Ill-timed fund-raising by selling shares can mar a company’s earnings momentum. But this may not be true for Apollo Tyres Ltd. To expand capacity, the firm made a preferential issue of warrants to promoters, convertible into equity shares in 18 months. The equity will be diluted by 1% from the present 504 million shares, which have a face value of Rs.1 each.
Although this may not impact earnings much, Apollo Tyres may in the medium- to long-term raise more money. If it exercises the approval to raise $150 million (around Rs.827 crore today) through the qualified institutional placement route, there would be a dilution of 15-20% in equity and earnings. This will certainly impact earnings growth, even as capital expenditure affects return ratios such as return on equity and capital employed.
That said, the magnitude of the impact hinges on rubber prices. For now and for some quarters ahead, Apollo Tyres will get help from falling rubber prices—at Rs.159/kg, it is 33% down from its peak rate. And the benefits from this will trickle down from the first quarter of fiscal 2014. During the September quarter, the 3 percentage point improvement in operating margin from a year ago fell below analysts’ expectations, as the company had high-cost inventory of rubber.
Stable rubber prices will help improve profitability, even as the after-sales market for tyres in the country improves. The September quarter also mirrored this trend, as domestic market revenue jumped by 23% and comprised more than two-thirds of consolidated revenue. Robust winter sales in Europe will add to consolidated revenue for the next couple of quarters.
Robust sales and falling rubber prices should improve profit margins and net profit until fiscal 2014. According to Surjit Arora, analyst, Prabhudas Lilladher Pvt. Ltd, “Apollo’s earnings growth trajectory is unlikely to be under pressure on account of current equity dilution. In fact, the return on equity is likely to move up to around 19% by fiscal 2014 from the present 15%.”
Under the present circumstances, analysts concede that the one-year estimated earnings per share (EPS) is discounted around six times. Even in the event of a 15-20% dilution, the future EPS is discounted around seven times, leaving room for appreciation. Stable or falling rubber prices would only protect downsides and improve valuations from current levels.