Tire stocks are up. Should you ride along?

But investors should note that input cost inflation remains a concern in the near future. Margins of major listed tire makers declined sharply in the September quarter due to higher raw material prices. Raw materials for tire manufacturers include natural rubber, carbon black and synthetic rubber. Fortunately, given the strong demand, they are able to pass the burden of higher input cost pressures on the end-users to prevent further margin erosion.

“So far in FY22, the product portfolio in the tire sector has seen a price hike of 7-9%. Among the major players, Apollo Tyres, CEAT and Balkrishna Industries have been more active and raised prices in November-December. MRF remained sluggish; Varun Baksi, an analyst with Prabhudas Lilladher said, “It had last hiked prices in September.”

While the price hike is sentiment positive, this volume may not be enough to offset the overall cost pressure. “If commodity prices remain the same, an additional price hike of 3-4% would be required to compensate for the fall in margins,” he said.

Sharing a similar view, in a December 21 report, analysts at JM Financial Institutional Securities said the current market prices of raw materials are above their five-year average. Hence, he feels, to maintain healthy margins, tire makers will have to increase the prices by 3-5% in the replacement segment.

Also, investors should note that the benefits of price increases are usually visible with a lag of a few months, which means that there may not be a complete improvement in margins immediately.

Besides, analysts cautioned that demand weakness in certain sectors such as tractors, coupled with higher tire prices, could impact sales growth. Besides, last year’s high base poses a challenge for the second half of FY12. Investors also need to keep an eye out for any disruption to sales from a possible third wave.

Apart from demand and margin recovery, the catalyst for tire stocks could come from reducing the industry’s capital expenditure intensity, which will improve cash flow. While the long-term demand outlook looks promising, investors should avoid some near-term pressure.