leaders in this category,” he explains. Kanwar adds that Apollo’s acquisition of the Netherlands-based Vredestein Banden BV (since renamed Apollo Vredestein BV) in 2009 and the capacity increase at this facility from 5 million tyres to 7 million tyres over the past five years has helped take the company’s margins from 10% to close to 18%.

Travelling a long way

Global sales account for a third of revenue, dominated by bus and truck tyres 

Analysts who track the company agree with his conjectures, albeit, in part. “The initial spurt in Apollo’s stock, from ₹60 to ₹100, can be attributed to the calling off of the Cooper transaction, which investors perceived as risky. The subsequent price rise is mostly due to a fall in rubber prices,” says Arun Agarwal, associate vice-president, equity research at Kotak Securities. On the other hand, Apollo President and CFO Sunam Sarkar — a key player in the Cooper deal who took a lot of heat for the company’s supposedly overleveraged books — believes that the company’s strong balance sheet has contributed to the rise in the stock price. “The constant complaint we face from our banks is that we aren’t utilising our full capacity. If anything, we are currently under leveraged as we have a lot of debt capacity on our books,” gloats Sarkar. He says many shareholders saw value in the company’s shares and kept buying in, even as prices tanked last year. “But some investors have shorter investment horizons. As a company, you can’t be all things to all people; you have to believe that what you are doing in good faith is the right thing for a majority of investors and for the long-term growth of the company.” 

Finding their strength

Though he admits that the Cooper deal would have served as a booster shot for the company’s fortunes, Kanwar nevertheless terms it a learning experience. “The Cooper transaction was not our first international acquisition anyway; we have successfully completed two in the past,” he quips. Besides, the pay-off from all the preparation that went into making the deal come alive was worth it. “When the transaction was announced, our internal teams started working towards exploring the synergies that existed between the two organisations. While the deal didn’t go through, our teams managed to take forward the exercise and implemented key synergies between our own operations in India, Europe and South Africa. This helped us squeeze out more profits, thereby improving our balance sheet.”

Leading the race

The company’s lead over MRF is much thinner in the LCV segment than truck tyres

The company recorded net sales of ₹3,300 crore in Q2FY15, as against ₹3,433 crore in Q2FY14. At ₹513 crore, its operating profit was up by 9% from ₹470 crore a year ago, and net profit hovered around the ₹257 crore mark, up 18% from ₹219 crore a year ago. Though the replacement market is Apollo’s sweet spot in terms of sales, at 65%, the biggest contributor to its revenue in India continues to be the commercial vehicle (that is, truck and bus tyres) segment, which hasn’t seen much growth in the past three years. Though analysts, companies and fleet owners predict a recovery in the market in the second half of the current fiscal, it remains to be seen if it comes through. But Kanwar feels there is enough demand for the company’s truck-bus radials from both OEMs and the replacement market. “This projected demand has led us to expand our truck-bus radial capacity in Chennai from 6,000 tyres per day to 8,900 tyres per day,” he says. 

More for the road

A debt/equity of about 0.5 gives the company enough capex flexibility

Analysts are positive that Apollo can leverage this dominant position once the market recovers. “To prepare for its next leg of growth, the company is planning to spend ₹1,500 crore over the next few years to expand capacity at its Chennai plant, which is operating at a more than 80% utilisation,” says Ambrish Mishra of JM Financial. The slowdown has not restricted Apollo from going ahead with investments and capacity expansion, both in India and overseas. Plans are underway to set up the company’s first greenfield facility outside India — in Hungary — over the next five years, at an estimated expense of €475 million. This facility will create an additional capacity of an estimated 5.5 million passenger car and light truck (PCLT) tyres and 675,000 heavy commercial tyres. In addition to the Chennai investment, Apollo plans to add an off-highway tyre unit to its existing truck bus bias facility in Kalamassery, Kerala. This move would require an additional investment of ₹500 crore over the next three-four years. 

“These capex plans will retard free cash flows in the future,” believes analyst Priya Ranjan of Phillip Capital. If nothing else, these projects can definitely put pressure on the company’s margins in future. Sarkar defends the capex flow. “When you invest in capacity, you are investing in a margin and revenue stream. This is not a sunk cost; it is an investment. Today, the company enjoys the kind of margins it does because we had invested in the radial facility in Chennai in the past. This hedge now allows us to sell products that are higher up the value chain,” he asserts. 

Slippery slope

In the light of such capex, the performance of the company’s subsidiaries also merits a mention. Currently, Apollo has a presence in the European market thanks to sales of winter tyres through subsidiary Apollo Vredestein. Unfortunately, the market for such tyres is niche yet competitive, and the other players have taken advantage of falling rubber prices and introduced price cuts. Apollo, too, has been forced to follow suit. If demand falters further, another cut in prices and ensuing stress on margins could be imminent. Kanwar rises to the defence of Apollo’s European adventure. “While it is difficult to accurately predict margins, we are trying our best to sustain, if not better, our current performance. We have always believed in profitable growth for the company.” Analysts, however, believe that Apollo’s margins in Europe may have peaked already. 

Playing third fiddle

Japanese major Bridgestone continues to ride ahead of Apollo in the passenger car market

Kanwar does agree that maintaining overall profit margins may be a bit of a challenge, going forward. “Sudden commodity price spikes can hit any company. That continues to be a risk factor,” says Kotak Securities’ Agarwal. Kanwar takes the argument a step further. “Ours is a raw material-intensive industry. While raw material prices are stable at present, we have seen irrational movement in prices in the past. Such movements will always be challenging for the concerned industry,” he says. However, Sarkar believes that the company is better placed as compared with the last upward spike in commodity prices during 2006-07 because “today, our products and brands are much well established.” 

What, then, is the way forward for Apollo? Kanwar says the company is working on a specific list of goals that it plans to make public soon. “We are currently in the process of setting goals — not just for the top line but for the year 2020, which we might announce early next year,” he adds, cryptically. Despite having burnt its fingers with its acquisition misadventure in the past, Apollo has not given up the inorganic route for expansion. “We are always on the lookout for suitable long-term opportunities that can help us either from the brand or market perspective,” smiles Sarkar. The small puncture that tripped it up in the past clearly won’t keep Apollo’s show from hitting the road with a completely different plan.