Apollo Tyres Trades Volume for Value in Strategic Overhaul

Despite being a prominent player in the Indian tyre industry, particularly in the truck segment, Apollo Tyres, headquartered in Kochi and established in 1972, had become an "ugly duckling" for investors about five years ago. This was largely due to its high debt burden, concerns over cost efficiencies, and issues with capital allocation.

Many investors also kept their distance because they still remembered the company's contentious acquisition battle for the U.S.-based Cooper Tires, where management was perceived as overly aggressive in trying to elevate the company into the top ten global tyre manufacturers. As a result, Apollo Tyres was assigned a lower valuation multiple compared to its competitors.

However, the tide seems to have turned. The company has begun to focus on improving its financial performance, a shift supported by the involvement of U.S.-based private equity firm Warburg Pincus, which acquired a stake of around 10% through convertible preference shares in 2020. 

The volatility in the company’s financial performance can be assessed by looking at its Return on Equity (RoE) numbers through the years. It fell to single digits in FY18 and FY19 from the 19-20% range seen in FY16 and FY17. Additionally, due to COVID-related disruptions, the RoE reached a multi-year low of 4.77% in FY20, with annual profits shrinking to just Rs 500 crore on a topline of Rs 16,350 crore. By FY21, gross debt ballooned to Rs 7,333 crore – nearly double the Rs 3,436 crore level in FY17 – resulting in a market capitalisation of just Rs 10,000 crore. 

Recognising these pressures, and under the guidance of Warburg Pincus, the management began implementing corrective measures to improve profitability and repair the balance sheet. The company underwent a complete transformation, shifting its focus from "growth at any cost" to sustainable, profitable growth while maintaining healthy top and bottom lines.

Efforts included optimising the product mix by increasing the share of passenger vehicles – which have better profitability – promoting premium products with larger rim sizes, and expanding into new markets in Asia, the Middle East, and North America.

Internally, Apollo implemented several initiatives aimed at reducing costs and enhancing manufacturing efficiencies. The management realised that eliminating unnecessary costs is crucial for distinguishing a profitable company from a struggling one in an increasingly competitive global landscape. Furthermore, the company became more judicious with capital expenditure (capex). Traditionally, tyre companies expand capacity towards the end of an economic cycle, which compresses return ratios; Apollo opted for a more strategic approach, including exiting lower-margin automotive segments.
 
These improvements gradually began to reflect in the company’s financials. The share of passenger car volumes in the Indian business rose to 22% in FY24, up from 17% in FY19, while the cyclical truck business fell to 55% from 60% in FY21. Contributions from the lower-margin truck and bus bias (TBB) segment dropped to 19% of revenue in FY24 – a reduction of 400 basis points from FY20.

Additionally, the export share increased to 12% in FY24, a gain of 300 basis points. The shift to a richer product mix boosted net realisation per kilogram, even as volume growth remained subdued. Indian business volume growth averaged 2.6% annually, reaching 680,448 tons between FY19 and FY24, while revenue grew by 7% annually during the same period. This indicates that net realisation per kilogram has been a primary driver of the company’s success, with realisation rising to Rs 257 in FY24 compared to Rs 207 in FY19—a 4.4% annual growth.
 
The strategic focus on profitability has yielded impressive results, positioning Apollo Tyres as the most profitable company in terms of EBITDA per kilogram among peers like CEAT and MRF. Interestingly, while gross margins per kilogram for all three tyre manufacturers ranged from Rs 103 to Rs 109 in FY24, Apollo's EBITDA per kilogram was Rs 45.5, compared to CEAT's Rs 36.1 and MRF's Rs 42.9.

This Rs 45.5 figure marks a record high for Apollo and is nearly double the five-year average. This achievement suggests that Apollo has better managed its employee costs and other expenses than its peers, leading to industry-leading EBITDA figures. Employee costs per kilogram for Apollo stood at Rs 16.3 in FY24, while CEAT and MRF reported Rs 18.5 and Rs 18.4, respectively.

In European operations, while revenue decreased by 2.6% to €671 million, the operating profit margin expanded to a multi-year high of 17%, primarily due to an increased share of ultra-high-performance tyres. Consequently, the company’s net profit rose to Rs 1,721 crore in FY24 from Rs 476 crore in FY20 on a consolidated basis.

This higher profit generation enabled Apollo to achieve superior free cash flow—after capex—amounting to Rs 2,240 crore in FY24, up from Rs 847 crore the previous year. As a result, the company was able to deleverage its balance sheet, with net debt declining to Rs 2,526 crore in FY24 from a peak of Rs 6,473 crore in FY20.

The net debt-to-EBITDA ratio improved to 0.6 in FY24 from 3.3 in FY20, validating the company’s deleveraging strategy. The intensity of capex also decreased, with total expenditure at Rs 673 crore in FY24, lower than the guided capex of Rs 750 crore. Between FY17 and FY20, Apollo had an annual capex of Rs 2,000-3,000 crore.
 
The improved financial performance has been rewarded by the market, with Apollo’s market capitalization rising to Rs 30,000 crore and its stock trading above its historical average price-earnings multiple, signaling higher expected earnings growth. Local mutual funds hold a 19.23% stake, making them the second-largest shareholders after promoters, who hold 37.36%.

Notable investors like LIC and the Government of Singapore held stakes of 3.92% and 1.91%, respectively, as of June 2024, according to BSE. With these improving business dynamics and the backing of Warburg Pincus, the company announced its Vision 2026 in 2023, aiming for revenues of $6 billion by 2026.

The performance in FY24 has surpassed several long-term targets set for FY26 ahead of schedule. The company has already achieved an EBITDA margin of 17%, compared to its target of over 15%. Additionally, Return on Capital Employed (ROCE) reached 16%, significantly surpassing the target range of 12% to 15%. This disciplined financial management is further evidenced by a Net Debt to EBITDA ratio of 0.6x, well below the target of less than 2x. These accomplishments underscore Apollo’s commitment to sustainable and profitable growth.
 
In FY24, the truck and bus segment accounted for 41.8% of consolidated business, followed by passenger cars at 38.1%, off-highway vehicles at 8.5%, light trucks at 6.2%, and others making up the remainder. The consolidated revenue includes operations in Europe, where products are sold under the Vredestein brand. The Asia-Pacific, Middle East, and Africa regions contributed 71% of revenues, with Europe (primarily Vredestein) accounting for 26%.

The standalone business reported total revenue of Rs 17,539 crore, largely from India, while European operations generated €671 million in FY24, collectively contributing to the consolidated revenue. In the standalone context, the truck and bus segment contributed 55% of revenues, followed by passenger cars at 23%, light vehicles at 7%, farm vehicles at 6%, and others at 8% in Q1 FY25.

On the downside, the higher operating profit has come at a cost. Industry veterans believe Apollo has consistently lost market share in several segments by prioritizing returns over market share, resulting in a diminished share of replacement business revenue.

This loss of market share is evident in revenue growth comparisons over the last eight quarters with CEAT and MRF, where it lagged its counterparts. In Q1 FY25, Apollo's standalone revenue growth was 4%, while CEAT and MRF recorded growth rates of 8.5% and 11.5%, respectively.

In a recent interaction with investors, the company acknowledged its underperformance relative to peers and stated that it would revise its pricing strategy to regain lost market share. Additionally, competitors have been adopting aggressive pricing strategies, particularly in the truck segment, which is a forte for Apollo. The company has struggled to raise prices for truck tyres compared to other segments, making it difficult to pass on increased costs to fleet operators.
 
Moreover, rising raw material costs are emerging as a challenge, with natural rubber prices – constituting about 40-45% of raw material costs – reaching record highs, which is beginning to impact margins this fiscal year. In Q1 FY25, Apollo’s EBITDA per kilogram fell to Rs 37.2 as raw material costs rose by 7.7% quarter-over-quarter to Rs 167.2 per kilogram, while realizations only increased by 3.4%.
 
The focus on profitability has worked for Apollo Tyres, but it has come at the expense of losing market share over the past four years, during which the Indian tyre industry experienced growth. Total industry revenue increased to Rs 95,000-98,000 crore at a CAGR of 9.6% from FY18 to FY24.

However, the industry is now shifting toward low single-digit growth, and pricing wars are becoming more intense. Consequently, the company must find a balance between profitability and market share to achieve revenue growth of more than 10% in the medium term.

In a recent note on Apollo Tyres, Kotak Institutional Equities stated that while demand in the European business is expected to improve in the coming quarters, demand trends in India may remain muted compared to peers due to aggressive pricing strategies, particularly in the truck and bus segment.

The note further indicated that near-term headwinds persist, given the sharp rise in natural rubber prices, which will impact profitability. The company will need to balance growth and profitability while addressing its ongoing market share losses and will likely adopt a cautious approach to price increases compared to peers in the coming quarters.