Morgan Stanley is positive on India's tyre market on stable volume outlook, improving margin and return ratios.
The research house also favours India over exports to the EU and the U.S., according to its report. That prompted an ‘overweight' rating on Apollo Tyres Ltd. as it focuses on passenger and commercial vehicle tyre space in India and the EU.
It also initiated coverage on Balkrishna Industries Ltd. but with an ‘underweight' rating as the company's engaged in off-highway tyre exports.
India, according to the report, accounted for 68% of Apollo's FY22 sales, but only 17% of Balkrishna's.
Morgan Stanley's target price for Apollo Tyres was at Rs 329 apiece, implying a potential upside of 31%. Its target price for Balkrishna Industries was at Rs 1,649 apiece, implying a 17% potential downside.
Of the 32 analysts tracking Apollo Tyres, 24 maintain 'Buy', one suggests 'Hold' and seven recommend 'Sell', according to Bloomberg data. The average of analyst price targets implies a return potential of 4% on the stock. The company's shares fell as much as 1.2% in early trading on Tuesday and were trading 0.3% lower as of 9:40 a.m.
Of the 28 analysts tracking Balkrishna Industries, 14 maintain 'Buy', five recommend 'Hold' and nine suggest 'sell'. The return potential of the stock is 9.1%. It was trading 0.4% lower in early morning trading on Tuesday.
Morgan Stanley estimates a 33% annualised earnings growth for Apollo Tyres in FY22-25, compared to 9% for Balkrishna. Apollo trades at 0.6 times its price-to-earnings growth, while while Balkrishna trades at 3 times.
The research house expects Apollo's return-on-equity to expand from 6% in FY22 to 11% in FY25. Balkrishna's RoE, however, is likely to narrow from 21.8% to 19% during this period, as its revenue growth slows and capex needs rise.
Apollo Tyres is looking at an RoE expansion and subsequent rerating, which will make valuations “attractive”. While Balkrishna has a superior business model, Morgan Stanley said the risk-reward was “unattractive” given the slowing growth and pressure on return ratios.
Apollo Tyres is likely to see stable domestic volumes and improving export volumes on strong market positioning and export-suitable portfolio. The company's financials will also benefit from pricing growth in conjunction with softening commodity headwinds, Morgan Stanley said.
Apollo has been investing toward capacity expansion, brand building, improving R&D as well as distribution efforts over the past few years, and will see incremental rise in asset turnovers, the report said.
Balkrishna, however, is expected to register slower volume growth despite an increase in market share, Morgan Stanley said. A delay in passing on the rising input costs will see margins improve, but at a slower rate. It also sees elevated capex requirements keeping return ratios under pressure.
Morgan Stanley expects a sustained replacement demand in the EU, market share gains in the U.S. and India, and a steep fall in commodity prices as upsides for India's tyre sector. A slowdown in the EU, continued commodity headwinds, and weakness in pricing environment are certain downside risks.
The replacement demand has been stable, while demand from vehicle OEMs is also returning, Morgan Stanley said. It estimates these two segments to grow at an annualised rate of 4.3% and 11%, respectively, over 2021-25.
Also, a switch to electric mobility will require minimal capex and R&D investments for tyremakers, shielding them from the ensuing disruption.
While high crude oil prices and commodity crisis dragged margins for tyre companies in the fiscal ended March 2022, softening commodity prices, improvement in price discipline and premiumisation are now likely to lead to margin expansion.
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