Stuck in a rut

The outlook for the tyre industry has taken a beating amid a drop in demand from domestic as well as global auto firms, while the replacement market holds little hope

Stuck in a rut
Fall in natural rubber prices and the recent decision by Competi-tion Commission of India (CCI) to clear cases against six tyre makers (Apollo Tyres, CEAT, JK Tyre, Kesoram Industries and MRF) on cartelisation charges are seen as positives for the tyre industry. However, experts have mixed views on the sector because of uncertainty over near-term demand.

While, demand from domestic auto players is expected to fall post festive-season, outlook from global markets too looks grim amidst drought in the US and weak economic activity in Europe. Experts have neutral to positive view on growth in the replacement market, which has so far remained more or less stagnant, raising further topline concerns.

According to geographic data available with Bloomberg, tyre makers such as Balkrishna Industries (85 per cent), Apollo Tyres (34 per cent) and JK Tyre (19 per cent) derive substantial proportion of their revenues from outside India. Others, such as MRF, CEAT, Falcon Tyres, TVS Srichakra and Goodyear Tyres are more of domestic play.

“Given the economic slowdown, domestic tyre demand is subdued. Original equipment demand has been weak over the past few months and we expect the situation to improve in a gradual manner over the medium-to-long term, with possible cut in interest rates and expected pick-up in economic activity. Replacement demand has held up rather well and we expect the trend to continue in the near term. On the global front, the demand is largely weak,” said Arun Agrawal, an auto analyst at Kotak Securities. However, he pointed out that the impact of weak global demand on tyre players operating in niche segments/categories would be relatively less.

Input costs

Rubber prices have been falling since last year. Spot price of rubber in Kottayam as suggested by NCDEX have fallen drastically from its April 2011 peak of Rs 24,250 per 100 kg levels (Rs 242.50 per kg) to Rs 16,890 per 100 kg (Rs 168.90 per kg) as of Friday, signalling a 30 per cent drop. Data available with Capitaline showed raw material costs of top eight tyre makers constituted over 70 per cent of the total expenditure. Rubber constitutes 60-65 per cent of the total raw material cost, while the rest is used to buy black carbon, chemicals and tubes. A fall in rubber prices help raise operating profit margins (OPM). However, one must note that OPM varies substantially from one tyre maker to another.

For example, for September quarter, where Balkrishna Industries and Apollo Tyres reported OPM of 21.37 per cent and 11.29 per cent, respectively, companies such as TVS Srichakra and CEAT reported lesser OPM at 6.82 per cent and 6.33 per cent, respectively.

Prayesh Jain, AVP of research at IIFL said that OPMs are influenced by several factors, including product mix between categories of automobiles serviced, product mix between OEM and replacement market and sourcing of raw materials.

“Balkrishna has dominance in niche category of off-the-road vehicles, while Apollo Tyres has a high proportion of the replacement market and large international exposure through its foreign subsidiaries. CEAT loses on account of octroi charges. Replacement market demand is likely to remain strong given robust sales across categories over the past couple of years. OEM (original equipment maker) demand is likely to be weak, considering headwinds for automobile demand such as high interest rates, increase in fuel prices and high vehicle prices,” he said.

Earnings

Balkrishna Industries has reported 96 per cent rise in net profit to Rs 123.71 crore for the September quarter on 34 per cent rise in sales at Rs 881.22 crore. Still, the results failed to impress many marketmen.

The company earns over 40 per cent of its revenues from Europe and nearly 20 per cent from North America.

“Order inflows continue to be weak, due to postponement in orders from distributors in Europe; and weak demand for farm tyres in the US due to drought conditions. Although rubber prices continue to be benign, we believe the slowdown in revenues and higher fixed costs may adversely impact company’s near-term earnings,” said Ashvin Shetty of Ambit Capital in a note available with Bloomberg.

Apollo Tyres has clocked 95.71 per cent YoY rise in consolidated net profit for September quarter.

“We like Apollo tyres even at present levels owing to its high exposure to replacement market and recovery in the performance of its subsidiary. Replacement demand is expected to be strong even in developed world, while OEM demand might recover owing to strong liquidity infusion. Most players have high element of imported raw materials, giving them a natural hedge against rupee depreciation,” Prajesh said.

CEAT reported 70 per cent YoY rise in net profit to Rs 3.80 crore. However, sales grew only six per cent YoY which were below expectations. Experts pointed that revenues were primarily impacted by change in product mix (a shift from replacement to OEM segment). They pointed that the slowdown in exports to Europe and Latin America had hurt its volumes.

“Going forward, we expect CEAT to report improvement in its operating performance, led by improving utilisation at the Halol plant and declining raw material prices (benefit to be visible more in H2FY13). Changing product mix (radial vs bias), expanding presence (tapping new geographies) and attractive valuations seem propelling for CEAT at present levels,” said Silky Jain of Nirmal Bang Securities.

JK Tyre reported a profit of Rs 25.99 crore in the September quarter compared with a net loss of Rs 54.99 crore in the corresponding quarter of last year. Sales were up 5.86 per cent YoY. Still, its results failed to impress marketmen.

“JK reported subdued at the standalone level as operating margins witnessed a decline of 70 basis points on quarter-on-quarter (QoQ) basis, despite a 220-basis points reduction in raw-material expenses. Demand from OEMs remained muted as the domestic MHCV segment witnessed a decline of 12.9 per cent YoY in H1FY2013. As a result, total volumes posted a decline of 6.1 per cent YoY to 62,000MT,” said Yaresh Kothari of Angel Broking. MRF is yet to announce its earnings.

Stock performance

Most tyre stocks have performed well this calendar.

JK Tyre, Balkrishna Industries, MRF and CEAT have climbed 87.23 per cent, 63.28 per cent, 43.98 per cent and 37.38 per cent, respectively.

“We believe, on a structural basis, one of the major overhangs on the sector has been removed, which had caused general investor anxiety in terms of probable impact on the sector. In case the order had been unfavourable, it would have led to a prolonged scenario of litigation, which may have hindered any expansion of sectoral multiples,” said Nishant Vass and Venil Shah, analysts at ICICI Securities in a recent note.

Apollo Tyres gained 36.24 per cent year-to-date, while TVS Srichakra and Goodyear India gained modest 5.61 per cent and 5 per cent, respectively during the same period. Falcon Tyres remained an exception with 20.85 per cent fall. zz

amitmudgill@mydigitalfc.com

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