sa_ report

A REPORT

ON

THE INDIAN TYRE INDUSTRY

By

Harsha Verma 09BSHYD0310

Nehal Basedia 09BSHYD0509

Prabani Phukan 09BSHYD1064

Jitendu Kumar Dixit 09BSHYD0336

Sandeep Kumar Gupta 09BSHYD0733

Date of Submission: September 03, 2010

The Indian Tyre Industry 2010

TABLE OF CONTENTS

Acknowledgement.................................................................................................................. 4

Executive Summary................................................................................................................. 5

Introduction.............................................................................................................................. 7Purpose of Report.................................................................................................................................................7Scope of the Report...............................................................................................................................................7

Phase I: Industry Analysis............................................................................................................................7Phase II: Test of Efficiency of Market......................................................................................................7Phase III: Company Analysis.......................................................................................................................7

Scope of Study.........................................................................................................................................................7Limitations of Study.............................................................................................................................................8

Methodology............................................................................................................................. 8Methods of data collection and their sources...........................................................................................8Event Study.............................................................................................................................................................. 8Free Cash Flow....................................................................................................................................................... 9WACC.......................................................................................................................................................................... 9Cost of Equity.......................................................................................................................................................... 9Cost of Debt........................................................................................................................................................... 10Miscellaneous.......................................................................................................................................................10

Phase I: Industry Analysis.................................................................................................. 11Industrial Overview...........................................................................................................................................11Company Profiles................................................................................................................................................19

MRF Ltd............................................................................................................................................................. 19Apollo Tyres Ltd.............................................................................................................................................20CEAT Ltd............................................................................................................................................................20JK Tyres & Industry Ltd..............................................................................................................................21

Phase II: Test of Market Efficiency..................................................................................22Results and Analysis..........................................................................................................................................24

Phase III: Company Valuation........................................................................................... 25Apollo..................................................................................................................................................................25JK...........................................................................................................................................................................26MRF......................................................................................................................................................................28CEAT....................................................................................................................................................................29

Competitors Analysis........................................................................................................... 31Liquidity Ratios................................................................................................................................................... 31Leverage Ratios...................................................................................................................................................33Activity Ratios...................................................................................................................................................... 34Profitability Ratios.............................................................................................................................................36

Conclusion............................................................................................................................... 39

Recommendations................................................................................................................ 39

Bibliography........................................................................................................................... 40

Security Analysis Project Report


List of Figures

Figure 1: Category wise Tyre Production in India.....................................................................................12Figure 2: Tyre Demand by Market....................................................................................................................15Figure 3: Cumulative Excess Returns and Abnormal Returns around Announcement date.24Figure 4: Valuation of Apollo..............................................................................................................................25Figure 5: Stock Price Movement of Apollo....................................................................................................26Figure 6: Valuation of JK.......................................................................................................................................27Figure 7: Stock Price Movement of JK.............................................................................................................27Figure 8: Valuation of MRF..................................................................................................................................28Figure 9: Stock Price Movements of MRF......................................................................................................29Figure 10:Valuation of CEAT...............................................................................................................................30Figure 11:Stock Price Movement of CEAT....................................................................................................30

List of Tables

Table 1: Data for Indian Tyre Industry Year 2008-'09............................................................................11Table 2: Current Ratio............................................................................................................................................31Table 3: Quick Ratio................................................................................................................................................31Table 4: Cash Ratio..................................................................................................................................................32Table 5: Net Working Capital Ratio..................................................................................................................32Table 6: Debt Ratio..................................................................................................................................................33Table 7: Debt-Equity Ratio...................................................................................................................................33Table 8: Interest Coverage Ratio.......................................................................................................................34Table 9: Inventory Turnover and Days of Inventory................................................................................35Table 10: Debtors Turnover & Collection Period......................................................................................35Table 11: Gross Profit Margin.............................................................................................................................36Table 12: Net Profit Margin.................................................................................................................................37Table 13: Return on Equity..................................................................................................................................37Table 14: Earnings Per Share..............................................................................................................................38



Acknowledgement

Hard work, guidance and perseverance are the prerequisites for achieving success.

Support from an enlightening source helps to tread on the path to it.

We would like to express my profound gratitude to all those who have been

instrumental in completion of the project.

We are deeply grateful, to Dr. Ajay Kumar Panda.

A thank you is also deserved for the all our friends for their support and

cooperation.



Executive Summary

The project deals with analysis of Tyre Industry, Indian Market and then finally the

Companies in ITI.

ITI is growing with Compounded Average growth Rate (CAGR) of 15%. Year 2009

had a turnover of Rs. 22500 Crores1 and annual tyre production of 821 Lakh. There

are 36 tyre manufacturing companies operating in India, however, 10 large tyre

companies account for over 95% of total tyre production. Currently 98% of

production contributes for Passenger Car tyres, 18% for Light Commercial Vehicles

(L.C.V) and 8% for Heavy Vehicles2.

ITI has an oligopoly kind of market structure. There is limited number of players in

the market. This is mainly due to the capital intensive nature of the Industry. In our

study we have taken major players of ITI for our analysis purposes. The Industry as

a whole has been analyzed focusing the market structure the competitive

environment and factors driving demand and supply in the industry. The project

also deals with a test of market efficiency which confirms the impression that we

have a semi strong form of efficient market.

It is concluded from the even study test that Indian Market is semi-strong form of

efficient market. Hence stock prices do not always reflect all the information. This is

also justified by means of our valuation results. As it is observed that only one stock

(JK) is correctly valued in stock market rest all are either undervalued or

overvalued.

1 Source: Automotive Tyre Manufacturers' Association – Year 20092 Source: www.atmaindia.org



The impact of global meltdown can be very easily observed by the fluctuating ratios

over the past three years. Since ITI is a highly capital intensive industry the

Liquidity ratios are not very high.

Days of inventory is also very high, this is mainly because the companies usually

maintain reasonable inventory level at each warehouse and this results in higher

rates of inventory.

The gross profit Margin of the firms is around 20% on an average across companies

whereas the Net Profit Margin is only around 2.5% on an average across the

companies.

Based on the valuation done it is recommended that Investor should invest into

Apollo and CEAT as the stocks are very much undervalued. Therefore, investor can

earn capital gains in near future. They should sell off MRF stocks as it is highly

overvalued.

Tyre companies have very high days of inventory therefore they should devise a

strategy to reduce it.



Introduction

Purpose of Report

The report provides an insight about the research done for the Indian Tyre

Industry by our group.

Scope of the Report

The report talks about the Industry Analysis of ITI and Company analysis of

four major companies in this industry.

Phase I: Industry Analysis

This phase deals with background of ITI and different players in this

industry.

Phase II: Test of Efficiency of Market

This phase deals with Test of efficiency of Market Using Event Study

technique.

Phase III: Company Analysis

This phase deals with analysis of four major companies in this industry, viz.

MRF, Apollo, JK and CEAT.

Activities included are as follows:

Valuation of all the selected four companies using Free Cash Flow to

Equity Model.

Comparison of all the four companies by using different ratios.



Scope of Study

The general purpose of the project is to study and analyze ITI and to apply various

tools, techniques and theoretical concepts learnt into practical scenario. In defining

the limits of the study areas to be addressed were identified. A careful review of

those areas led to the development of following specific project objectives:

To do a test for Market Efficiency

To analyze Industry Structure and competitive environment.

To do valuation of Equity of chosen five companies by using Free Cash

Flow to Equity Model

To do a comparative analysis of chosen four firms by means if ratio

comparison.

Limitations of Study

Data regarding certain specific problem/question could not be obtained

because they are considered too sensitive to be disclosed by the

company.

Some level of subjectivity is involved while doing valuation with respect

to the assumptions made, which could bring in some partiality to the

recommendations made.

The study is based on secondary data.

Methodology

Methods of data collection and their sources

Secondary data is used for the project.

Data is collected from www.moneycontrol.com and prowess


http://www.moneycontrol.com/


Event StudyThe event study methodology is designed to investigate the effect of an event on a specific

dependant variable. A commonly used dependent variable in event studies is the stock price

of the company. The definition of such an event study will be ‘a study of the changes in stock

price beyond expectation (Abnormal returns) over a period of time (event window). We

attribute the abnormal returns to the effects of the event.’ The event study methodology

seeks to determine whether there is an abnormal stock price effect associated with an

event. From this, the researcher can infer the significance of the event.

The key assumption of the event study methodology is that the market must be efficient.

Given an efficient market, the effects of the event will be reflected immediately in the stock

prices of the company. This will allow us to observe the economic effect of the event over a

relatively short period

Free Cash FlowFree cash flow (FCF) reflects the amount of cash free for distribution to both debt

and equity shareholders. Firstly, the EBIT is calculated based on the historical data.

A projected EBIT for the next two years are computed less tax. Then the non cash

items such as depreciation are added and the capital expenditure is deducted and

finally adjustments for working capital are also done. The final gross figure is the

free cash flow to the firm.

WACCWeighted average cost of capital (WACC) is the average of debt and equity capital

costs that all publicly traded companies with debt and equity stakeholders incur as a

cost of operating. We provide the details behind our WACC calculations:



Cost of EquityThe cost of equity calculation is based on the capital asset pricing model

methodology. Though there are many other more complicated approaches for

arriving at a firm’s cost of equity, we do not feel their additional complexity offers

commensurate accuracy. CAPM is simple, close enough approach, and is easy to

implement consistently across all companies that is analyzed.

The market value of equity is used when calculating the debt to total market capital

ratio that is used in the cost of equity calculation.

The equity risk premium is based on a last five year mean average market return of

SENSEX.

Beta was extracted from Prowess

Cost of Debt The cost of debt capital is equal to a business’s long-term marginal borrowing rate.

The risk-free rate (RFR) is approximated by the 10-year Indexed Indian T-Bill.

Miscellaneous The terminal rate is an adjusted rate based on the economic activity, sector growth

and the tax regime for the sector. Subsequently, this rate is extracted from various

research papers available online.

Except for Reserve and surplus, all other items in Sources of funds in BS are

assumed to be same. The allocation of funds or Assets is calculated on percentage of

total liabilities.

The projected P&L is based on percentage of sales approach till the EBIT.

Tax rate is based on the current tax paid. The break up of tax is grossed and clubbed

into one and divided by PBT (profit before tax) to get the effective tax rate.



Phase I: Industry Analysis

Industrial Overview

Indian Tyre Industry (ITI) originated in year to 1926 with Dunlop Rubber Limited

set up in West Bengal. MRF followed it in 1946. Since then, Indian tyre Industry has

grown rapidly.

Although the tyre industry faces huge competition, price and cost pressure and high

entry barriers yet zooming auto industry has driven the growth for ITI, keeping both

Original Equipment Manufacturers (O.E.M) and replacement demand buoyant.

ITI is growing with Compounded Average growth Rate (CAGR) of 15%. Year 2009

had a turnover of Rs. 22500 Crores3 and annual tyre production of 821 Lakh. There

are 36 tyre manufacturing companies operating in India, however, 10 large tyre

companies account for over 95% of total tyre production. Currently 98% of

production contributes for Passenger Car tyres, 18% for Light Commercial Vehicles

(L.C.V) and 8% for Heavy Vehicles4.

Financial Year 2008-2009 (Est.)Turnover of Indian Tyre Industry Rs. 22,500 Crores Tyre Production – All Categories (Nos.)

821 Lakh

Tyre Export from India (Value) : Rs. 3500 (est) crores Number of tyre companies: 36Industry Concentration 10 Large tyre companies account for over 95%

of total tyre production.Radialisation Level - Current(as a % of total tyre production)

Passenger Car tyres: 98%Light Commercial Vehicles: 18%Heavy Vehicles ( Truck & Bus ): 8%

Source: ATMA

Table 1: Data for Indian Tyre Industry Year 2008-'09

3 Source: Automotive Tyre Manufacturers' Association – Year 20094 Source: www.atmaindia.org



CAGR for the Passenger Car tyre Category, L.C.V, scooter, motor cycle and Off the

Road (O.T.R) has been 16 %, 10%, 13%, 16% and 18% respectively from year 2007

to 2009. O.T.R tyres category is growing at a fast pace. Most of the top players are

increasing their production capacity of O.T.R.

0 5000 10000 15000 20000 25000 30000 35000

Truck & Bus

Jeep

Tractor Front

Tractor Trailer

Scooter

Moped

O.T.R.

2008 - 09

2007 - 08

2006 - 07

Source: ATMA

Figure 1: Category wise Tyre Production in India

ITI is two tiered; Tier I players (top five companies), account for over 80% of

industry turnover and have diversified product mix consisting of Replacement

Market, OEM’s and exports. Tier II companies are small in size, mainly concentrating

on production of small tyres, tubes & flaps and the replacement market5.

ITI exports to over 65 countries. For the year 2009, exports has increased with a

CAGR of 13%6

The characteristics of the industry are raw material intensive, cyclicality,

competition, wide distribution network, capital intensive, low bargain power, brand,

5 Source: www.way2wealth.com The Indian Tyre Industry – Rolling on the drive : Way 2 wealth

6 Source: www.atmaindia.org


http://www.way2wealth.com/


technology requirements and duty structure. Demand drivers are vehicle

production and population, regulatory norms, retreading of tyres etc.

Demand

The demand for tyres can be classified in terms of:

Type: Bus and Truck; Scooter; Motorcycle; Passenger Car; Tractor

Market: OEM; Replacement; Export

Tyres by Type

The Indian tyre industry produces the complete range of tyres required by the

Indian automotive industry, except for aero tyres and some specialized tyres.

Domestic manufacturers produce tyres for trucks, buses, passenger cars, jeeps, light

trucks, tractors (front, rear and trailer), animal drawn vehicles, scooters,

motorcycles, mopeds, bicycles and off-the-road vehicles and special defense

vehicles.

The scenario in India stands in sharp contrast to that in the world tyre market,

where car tyres (including light trucks) have the major share (88%) by volume

followed by truck tyres (12%). In India, however, passenger car tyres have a mere

more than 20% share of the overall tyre market. (As of FY2009).

Truck and Bus Tyres

The truck and bus tyre segment accounted for large percentage of tyres produced in

India in FY2009. Every truck/bus manufactured generates a demand for seven tyres

(six regular and one spare) as against three in the case of two-wheelers and five for

passenger cars. In addition, the price of a truck tyre is significantly higher than that

of a passenger car tyre (roughly 10 times) or a motorcycle tyre. Thus the demand



multiple emanating from the commercial vehicle segment is highest in value terms.

Given the regular use and heavy wear and tear of truck and bus tyres, the demand

from the replacement market in this segment worked out to 68% of the total

demand for truck and bus tyres in FY2009; the OEM demand accounted for around

9% the same year. With the Indian manufacturers of cross-ply tyres focusing on the

export market, this segment accounts for around 22% of the demand for truck and

bus tyres.

Passenger Car Tyres

The passenger car tyre segment accounted for 17% of all tyres produced in India in

FY2009. With passenger car production witnessing a growth of 12% in FY2009 over

the previous year, OEM demand accounted for about 33% of the total sales that

year. The replacement market accounted for around 63% of the total sales of

passenger car tyres in FY200. Exports accounted for 4% of the total passenger car

tyre demand in FY2003. With the stock of cars increasing, replacement demand is

likely to continue.

Motorcycle Tyres

Motorcycles accounted for 76% of two-wheelers sold in the domestic market in

FY2009. Motorcycle tyres constitute the largest segment of the domestic tyre

industry (29% of total tyre demand in FY2009). The replacement market accounted

for around 49.8% of the total motorcycle tyres sold in FY 2009, while OEM demand

accounted for around 50%.

Scooter Tyre

Scooters were the dominant segment in the Indian two-wheeler industry till

FY1998, accounting for around 42% of domestic two-wheeler sales. However, the



introduction of new motorcycle models has seen the share of scooters declining to

19% of domestic two-wheeler sales in FY2009. The OEM segment accounted for

around 34% of the total sales in the scooter tyre segment in FY2009, with the rest

being accounted for by the replacement market.

74%

11%

14%

ReplacmentExportOE

Figure 2: Tyre Demand by Market

Vehicle Manufacturers or OEMs

The demand from the OEM segment is a derived one and directly correlated to the

level of automotive production. The OEMs demand varies significantly across

categories from between 8% for truck and bus tyres to over 50% for some other

segments like, jeeps and mopeds.

Replacement Market

The replacement market, including State transport undertakings and Government

buying, accounted for around 59% of the total tyre demand in FY2009. The demand

in the replacement market depends on the vehicle population, the level of economic



activity, life of the products transported, kilometreage per vehicle, the price of the

tyres and the quality of the existing road infrastructure. Additionally, the

replacement market, which offers better margins, is extremely competitive. The

replacement market is dominated by the truck and buses segment, which accounted

for 22% of all tyre sales in the replacement market in FY2009.The large size of the

replacement in turn is determined by the interplay of various factors as discussed

below:

The replacement demand may be lower because of longer replacement

intervals and lower business mileage if the economic activity slows down.

Replacement demand in India is higher because of a low vehicle scrappage

rate.

Poor road conditions by lowering the life of tyres, have a positive impact on

replacement demand.

Stricter enforcement of the MV Act, which seeks to prevent overloading of

vehicles, will result in an increase in the life of tyres and thus impact

replacement demand negatively.

Applying a new tread or "re-treading" can extend the life of the tyre at a

significantly lower cost, thereby lowering replacement demand. In India, re-

treading finds greater acceptance in the commercial segment.

Radialisation of tyres is likely to result in lower replacement demand. While

car radialisation in the country has reached a level of 65%, truck and bus

radialisation stands at just 2-10%. Poor road and support infrastructure as

well as traditional vehicle designs act as a barrier to radialisation in the

commercial vehicle segment. Radial technology for trucks and buses would

help increase operating efficiencies by delivering better mileage and

minimising wear and tear. According to ATMA, even if only 25% of the truck

and bus segment is radialised, the savings in fuel costs would be around Rs.

7,500 million.



Introduction of tubeless tyres in the passenger car segment is also likely to

affect replacement demand adversely.

Introduction of eco-friendly radial tyres such as hyper-bonding silica

technology in the passenger car segment may affect replacement demand

adversely.

Exports

In the light of the prevailing domestic market situation, most of the tyre

manufacturers have taken to exports to reduce inventory build-ups. In FY2003,

Indian tyre exports stood at Rs. 10.8 billion (10% of the total industry) in value

terms and 3.1 million in unit terms (6.5% of total production). Indian companies

have currently entered into sourcing agreements (for tyres) with neighboring

countries. For instance, Ceat and J K Tyres have sourcing agreements with tyre

producers in Sri Lanka and China. This is likely to have a positive impact on tyre

exports from India.

Challenges faced:

High tax usage

The high tax content on tyres can be gauged from the fact that the percentage of

total tax to the tax excluded price for various categories of tyres is - 44% for Truck

Tyre; 41% for Passenger Car Radial Tyre, 35% for Tractor Rear Tyre and 76% for

Truck Tyre Tube

Increase in raw material costs

Apart from being capital intensive, the tyre industry is highly raw material

intensive. Any change in the prices of raw materials affects the profitability of tyre

companies. The raw materials used in the manufacture of tyres are rubber and

petroleum derivatives like nylon tyre cord, carbon black, styrene butadiene rubber



and poly butadiene rubber. The most important raw material is rubber-natural and

synthetic. Natural rubber (NR), with 29% weight age in the cost of raw materials

used by tyre industry, is the highest cost item. Annual consumption of NR by tyre

industry is 3.50 lakh tones, valued at Rs. 14 billion. Over 85% of NR consumed' by

the industry is procured domestically 15% is imported.

Import of Tyres

During the FY2005, over 1, 10,000 passenger car tyres were imported. Although this

constitutes a small percentage (1.5%) of total passenger car tyre production in the

country, since total imports are of radial passenger car tyres, the percentage is

higher when compared against domestic production of radial passenger car tyres. A

large percentage of imports are from South Korea at a concessional rate of customs

duty (i.e. 15%) under the Bangkok Agreement - as against 20% normal rate of

customs duty.

Even though the Government has imposed a restraint on the import of used tyres

into India, occasionally there are reports of import of such tyres in a clandestine

manner, sometimes as new tyre at low value, since there is no restriction on import

of new tyres or as tyres under the "others" category. Many countries such as Japan,

Bangladesh, Pakistan, Philippines, Thailand, Kenya, South Korea, etc. have either put

a complete ban on import of used tyres or have placed stringent conditions on such

imports.

Tyre Exports

The product focus of tyre exports from India has been Traditional Truck Tyres.

Globally this segment of tyre export is shrinking due to greater acceptance of radial

tyres. Over the years, China has emerged as a major exporter in bias tyre category.

Additionally, export of Indian tyres to select countries is subjected to non-tariff

barriers (NTBs) by way of standards, tests, etc. Export of cheaper tyres from China



to major tyre importing markets, like US, is adversely affecting Indian tyre exports

to these markets. India's share in exports to these countries (especially USA) is

progressively declining. If the trend is not reversed, Indian tyre industry will find it

extremely difficult to regain its erstwhile position in these markets. Low rate of

interest, cheaper electricity tariff, and hidden subsidies by the Chinese Government,

better infrastructure facilities and lower transaction costs are factors favorable to

Chinese tyre industry.

Demand Supply Gap

The demand for tyres is either in the domestic market or in the export market. As

far as domestic demand is concerned, the OEM and the replacement segments are

likely to witness strong growth given the current performance of the automotive

sector. Given the strong linkages of tyre industry with automotives, its demand is

likely to be strong over the short to medium term. As for the export demand for

tyres, the outlook is positive, even though some downsides remain.

As regards supply of tyres, currently, the major players are in the process of

expanding their capacities, in anticipation of uptrend in sales. For instance, Apollo

Tyres has set up a joint venture with Michelin for manufacture and sale of bus and

truck radials. JK is expanding its Mysore truck and bus radial facility along with

eyeing acquisitions of smaller units. Ceat has increased its off take by 3 times from

Pirelli. However, a characteristic of the Indian tyre industry is that most of the tyre

manufacturers in the past had increased capacities in anticipation of a surge in

demand, but when it did not materialize, they reduced their addition to capacities.

Thus, the demand-supply gap is likely to be an important issue for the Indian tyre

industry over the short to medium term.



Company Profiles

MRF Ltd.7

MRF Limited engages in the manufacture, distribution, and sale of tires for various

kinds of vehicles in India and Internationally. The company offers tires primarily for

trucks, busses, light commercial vehicles, passenger cars, and two wheelers, as well

as off the road tires, and farm service tires. It also provides conveyor belts, specialty

coatings, various types of paints and coats, and pre-treads. The company offers its

products primarily through distributors, as well as through retail outlets. In

addition, through a joint venture with Hasbro, Inc. MRF offers a range of toy

products. The company was founded in 1946 and is based in Chennai, India.

Apollo Tyres Ltd.8

Apollo Tyres Ltd. (Apollo) is an India-based tyre manufacturer. The company offers

its products primarily under ‘Apollo Tyres’ and Dunlop brand names. The Company

produces the entire range of automotive tyres for passenger cars, truck and bus,

farm, Off-The-Road, industrial and specialty applications like mining, retreaded

tyres and retreading material. Apollo Tyres, Ltd. also provides retreading material

under DuraTread brand, and retreaded tyres under the brand name of DuraTyres. It

exports its products to Africa, Middle East, South America, Asia Pacific, and Europe.

The company was founded in 1975 and is headquartered in Gurgaon, India. These

are produced across Apollo's eight manufacturing locations in India, Netherlands

and Southern Africa. A ninth facility is under construction in southern India. The

brands produced across these locations are Apollo, Dunlop, Kaizen, Maloya, Regal

and Vredestein. In the three domestic markets of India, Southern Africa and Europe,

Apollo operates through a network of multi-product outlets. In South Africa the

branded outlets are called Dunlop Zones, while in India they are variously named

Apollo Tyre World (for commercial vehicles) and Apollo Radial World (for

7 http://www.mrftyres.com/8 http://www.apollotyres.com/india_homepage.htm



passenger cars). On May 15, 2009, the Company completed the acquisition of

Vredestein Banden B.V.

CEAT Ltd.9

CEAT Limited engages in the manufacture and sale of automotive tires, tubes, and

flaps in India and internationally. It offers tires for heavy-duty trucks and buses,

light commercial vehicles, earthmovers, forklifts, tractors, trailers, passenger cars,

motorcycles, scooters, and auto-rickshaws. The company sells its products through

a network of 34 regional offices and approximately 3,500 dealers. It was formerly

known as CEAT Tyres of India Ltd and changed its name to CEAT Limited in 1990.

The company was founded in 1958 and is headquartered in Mumbai, India.

JK Tyres & Industry Ltd.10

JK Tyre & Industries Ltd. is an India-based tire company that develops,

manufactures, markets and distributes automotive tires, tubes and flaps for the

transportation industry. The Company manufactures its products in four

manufacturing centers in India, and has marketing operations spread across India

and abroad in over 75 countries, including the United States, Latin America, the

Middle East, South East Asia, Africa and Australia. It markets tires for sale to vehicle

manufacturers for mounting as original equipment and for sale in the replacement

markets worldwide. The Company subsidiaries include J.K International Ltd, J.K Asia

Pacific Ltd, and J.K Asia Pacific (S) Pte. Ltd. The Company’s products include Jet Trak,

Jet One, Jet Trak-39, Jet Trak-39 DX, Jetking-10, Jet Trak XL, Jet Speed, Jet Xtra, Jet

Rib, Jet R Plus, Ultima XP, Tornado, Brute, Steel King, Sona HF and Sona 2001. In June

2008, the Company acquired 100% interest in Tornel, a Mexican tyre company.

9 http://www.ceattyres.in/aboutus/ceat-company-overview.asp10 http://www.jktyre.com/AboutJKTyre/Mission_Vision.aspx



Phase II: Test of Market Efficiency

In order to test the efficiency of market, we have used event study methodology.

Following are the used to carry out this test of market efficiency:

Event: Mergers and Acquisitions between 1999 and 2010

Event Window: 10 days before and 10 days after the event day.

Estimation Window: 210 days before the tenth day prior to event day.

Model used: CAPM is used to compute the returns.

Tool Used: SAS 9.1 is used to perform the test.

Null Hypothesis: Indian Market is Strong form of Efficient Market.

Alternate hypothesis: Indian Stock market is Semi-Strong form of Efficient Market.

Steps Followed:

Step 1: Event M&A is used for the test. We have considered all the M&A from 1999

to 2010.

Step 2:

Estimation Window: data from 210 days before the Event Window is considered

Event Window: consists of 10 days before and after the Event date

Post Event Period: data after Event window is considered.

To T1 0 T2 T3

Estimation Window Event Window Post Event Period

Step 3: Daily Returns are calculated for each stock under study. They are referred as

Rij where i and j are stock and day respectively.



Step4: Since we are using Market Model (CAPM) Estimates of alpha(y –intercept)

and beta (slope) is calculated for all the stock for which event has taken place. This

is done by using the returns of estimation Window. They are referred as αij and β ij

where i and j are stock and day respectively.

Step 5: Expected returns for the Event window for each day and for each stock is

calculated by using alphas and betas calculated in step4. They are referred as E(Rij).

Step 6: Abnormal returns (AR) are calculated using following formula:

ARij = Rij – E(Rij)

Step 7: Mean of AR for each stock for each day and cumulative abnormal return

(CAAR) is calculated.

Step 8: A graph is plot between the CAAR and Day Relative to Event announcement

day is plot.

Step9: Graph is analyzed and conclusion is made.



Results and Analysis

By following all the above mentioned steps following graph is obtained:

AAR

- 0. 011

- 0. 010

- 0. 009

- 0. 008

- 0. 007

- 0. 006

- 0. 005

- 0. 004

- 0. 003

- 0. 002

- 0. 001

0. 000

0. 001

0. 002

0. 003

0. 004

0. 005

0. 006

0. 007

0. 008

0. 009

0. 010

0. 011

0. 012

0. 013

0. 014

0. 015

di ff

- 10 - 9 - 8 - 7 - 6 - 5 - 4 - 3 - 2 - 1 0 1 2 3 4 5 6 7 8 9 10

Figure 3: Cumulative Excess Returns and Abnormal Returns around Announcement date

The graph shows positive abnormal return before and after 2 to 3 days of the

announcement. The abnormal returns before the event could be due to the leakage

of information about the event. However, those after the announcement date is

either due to information taking time to be reflected in the share price or the

announcement taking place so late in day zero that, possibly even after the market

close that its effect can only be reflected in trades in following days.

In an efficient market all the information is reflected in the stock prices and hence

the stock prices do not fluctuate because of any new information.

But in out study it’s been observed that there have been fluctuations in returns

because of the event and hence we reject our Null hypothesis and accept the

alternate hypothesis that Indian Market is semi strong form of Efficient Market.


____ AAR____CAAR

Day relative to Event Announcement Day


Phase III: Company Valuation

Apollo Buy (target: 91.8)

While doing valuation of MRF following are the assumptions made:

Growth rate is assumed to be 10% which has been the YOY growth for the last 3

years.

All expenditures have been represented in percentage of revenues.

Tax rate is considered constant at 32 % which is the current applicable tax rate.

Risk free rate is the current rate on long term govt. bonds.

Market Risk is obtained from secondary sources.

Beta is obtained from secondary sources(0.66)

Growth 8%2010 2011 2012 2013 2014 2015 Tax 0.32

Revenues 5438.57 5873.656 6343.548 6851.032 7399.114 7991.044 1-tax 0.68COGS 4356.78 4705.322 5081.748 5488.288 5927.351 6401.539AS % 80.10893Operating Income 1081.8 1168.3 1261.8 1362.7 1471.8 1589.5 CAPM

Rm 13Capex 341.23 368.5284 398.0107 429.8515 464.2396 501.3788 Rf 7.5AS % 6.27426 Beta 0.66Dep 122.78 132.6024 143.2106 154.6674 167.0408 180.4041 ke 11.13AS % 2.257579Change In WC 61.23 66.1284 71.41867 77.13217 83.30274 89.96696 Total 4632.561AS % 1.125847 Shares 50.41EBIT 959.01 1035.731 1118.589 1208.076 1304.723 1409.1

EBIT(1-t) 652.1268 704.2969 760.6407 821.492 887.2113 958.1882 Price 91.898Capex-Dep 218.45 235.926 254.8001 275.1841 297.1988 320.9747FCFE 372.4468 402.2425 434.4219 469.1757 506.7098 547.2465Term. Value 4952.457Present Value 361.9568 351.7622 341.8547 332.2263 322.8691

2921.892

Figure 4: Valuation of Apollo

Using above mentioned assumptions, the price of the stock is calculated to be Rs. 91.898.

The stock is currently trading at Rs. 74.9. This means that the stock is undervalued and

hence investor should buy the stock to make capital gains in future.



JK ____ ____ Hold While doing valuation of MRF following are the assumptions made:

Growth rate is assumed to be 8%. We have taken the CAGR of the Industry as a whole since there were large amount of fluctuations in the growth rate of the company in the previous years.

All expenditures have been represented in percentage of revenues. Tax rate is considered constant at 32 % which is the current applicable tax

rate. Risk free rate is the current rate on long term govt. bonds. Market Risk is obtained from secondary sources. Beta is obtained from secondary sources(0.89)


Figure 5: Stock Price Movement of Apollo


Growth 8%2010 2011 2012 2013 2014 2015 Tax 0.32

Revenues 3956.29 4272.793 4614.617 4983.786 5382.489 5813.088 1-tax 0.68COGS 2765.23 2986.448 3225.364 3483.393 3762.065 4063.03AS % 69.89452

Operating Income 1191 1286 1389 1500 1620 1750 CAPMRm 13

Capex 182.26 196.8408 212.5881 229.5951 247.9627 267.7997 Rf 7.5AS % 4.606841 Beta 0.89Dep 109.42 118.1736 127.6275 137.8377 148.8647 160.7739 Ke 12.395AS % 2.765722Change in WC 19.68 21.2544 22.95475 24.79113 26.77442 28.91638AS % 0.497436 Total 7134.101

Shares 41.06EBIT 1081.64 1168.171 1261.625 1362.555 1471.559 1589.284

EBIT(1-t) 735.5152 794.3564 857.9049 926.5373 1000.66 1080.713 Price 173.7Capex-Dep 72.84 78.6672 84.96058 91.75742 99.09802 107.0259FCFE 642.9952 694.4348 749.9896 809.9888 874.7879 944.7709Term. Value 7671.708Present Value 617.8521 593.6921 570.4768 548.1694 526.7342

4277.1761

Figure 6: Valuation of JK


The stock is currently trading at Rs. 174.3. This means that the stock is valued correctly

and hence investor should hold the stock.



MRF Sell (Target: Rs.4926)


Growth rate is assumed to be 9% which has been the YOY growth for the last

4 years.

All expenditures have been represented in percentage of revenues.

Tax rate is considered constant at 32 % which is the current applicable tax

rate.

Risk free rate is the current rate on long term govt. bonds.

Market Risk is obtained from secondary sources.

Beta is obtained from secondary sources (1.07)

Growth 19%

2010 2011 2012 2013 2014 2015 CAPMRevenues 6164 7335.16 8362.082 9532.774 10867.36 12388.79 Rf 7.5COGS 3567.8 4245.682 4840.077 5517.688 6290.165 7170.788 Rm 13COGS AS % 57.88125 Beta 0.64Operating Income 2596.2 3089.5 3522 4015.1 4577.2 5218 ke 11.02

CAPEX 341.99 406.9681 463.9436 528.8957 602.9411 687.3529AS % 5.55Depreciation 249.32 296.6908 338.2275 385.5794 439.5605 501.0989 Total 20887.85AS % 4.044776 Shares 4.24Change IN WC 24.76 29.4644 33.58942 38.29193 43.65281 49.7642

AS% 0.401687 Price 4926

Tax 32%1-tax 68%EBIT 2346.88 2792.787 3183.777 3629.506 4137.637 4716.906EBIT(1-t) 1595.878 1899.095 2164.969 2468.064 2813.593 3207.496CAPEX-DEP 92.67 110.2773 125.7161 143.3164 163.3807 186.254FCFE 1253.888 1492.127 1701.025 1939.169 2210.652 2520.143

23270.02PV 1344.017 1380.093 1417.137 1455.176 1494.236

13797.19

Figure 8: Valuation of MRF

Using above mentioned assumptions, the price of the stock is calculated to be Rs. 4496.

The stock is currently trading at Rs. 7840. This means that the stock is overvalued and

hence investor should make capital gain before the stock falls.


Figure 7: Stock Price Movement of JK


CEAT Buy (Target: Rs. 183.45)


Growth rate is assumed to be 8% which has been the YOY growth for the last 3 years.

All expenditures have been represented in percentage of revenues. Tax rate is considered constant at 32 % which is the current applicable tax

rate. Risk free rate is the current rate on long term govt. bonds. Market Risk is obtained from secondary sources. Beta is obtained from secondary sources (1.13)


Figure 9: Stock Price Movements of MRF


Growth 8%2010 2011 2012 2013 2014 2015

Revenues 2989.97 3229.168 3487.501 3766.501 4067.821 4393.247 Tax 32%OpEx 1-tax 68%Materials 1728.25 1866.51 2015.831 2177.097 2351.265 2539.366

As % Of Rev 57.80 CAPMMfg. Costs 163.13 176.1804 190.2748 205.4968 221.9366 239.6915 Rf 7.5As % Of Rev 5.46 Beta 1.13Other Exp 658.07 710.7156 767.5728 828.9787 895.297 966.9207 Rm 13As % Of Rev 22.01 Ke 13.715Operating Income 440.52 475.762 513.823 554.928 599.323 647.268

Capex 233.63 252.3204 272.506 294.3065 317.851 343.2791As % of Rev 7.81 Total 627.4034346Deprecn 56.83 61.3764 66.28651 71.58943 77.31659 83.50191As % of Rev 1.90 Share 3.42Change in WC 21.13 22.8204 24.64603 26.61771 28.74713 31.0469

As % of Rev 0.71 Price 183.4513EBIT 383.69 414.3852 447.536 483.3389 522.006 563.7665EBIT * (1-Tax) 260.91 281.78 304.32 328.67 354.96 383.36Capex - Dep 176.8 190.944 206.2195 222.7171 240.5344 259.7772FCFE 62.98 68.02 73.46 79.34 85.68 92.54Terminal Value 678.6733 Present value 59.81404 56.80795 53.95294 51.24142 48.66617

356.9209

Figure 10: Valuation of CEAT


The stock is currently trading at Rs. 155.3. This means that the stock is undervalued and

hence investor should buy the stock to make capital gains in future.


Figure 11: Stock Price Movement of CEAT


Competitors Analysis

Liquidity RatiosLiquidity Ratios measure the ability of the firm to meet current obligations.

Current ratio

2007 2008 2009

Current

Apollo 0.810406 0.718788 0.614159JK 1.083581 0.998506 0.950512

CEAT 0.771233 0.938574 0.808274

MRF 1.401203 1.305397 0.914874

Table 2: Current Ratio

Current Ratio (CR) for JK, Apollo and MRF is decreasing over the years whereas that

of CEAT is fluctuating. Continuous increase in current liabilities, fluctuations in

inventories and debtors resulted in fluctuations of the ratio over the past three

years.

Quick Ratio 2007 2008 2009

Quick

Apollo 0.344843 0.271336 0.237318JK 0.629468 0.476704 0.51094

CEAT 0.442697 0.472295 0.503342

MRF 0.664172 0.547979 0.453593

Table 3: Quick Ratio

Quick Ratio (QR) of Apollo, JK and MRF has decreased for the year 2008. JK has

improved the ratio in the year 2009 whereas Apollo and MRF continued the

declining trend.

CEAT has shown a consistently increasing QR, which could be due to increase in

debtors over the years and decrease in CL11 and Inventories for year 2009. All the

11 Current Liability



companies under study, except CEAT have shown a decline in quick ratio from year

2007 to 2009 which means that they are loosing on respective liquidity positions.

Cash Ratio 2007 2008 2009

Cash

Apollo 0.135667 0.136104 0.158453JK 0.040694 0.02477 0.04165

CEAT 0.05186 0.051336 0.060425

MRF 0.077473 0.078537 0.042265

Table 4: Cash Ratio

Cash ratio for firms is fairly constant. A sudden decline in Cash Ratio of MRF is

observed for year 2009 which could be due to decrease in Cash by 41% and increase

in CL by 8.5%

Net Working Capital Ratio

2007 2008 2009

NWC

Apollo 0.317277 0.283923 0.297172JK 0.268915 0.164899 0.184123

CEAT -0.12224 0.059567 0.155537

MRF 0.661419 0.541885 0.202703

Table 5: Net Working Capital Ratio

It is said that firm with higher NWC has greater ability to meet current obligations

and its day to day operating activities.

NWC Ratio for MRF is consistently declining whereas for JK, Apollo and CEAT it has

improved for year 2009.

CEAT has improved the most on NWC converting the scarcity of NWC to its

abundance from year 2007 to 2009.



From the above analysis it can be concluded that MRF has better liquidity position

when compared with other firms under consideration.



Leverage RatiosLeverage Ratios judges Long Term financial position of the firm.

Debt Ratio 2007 2008 2009

Debt

Apollo 0.390143 0.272659 0.339075JK 0.614663 0.631492 0.65676

CEAT 0.498915 0.391357 0.485656

MRF 0.38134 0.46193 0.176997

Table 6: Debt Ratio

Debt Ratio for Apollo, CEAT and MRF has been fluctuating for the past three years

whereas that for JK is consistently increasing. JK has been increasing its borrowings

over the years.

MRF has also reduced its borrowings by 69% which has reduced its debt ratio.

Constant increase in Debt Ratio of JK is due to increase in Secured Loans.

Firms like Apollo, CEAT and JK have added more Secured Loans to their capital

structure this shows that firm are not self sufficient in regards to meeting the

operating expenses.

Debt – Equity Ratio

2007 2008 2009

Debt-Equity

Apollo 0.639728 0.374871 0.51303JK 1.595129 1.713646 1.913412

CEAT 0.995669 0.643 0.944223

MRF 0.616397 0.858493 0.215062

Table 7: Debt-Equity Ratio

Contribution of owners is greater than that of the lenders in case of Apollo and CEAT

whereas for JK its vice-versa.



In case of CEAT, the firm can face difficulties in times of less profit as its capital

structure consists of equal weight age of debt and equity.

JK has a very high Debt-Equity ratio which is greater than 1.5. The firm might have

tough time meeting its debt obligations.

Debt – Equity Ratio for MRF has reduced drastically for the year 2009 due to

decrease in debt by 69%.

Interest Coverage

2007 2008 2009

Coverage

Apollo 3.077552 5.154373 2.581142JK 1.345687 2.153458 1.047617

CEAT 1.78665 3.734918 0.509632

MRF 6.299756 4.020226 6.781776

Table 8: Interest Coverage Ratio

Firms have fair Interest Coverage ratio though it’s highly fluctuating. Ratio for CEAT

has dropped significantly due to significant decrease in operating profit which is

mainly due to increase in COGS12.

Activity RatiosActivity Ratios evaluates the efficiency with which firm manages and utilizes its

assets. These are also called as turnover because they indicate the speed with which

assets are being converted into sales.

12 COGS: Cost of Goods Sold – Calculated as difference between Sales and summation Employee Cost, Power and Fuel cost, Raw Material and Other Manufacturing Expenses



Inventory Turnover and Days of Inventory

2007 2008 2009

Inventory Turnover

Apollo 6.019449 5.721483 8.06697JK 6.268483 4.769335 9.898082CEAT 8.020613 5.533953 9.889527

MRF 5.245377 4.372618 6.597891

2007 2008 2009

Days of Inventory

Apollo 59.80614 62.92075 44.62642JK 57.43017 75.48222 36.37068CEAT 44.88435 65.05296 36.40215

MRF 68.63186 82.33055 54.56289

Table 9: Inventory Turnover and Days of Inventory

Inventory turnover for all the firms has decreased for the year 2008 followed by an

increase in the year 2009. MRF has lowest Inventory Turnover. JK and CEAT convert

its inventory into sales 9.8 times a year. Higher ratio means faster conversion i.e.

lesser days of Inventory Holding.

Debtors Turnover and Collection Period

2007 2008 2009

Debtors Turnover

Apollo 18.62016 27.42887 52.23682JK 6.178598 7.337688 12.40834CEAT 9.109131 8.481082 8.689498

MRF 9.157487 9.395345 10.62714

Collection Period

Apollo 19.33388 13.12486 6.89169JK 58.26565 49.06177 29.01274CEAT 39.52078 42.44741 41.42932

MRF 39.3121 38.31685 33.87553

Table 10: Debtors Turnover & Collection Period

Apollo has highest Debtors Turnover Ratio. Higher is the ratio more efficient is the

management of credit for the firm.



Collection period has decreased for Apollo, JK and MRF from year 2007 to year

2009. This means that the quality of debtors has improved over the years. Decrease

in collection period decreases the chances of bad debt losses and also improves the

liquidity of the company.

Except Apollo all the other firms under consideration have more or less same collection

period. Apollo has a very low collection period which shows its efficiency in turning

around its debtors.

Profitability Ratios

Gross Profit Margin 2007 2008 2009

Gross Profit Margin

Apollo 0.280486 0.309811 0.262084JK 0.217493 0.249538 0.25282CEAT 0.259852 0.277245 0.21646

MRF 0.280434 0.2491 0.303749

Table 11: Gross Profit Margin

Gross Profit Margin (GPM) for the year 2009 has increased for JK and MRF which is

due to increase in GP of 74% and in Sales of 71% for JK and increase in GP of 31%

and in Sales of 7.5% for MRF.

GPM has decreased for CEAT and Apollo for the year 2009.

For Apollo, sales have increased by 7% whereas COGS has increased by 14.5% (a

result of increase in fuel and power prices and other manufacturing expenses) due

to which GP has decreased by 9% and this resulted in decline of GPM for Apollo.

For CEAT, sales have increased by 6% whereas COGS has increased by 14.9% (a

result of increase of fuel and power prices and employee costs) due to which GP has

decreased by 17.2% and this resulted in decline of GPM for CEAT.



GPM is reported highest for MRF in year 2009, which shows that it is doing better

than any other firms under study in regards to profitability.

Net Profit Margin 2007 2008 2009

Net Profit Margin

Apollo 0.029987 0.051537 0.022179JK 0.005724 0.020875 0.00347CEAT 0.016373 0.056904 -0.00582

MRF 0.033988 0.02477 0.041583

Table 12: Net Profit Margin

NPM for Apollo has decreased for year 2009 due to increase in COGS and interest by

14.5% and 29% respectively. PAT has gone down by 53.88%.

NPM is negative for JK and Apollo due to negative PAT which shows that company is

incurring losses. It can be observed that GPM for JK has increased for year 2009

despite which NPM has decreased, this is due to drastic increase of interest and

depreciation by 186% and 96.8% respectively.

NPM for MRF has decrease for year 2008 followed by an increase for the year 2009.

Return on Equity 2007 2008 2009

Return on Equity

Apollo 0.117233 0.178451 0.074588JK 0.028561 0.124944 0.033083CEAT 0.10366 0.289528 -0.03299

MRF 0.174193 0.12667 0.188274

Table 13: Return on Equity

ROE for MRF has also increased for the year 2009 which is also due to increase in

EBIT.



Earnings per Share 2007 2008 2009

Earnings per Share

Apollo 24.43429 4.489554 2.00625JK 5.487904 21.66261 4.639665CEAT 8.59671 43.39573 -4.70447

MRF 405.046 334.756 604.3858

Table 14: Earnings per Share

EPS for MRF has decreased for year 2008 which could be due to decrease in PAT,

mainly due to increase in COGS and Interest burden by 18% and 34% respectively

for an increase in sales of 13%. However, for the year 2009 EPS has increased by

80% which is mainly due to increase in sales by 7% for almost no increase in COGS

and only 4% increase in Interest burden.

It can also be observed that EPS for MRF is on higher side when compared with that

of other firms considered for the study undertaken. This is due to very small share

Capital of MRF.

EPS for the other three firms under study is highly fluctuating. Reasons for which

are mentioned below

PAT for Apollo has been increasing over the years however issue of new shares in

year 2008 as well as year 2009 resulted in decrease in EPS.

PAT for JK has increased for year 2008 which justifies the increase in EPS for year

2008. In the year 2009, GP had increased by 74% despite which PAT has declined by

71%. This is due to increase in Interest burden by almost 168% along with increase

in other expenses. Also JK has issued new share in year 2009 which brings EPS

further down.

PAT for CEAT has decreased over the years which are mainly due to increase in

COGS and Interest burden.



Conclusion

It is concluded from the even study test that Indian Market is semi-strong form of

efficient market. Hence stock prices do not always reflect all the information. This is

also justified by means of our valuation results. As it is observed that only one stock

(JK) is correctly valued in stock market rest all are either undervalued or

overvalued.

The impact of global meltdown can be very easily observed by the fluctuating ratios

over the past three years. Since ITI is a highly capital intensive industry the

Liquidity ratios are not very high.

Days of inventory is also very high, this is mainly because the companies usually

maintain reasonable inventory level at each warehouse and this results in higher

rates of inventory.

The gross profit Margin of the firms is around 20% on an average across companies

whereas the Net Profit Margin is only around 2.5% on an average across the

companies.

Recommendations

Based on the valuation done it is recommended that Investor should invest into

Apollo and CEAT as the stocks are very much undervalued. Therefore, investor can

earn capital gains in near future. They should sell off MRF stocks as it is highly

overvalued.

Tyre companies have very high days of inventory therefore they should devise a

strategy to reduce it.



Bibliography

(Indian Tyre Industry) (Tyres)Indian Tyre Industry. (n.d.). Retrieved May 2009, from www.bharatbook.com: http://www.bharatbook.com/Market-Research-Reports/Indian-Tyre-Industry.html

Tyres. (n.d.). Retrieved April 2010, from www.crisil.com: http://www.crisil.com/research/research-industry-information-report-tyres-contents.pdf

Pandey, I. M. (1999). Principles of Working Capital. In I. M. Pandey, Financial Management (pp. 807-842). New Delhi: Vikas publishing House Pvt. Ltd.

Campbell, Cynthia, Cowan, Arnold and Salotti, Valentina. 2009. Multi-Country Event

Study Methods. Iowa, U.S.A : s.n., March 11, 2009.

Duso, Tomaso, Guglerm, Klaus and Yurtoglu, Burcin. 2007. Is the Event Study

Methodology Useful for Merger Analysis? Vienna, Austria : s.n., October 2, 2007.

Economics, The Use of Event Studies in Finance and. 2001. Gerald P. Dwyer Jr. Rome :

s.n., 2001.

Event Study. [book auth.] Kane, Marcus Bode. Investments. s.l. : McGraw-Hill Primis,

pp. 551 -555.

Paula, Serra Ana. 2002. Event Study Tests. Porto, Portugal : s.n., May 2, 2002.


sa_ report

Documents