Why It’s Still The Right Time To Buy Tyre Stocks

Tyre companies have been catching analysts’ and media fancy in the last week due to the depreciating trend seen in rubber prices. This downward movement though commenced after rubber prices reached their peak during February and April 2012. This has led to considerable capital appreciation in most of the tyre stocks in the range of 8.44 per cent for Ceat to 95.80 per cent for Balkrishna Industries. One might wonder if it’s alright to invest in these stocks now that they have already garnered gains over time due to which they bring in significant downward risk. We think investors can yet make a way into investing in tyres and benefiting over the medium term. Briefly:

1. Tyres are relatively less dependent on automobile sales than you think.

2. Rubber prices are likely to stabilize near a two-year low.

3. Radialisation is routing towards increased penetration.

Replacement Markets Over OEM Sales

Broadly 70 per cent of the turnover of tyre firms comes from the replacement market which consists of on-road vehicles. Due to increased sales and high growth rates witnessed in the past, this market has a strong base to grow on. A slowdown in the overall automobile industry will lead to a hampered demand due to subdued sales to original equipment manufacturers (OEMs) but robust replacement sales continue to exist.

The Rubber Decline

International rubber prices have been hit majorly due to the drastically hit global demand as a result of economic uncertainty and slowdown in manufacturing in China and Europe, leading to a sharp slide in prices which are not expected to recover till the strengthening of demand or till there’s corrective action taken by Malaysia, Indonesia and Thailand, the three major rubber producers accounting for about 70 per cent of the global production.

While the global macro economic situation has not yet caught the improvement mode, all eyes are on the prospective action to be taken by International Tripartite Rubber Corporation (ITRC) which is said to establish a mechanism to ensure that rubber prices remain stable and competitive by limiting exports and cutting down the rubber trees to reduce supply. Cumulative factors may help stop the slide and stabilize the rubber prices but an upward move is unlikely in the short term. However, it is important to remember that rubber accounts for about 45 per cent of the composition of a tyre.

Petroleum products account for a significant portion of tyre production with about 20 per cent of the composition being carbon black and about 10 per cent being chemicals and additives. In the same time frame (April 2011 to August 2012), crude prices have seen ups and down but have come to about the same level as seen earlier. Overall, this has led to improved margins for tyre manufacturers. For example, Apollo Tyres has witnessed a drastic improvement in the operating profit margin from 7.99 per cent in Q1FY12 to 10.29 per cent in Q1FY13.

Radialisation

While almost all of the cars running in India are on radial tyres, radialisation is gaining momentum in the truck and bus (T&B) segment. While 90 per cent of the T&B market in the U.S., Europe and China runs on radial tyres, the figure stood at 17 per cent in 2011-12. The Indian tyre companies are gearing up to catch on to this gap that offers huge potential. Radials consist of 30-35 per cent of the T&B tyre production for JK Tyre while Apollo Tyres has achieved 25 per cent radialisation in this segment. Though the growth rates of this trend are currently low, they are expected to pick up with an increase in awareness.

We thus think that there is a lot of potential that the Indian tyre industry has to offer. This coupled with lower rubber prices, which we expect to remain till 2013, will improve the margins. Moreover, the replacement market that continues to have a strong base will offer the industry with stability during tough times. All of these factors lead us to be bullish on the Indian tyre industry. Investors who have missed on the capital appreciation seen in tyre stocks can yet get invested to garner gains in the medium to long term.

Returns On Tyre Companies Since Peak Of Rubber Prices