Tire stocks are in the news. Shares of Apollo Tires Ltd and Ceat Ltd hit 52-week highs on the NSE this week on relief from easing in prices of raw materials including natural rubber, carbon black and other crude-based derivatives. Natural and synthetic rubber prices have also declined from their recent peaks, while Brent crude oil prices have declined. These components constitute a major part of the overall input cost of the sector. Given this, cost easing could provide much needed impetus to tire makers’ muted operating performance.
However, more importantly, the sector’s superior pricing power is said to be the main driver of excitement around tire stocks.
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“Earlier, the price cut was done by the leaders in each tire category and the price trend was determined by the leader. But, in the last one or two years, we have seen significant price action by all listed companies,” said Varun Baxi, an analyst at Nirmal Bang Institutional Equities. This augurs well for the margin outlook and will lead to double-digit margin growth in tyres. As for multiple re-ratings for the stock, Baksi said.
Tire companies’ gross margins have been under heavy pressure in recent quarters. Therefore, to prevent further decline in margins, the companies have done a series of price hikes. Given the impact of the lag in passing on the burden of increased input cost, margins should start improving gradually. In Q2FY23, margins may see a further decline but are expected to improve gradually from Q3FY23.
Here, the ability of tire makers to raise prices has boosted investor confidence.
Dealer channel checks by some broking firms indicate that tire prices across product categories are likely to see an additional hike of 1.5-2.5% in September. According to analysts, tire companies have increased prices by around 3 per cent in July and August as well.
Interestingly, market leader MRF Ltd.’s revenue and margin gap with its competitors is also supporting the industry’s pricing discipline. IIFL Securities Ltd said that historically, MRF has enjoyed significant margin gains due to higher exposure to two wheeler (2W) and dominance in TBB (truck, bus, bias tyre) segment.
“However, the 2W margin and market share of MRF have declined. MRF has not been able to replicate TBB dominance in TBR (radial),” said IIFL’s August 30 report. Therefore, in recent quarters, other companies have taken the lead on pricing ahead of MRF, it said.
Meanwhile, the demand outlook for the sector is expected to remain strong. The recovery in domestic original equipment manufacturers (OEM) and replacement segments is expected to boost volumes in FY13. Mitul Shah, head of research at Reliance Securities, said easing the semiconductor shortage should lead to improved sales to OEMs and replacement demand for tire companies.
On the flipside, concerns of a global slowdown, especially in the European Union, could impact FY13 volume growth for some companies such as Balkrishna Industries Ltd.
The shares of Apollo Tyres, CEAT, MRF and JK Tire & Industries Ltd have gained 12-27% so far in 2022. The Nifty 500 index has gained 3% during this period. There will be more meaningful gains on the pace of margin improvement.
Also, investors in tire stocks need to keep an eye on the leveraged capital expenditure trends of the sector. A major part of the capital expenditure of this sector is likely to lag behind. With improved profitability, tire companies are expected to utilize the free cash flow for loan repayment.
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