Weak replacement demand, cheaper imports, inability to pass on costs hit margins.
The scrips of leading tyre makers are down between 10 and 22 per cent in the last one month because of high rubber prices squeezing their margins and the inability of companies to increase prices. Natural rubber prices have doubled over the last one year to about Rs 200 a kg owing to supply constraints. While the leading players have effected price rises four times so far this year to the tune of 15 per cent, analysts at PINC believe that the softer commercial vehicle (CV) tyre-replacement demand and cheaper imports have forced manufacturers to be circumspect about effecting further hikes. While OEM demand is expected to pick up due to the continued higher auto sales (up 28 per cent year-on-year in the April-September 2010 period), analysts say manufacturers will have to absorb a part of the cost increase. While analysts have revised their earnings estimates for FY11 and FY12 downwards to account for higher rubber prices, the stock prices have corrected sharply and are available at attractive valuations, they feel.
Margin squeeze to stay
Apollo Tyres
The company had a forgettable September quarter, marred by lock-outs at its Cochin and South African facilities. With the consolidated volumes down 17.3 per cent, the consolidated sales were down 5 per cent year-on-year. The company was unable to pass on price hikes due to a dip in the domestic replacement demand. Analysts at Spark Capital say despite the spurt in natural rubber prices (up seven times over the last eight years), Apollo has been able to maintain margins around 10.5 per cent over the long term, which reflects its pricing power. Though most analysts have revised their price targets for the stock downwards, they believe its dominant presence in the CV segment and the move towards radialisation should help improve prospects in the medium term. The scrip (Rs 64.25) should deliver over 40 per cent returns over 12-18 months.
Ceat
While capacity constraints limited the revenue growth for the company in the September quarter, operating and net profit margins fell sharply due to a spurt in costs. The company is planning a major expansion in overseas markets such as Europe once its radial tyre factory at Gujarat comes on-stream. The company recently acquired the Ceat trademark from Pirelli, which will allow it to sell tyres under the brand in European countries. The stock (Rs 126.85) is trading at six times its FY11 earnings estimates and should fetch 40-50 per cent returns over a two-year period.
JK Tyre
The leading player in the truck, bus and car radial tyres reported a 21 per cent increase in sales but net profits were down 66 per cent due to higher raw material costs. Like other players, the company was unable to fully pass on the cost increase, which led to a drop in profits and profitability. Analysts believe the trend towards CV radialisation (share expected to double over the next three years from 12 per cent of the total CV market currently) should benefit the leader. Analysts have pegged a target of Rs 197, which indicates a 45 per cent upside from the current level of Rs 135.30.
MRF
While the operating profit margins for the country’s largest tyre player were down sharply year-on-year for the September quarter, they were up sequentially by 130 basis points due to a drop in staff costs and other expenses. Chinese imports in the motorcycle segment have jumped and this has impacted MRF, a major player in this segment.
While the top line is expected to grow 13 per cent, a Sharekhan report says cost pressures will keep the earnings performance muted in FY11 (year ending September). At Rs 7,237.55, the stock is trading at 9.1 times its FY11 earnings estimates. Most analysts are currently neutral on the stock.