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JK Tyres: Buy


The improved product mix in favour of high value, high margin radial and OTR tyres will benefit the company in terms of greater realisations and healthier margins.


Parvatha Vardhini C

Investors can consider buying the JK Tyres stock with a two-three year perspective. The company is the third largest manufacturer of tyres in India with a market share of 17 per cent. While the commercial vehicles segment brings in 75 per cent of the revenues, passenger vehicles chip in with the rest.

As is the case with most companies, bulk of these earnings (over 60 per cent) comes from the replacement market; exports contribute 14 per cent to the revenues.

Volume growth resulting from capacity expansion, increased demand from OEMs and an improved product mix in favour of radial and OTR (off-the-road) tyres suggest good earnings prospects. At the current market price of Rs 130, the stock trades at around a 5 times trailing 12-month (TTM) earnings. This valuation is at a discount to bigger players such as MRF and Apollo Tyres, which quote at about 10 times their TTM earnings.

Demand Scenario

The replacement market has been the key driver of growth for the industry so far. But the buoyant trends in automobile sales in the past few years has enabled the company step-up its supplies to OEMs. JK Tyres is the exclusive supplier for the Swift, SX4 and the Zen Estilo from Maruti and the Logan from the Mahindra stable.

The company will also be supplying to the Nano. The success of the Swift and the SX4 and the potential market for the Nano will translate into higher revenues for the company.

Besides, the duty cuts on buses and trucks announced in the Budget, coupled with the possibility of a softer interest rate regime, may provide a fillip to the commercial vehicle industry, which has otherwise been reeling under a slowdown in the medium and heavy commercial vehicles segment. JK Tyres, a supplier to Tata Motors, Force Motors and Volvo is a likely beneficiary from this revival.

Radial and OTR tyres

India has low levels of radialisation at less than 5 per cent for trucks and buses due to constraints such as higher costs and maintenance involved and poor road infrastructure. The fast improving highway infrastructure, the Supreme Court ban on the overloading of vehicles and the move towards a hub and spoke model are expected to indirectly rev-up the demand for radial tyres as they offer better fuel efficiency, have longer life and turn out to be cheaper in the long run.

The company already has the first mover advantage in the manufacture of radial tyres for commercial vehicles where its market share is around 80 per cent. To cater to this expected increase in demand, the company plans to increase its radial tyre capacity to 10 lakhs by FY-09 and 12 lakhs by FY-11.

Besides, the company is also increasing its capacity in the OTR segment. It has entered into a tripartite agreement with Bharat Earth Movers (BEML) along with Apollo tyres for the manufacture and supply of OTR tyres. The company will, thus, be able to ride on the construction boom to bring in higher revenues. The improved product mix in favour of high value, high margin radial and OTR tyres will also benefit the company in terms of greater realisations and healthier margins.

Financials

For the quarter ended December 2007, net sales grew by 10 per cent to Rs 723 crores on a year-on-year basis and net profits, by 175 per cent to Rs 22 crore. EBITDA margins also improved from around 8 per cent to 10.6 per cent. But both profits and margins have declined marginally on a sequential basis. This can partly be attributed to the firm trends in raw material prices.

Concerns

The reduction in Cenvat duty in the budget has been a welcome relief and the company has already announced price cuts to pass on the benefit to its customers. But with the reduction passed on, operating margins are likely to be under pressure due to firm trends in the prices of natural rubber and crude oil based raw materials. Any increase in prices pegged to increase in cost of raw materials could face resistance from its OEM customers. Net margins may also be affected from increased depreciation and interest costs due to ongoing capacity expansion.

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