The wheels may soon start to turn for tyre makers


Sector Insight

The tyre industry's performance has been lacklustre in the just-concluded quarter. Seven of the eight major listed tyre companies posted a year-on-year decline in standalone net profit. Top-line growth, however, has been robust for all. This trend — of strong top-line growth but falling profits — is nothing new. It had played out in the June and September 2011 quarters as well.

Rubber prices impact

Capacity expansions (resulting in high interest and depreciation costs) apart, a key reason for the pressure on bottom line so far has been high rubber prices.

Beginning December 2009, domestic rubber prices have relentlessly marched upwards. By April 2011, prices of RSS 4 variety, used by the tyre industry, peaked at around Rs 240 a kg, a 45 per cent gain over April 2010. Since then, rubber prices have stabilised at around a high Rs 220 a kg.

International prices too largely followed a similar trend. Though tyre makers periodically increased prices , they haven't fully covered for higher costs, meaning operating margins have taken a beating . Apollo Tyres, JK Tyres, Falcon Tyres, MRF and TVS Srichakra have all seen their operating margins shrink during the October-December 2011 quarter compared to a year ago.

Other factors

Other factors too have weighed on margins. One, price of crude oil — from which other raw materials such as synthetic rubber, nylon tyre cord fabric and carbon black — are derived, has risen during this period. Two, the industry hasn't been able to take advantage of any fall in international rubber prices due to high import duty and the depreciating rupee. Three, high interest costs and fuel prices have hit sentiment, resulting in truck owners postponing replacement purchases. Ceat and Apollo Tyres, for example, have admitted that they have been seeing softer replacement demand in the last two quarters.

This has led to lower realisations and margins too. This is because tyre makers enjoy higher margins in replacement market sales than in direct sale to auto makers as they have higher pricing power in the former.

Outlook brighter

The worst seems to be over for the industry. Improved production and lower demand from China, one of the major consumers, has depressed rubber prices. Prices now have eased by 23 per cent from the April 2011 peak. This would benefit margins going forward.

Already, with the lag effect of high prices beginning to fade, many companies had seen their raw material costs (as a percentage of sales) decrease quarter-on-quarter (December 2011 vs September 2011).

MRF's, for example, came down from 78 per cent to 72.5 per cent, bettering operating margins by 2 percentage points on a sequential basis. Goodyear and Falcon Tyres too saw sequential increases in operating margins. JK Tyres too — although it is still making losses — has seen a decrease in the raw material to sales ratio and has sequentially improved its operating margins.

Besides, considering the robust auto industry growth in 2009-10 and 2010-11, tyre replacement demand for vehicles sold then would kick in shortly. While car tyres have a life of about 3 years, commercial vehicle tyres are replaced every 1-2 years. Fast improving penetration of radial tyres for commercial vehicles too would improve realizations.


Published on March 01, 2012

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