Price hikes fuel rally in tyre stocks

Tyre stocks have jumped 10-14 per cent over the last month on expectations that higher volumes, market share gains from Chinese players, price hikes of 8-10 per cent since the start of the year, and any government action on Chinese imports will reflect favourably on tyre makers.

On the price hikes, Nitesh Sharma and Dhawal Doshi of Phillip Capital say with the competitive scenario easing—less Chinese imports—all tyre companies have been undertaking synchronised price hikes to fight cost pressures. The industry could end up with a cumulative 15 per cent price hike from the start of the year till date. Aggressive price hikes, coupled with any improvement in volumes, augur well for the sector. 

More importantly, analysts do not see imports from China increasing, given the shift in focus to the higher margin US market. Chinese tyre exports to the US had dipped after an anti-dumping investigation was launched. US authorities have, however, issued a notification stating that Chinese tyre exports to the US are not hurting American tyre companies and have refused to impose import duties. Chinese tyre companies are now increasingly targeting the US, leading to a drop in exports to India.

While Chinese imports are down by half after demonetisation and after the US action, Chinese tyre exporters have also raised prices of passenger car radials by 10-15 per cent. This will help bridge the gap between them and Indian manufacturers, leading to market share gains for Indian manufacturers. 

Ashwin Patil of LKP Research says a higher import duty on Chinese tyre imports may act as a substantial trigger for the tyre industry with respect to market share gains, topline growth and profitability. 

Apollo Tyres could be one of the major beneficiaries of falling Chinese imports as truck and bus radials form about half of its revenues. While the after market is a major source of revenue for all companies, the slowing sales of medium and commercial heavy vehicles would be a cause of concern. 

The other worry is over rubber prices. Prices of the raw material that constitutes about 70 per cent of costs for tyre companies have gone up in the March quarter as compared to the December quarter. ICRA expects a 15-18 per cent hike in raw material costs on a sequential basis in the March quarter. Though raw material costs, which are currently trading at Rs 143 a kg (RSS3-Bangkok), have come down from their February peaks, they are higher both from a year ago and sequentially. Given that raw material costs are the single biggest determinant of operating profit margins of tyre companies, these could dent margins if adequate price hikes are not undertaken. 

Analysts are, however, bullish on the prospects for the sector. Sharma and Doshi of Phillip Capital believe there is scope for rerating the sector as easing competitive intensity and price aggression will lead to cross-cycle margin resilience. Despite the fact that the sector has a large exposure to the lucrative after market, a similar segment such as automotive batteries trades at double the premium over the tyre space. 

In addition to Apollo Tyres, analysts favour Ceat Tyres, given its increased capacities, strong earnings growth trajectory as well as healthy return ratios. Investors, however, should await a correction in the stocks to accumulate quality names.