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Home / Markets / Mark To Market /  For Apollo Tyres, the road ahead is slippery

Tyre companies are the latest to join the list of sectors seeing earnings downgrades. As such, the recent management commentary by Apollo Tyres Ltd is likely to keep spirits of investors muted, for now.

Price increases in its India replacement market would continue to lag commodity cost inflation, the management said at its Corporate Day 2022 held on 17 June. The raw material basket is likely to rise by 3-4% in the June quarter (Q1FY23) and a further increase is expected in Q2FY23, it cautioned. “The commentary on margins was a negative surprise. Post the fourth quarter earnings of FY22, gross margin compression was expected to have bottomed out, but investors need to brace for more margin pressure. This does not bode well for the stock’s short-term earnings performance," said an analyst requesting anonymity.

Slippery slope
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Slippery slope

Recently, brokerage house Kotak Institutional Equities downgraded its ratings and trimmed the target price for shares of Apollo Tyres, MRF Ltd, and Ceat Ltd, saying that gross margins of domestic tyre companies will continue to remain under pressure because of multiple headwinds.

To cope with cost inflation, Apollo hiked prices by 3-4% in Q1FY23 in India market. As the cost pressures are severe in Europe, prices have been raised by almost double-digits in this quarter. Natural rubber, carbon black and other crude-based inputs are key raw materials to manufacture tyres. From January to May 2022, crude oil prices have risen by around 52% and rubber prices are up by nearly 7%, the management said. Crude derivatives form a major portion (over 40%) of raw material costs. Thus, the near-term stock performance of Apollo Tyres would depend on the movement in crude prices, analysts at Emkay Global Financial Services Ltd said in a report.

Price hikes have not moved the stock. So far this calendar year, shares of Apollo Tyres have declined by 20%. Stocks of competitors Ceat and JK Tyre & Industries Ltd have seen a bigger correction. Investors worry that recent price hikes by tyre companies may not be enough to offset the impact of cost inflation.

Meanwhile, the firm’s management said that it expects modest recovery in domestic demand driven by original equipment manufacturers. Further, its Vredestein launch in India has received good response in both the two-wheeler and four-wheeler segments. “We expect near-term challenges for the tyre industry because of high commodity inflation and strong rebound in volumes and commodity softening in 2HFY23. This would bring margin improvement and a better earnings scenario," said Mitul Shah, head of research, Reliance Securities. Over next five years, Apollo Tyres plans to achieve a consolidated revenue of $5 billion with an earnings before interest, tax, depreciation, and amortization margin of over 15%.

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