Strong demand to offset near-term cost pressure for tyre companies

MRF, Apollo among beneficiaries of higher demand, given dominant positions in growth segments

The tyre sector has fared better than others on the input costs front so far, as prices of its key input, natural rubber, continue to be benign. Natural rubber costs, which account for 40 per cent of a tyre company’s input costs, are down 15 per cent from the March 2017 quarter prices (year-on-year or y-o-y) and it has gone down 1.5 per cent since the September quarter. However, there could be near-term pressures, given supply side issues and higher crude oil prices.

Thailand, the world’s largest producer, Indonesia and Malaysia are looking at increasing prices by withholding exports. Factors such as rising crude oil prices, curtailed natural rubber supplies from Vietnam due to a typhoon and from Thailand (flash floods) in November is expected to push global prices higher in January and February, Pavethra Ponniah, vice-president and sector head of corporate sector ratings at ICRA, said.

CRISIL Research estimates domestic rubber prices will rise by three-five per cent in FY18, mainly led by an improvement in domestic demand for rubber with a pick-up in tyre demand in the second half of the year. The same is, however, expected to have a minimal impact on the margins of tyre companies, Binaifer F Jehani, director, CRISIL Research, said.

While the natural rubber costs so far have been benign, the rise in crude oil prices is not good for the costs mix, given synthetic rubber, tyre cord fabric, steel cord and carbon black are derivatives of crude oil prices and have increased. Though tyre companies have a bit of pricing power given higher demand, any sharp increase in crude oil prices will impact profitability.

Currently demand is strongest in the passenger segments of two-wheelers and cars, boosting the sales of companies catering to auto original equipment manufacturers (OEMs) in these two segments. Given the high demand, companies such as Apollo Tyres, MRF and Ceat are undergoing large capex programmes. But, given the steady internal accruals, it will offset the impact on return ratios.

With higher demand in cars and two-wheelers, its market leadership in this space and its staggered capex programme, analysts at Spark Capital expect MRF to generate strong cash flows as well as superior returns on capital. With growth expected to come back strongly in the medium and heavy commercial vehicles segment and the waning Chinese threat after the anti-dumping duty in September 2017, players such as Apollo Tyres, too, stand to benefit from the OEM and replacement market. Also, Apollo gets three-fourths of its revenues from the replacement market (the highest among tyre companies), which is more profitable than the OEM segment.