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B. Krishnakumar

THE performance of corporates in the auto-ancillary segment in recent quarters has been quite impressive. The steady increase in automobile production has had a positive impact on the financial performance of quite a few companies. This, however, has not been the case as far as the tyre companies are concerned.

After recording a sharp increase in earnings in the previous fiscal, tyre majors such as MRF, Goodyear India and Apollo have had to contend with an overall drop in profitability and earnings for the quarter ended June 2003.

A closer look at the recent developments and the factors influencing the tyre industry's performance would throw light on what went wrong and what is in store for the industry.

Surge in input cost

With raw material costs accounting for over 50 per cent of the turnover, the price trends in key raw materials have a major bearing on the profitability of tyre companies. The prices of critical inputs, such as natural rubber (accounting for about 24 per cent of total raw material cost), and other petro-based inputs, such as carbon black and nylon tyre cord, have ruled firm in recent months.

Natural rubber prices have jumped by over 40 per cent from what prevailed about a year ago. The firm trend in crude oil prices has had an inflationary impact on the prices of petroleum-based inputs such as carbon black, synthetic rubber and nylon tyre cord. The prices of carbon black and nylon tyre cord have gone up by over 20 per cent during this period.

This has pushed up the overall raw material cost for tyre companies. For instance, the proportion of raw material costs to sales for MRF has spurted to 55 per cent for the quarter ended March 2003 from about 41 per cent in the same period in the previous year. This has been the trend for almost all other tyre majors.

This trend indicates that tyre companies have not been able to raise product price to set off the rise in input costs. This is not surprising if the capacity-overhang and the intense competitive pressure in the industry are taken into account.

Tyre companies have built up capacities over the recent years, which has not been commensurate with the pick-up in demand, though. As a result, the industry has managed to operate at 75-80 per cent of the total capacity. This, in turn, has fostered competitive pressure within the industry and has also inhibited tyre companies from revising prices.

The closure of Dunlop's production facility, and more recently Modi Rubber's, provided the industry some relief during the previous fiscal. However, the sustained increase in raw material prices and the absence of any significant increase in demand from the replacement market have affected profitability in recent quarters.

The impact of increased raw-material costs is better reflected in the performance of Apollo Tyres. For the quarter ended September 2003, while the turnover rose 28 per cent to Rs 481.12 crore, the post-tax earnings dropped by 37 per cent to Rs 17.28 crore. Ceat, another tyre major, also witnessed a similar trend in performance.

OE demand picks up

The demand for tyres has increased, especially from the original equipment (OE) segment. The steady increase in automobile production, commercial vehicles in particular, over the recent quarters has been a crucial volume driver for tyre producers. As a result, the production of truck and bus tyres improved by 16 per cent to 98.63-lakh units and passenger car tyres by 14 per cent to 85.44-lakh units. This, in turn, has translated into increased revenues for tyre companies. For the quarter ended September 2003, Apollo reported a 28 per cent jump in turnover and Ceat came up with a 5 per cent rise.

However, the improvements in turnover have not translated into a corresponding increase in the bottomline. This is because OE demand is not a key driver of volumes or profitability for tyre companies. This segment accounts for about 37 per cent of the total tyre demand. It is the replacement market that accounts for a healthy 56 per cent of the demand.

Besides, the realisations and profitability associated with the OE market is relatively lower compared to the replacement market. These factors, along with the rise in raw-material costs, explain the lack of any significant improvement in profitability despite an increase in turnover flowing from the OE market.

Replacement demand may pick up

While the automobile production has resulted in increased demand from the OE market, the replacement market is likely to pick-up. Typically, realisations in the replacement market is anywhere between 35-40 per cent higher than the OE segment. While the demand from the OE segment has picked up, the volume growth in the replacement market has not been robust enough to have a material impact on the profitability of tyre companies.

Considering that replacement market demand normally lags the OE demand by 9-15 months, the recent increase in commercial vehicle sales could translate into improved demand from the replacement market in the next financial year.

Besides, the improved monsoon this year, along with the recovery in the economic fundamentals and the increased industrial activity, is likely to trigger an increase in demand from the replacement market. Taking into account these factors, the demand for tyres, especially from commercial vehicles and tractors, is likely to rise. Considering that the replacement market accounts for about 68 per cent of the demand for the truck and bus tyre segment, the pick up in demand is likely to have a beneficial impact for tyre producers.

What is in store?

The recent developments indicate that the there could be some improvement in the fortunes of tyre companies. The recovery in replacement market demand is critical for achieving higher profitability. The recent thrust towards infrastructure development and an increase in industrial production this year are likely to act as key drivers of the replacement market demand.

Low interest rate along with increased credit availability for the farming sector is likely to drive demand for tractors and, by extension, tyres that are sold in this segment. The farm tyre market is one segment that is yet to log any significant growth. The normal monsoon and the increased credit availability are likely to have a positive impact on the demand for farm tyres.

The recent increased offtake of multi-axle trucks is another positive long- term development. Typically, these vehicles have 10 tyres on an average compared to six in a normal truck. The growing popularity of these kinds of trucks is likely to drive the demand for truck and bus tyres.

While the outlook appears positive from the demand side, the recent price hike effected by tyre majors would also ease the strain on profitability on account of the increase in input costs. Lately, almost all tyre majors have hiked prices by 2-3 per cent. A few companies have altered the discount/dealer margin structure which, in turn, would result in higher realisation.

Apart from these factors, the recent capacity additions and expansion projects lined up by domestic carbon black producers — Indian Rayon and Phillips Carbon Black — are likely to see carbon black prices stabilise at lower levels.

On the other hand, the recent/proposed capacity additions planned by tyre majors such as Apollo Tyres, Ceat and J. K. Industries is a cause of concern. The commissioning of expanded capacities by these companies could add to the competitive pressure in the industry.

Going forward, considering that volume growth is a key driver of earnings in the industry, the anticipated improvement in demand from the replacement market is likely to have a positive impact on tyre companies. If raw-material prices were to drop, it could have a huge positive impact on profitability.

Taking these factors into account, companies having a significant exposure to the replacement market and presence across different market segments would be better placed to tide over any unfavourable business environment. .

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