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Stocks of tyre companies, on a roll for a year and a half on the back of falling prices of natural rubber (NR), could get a further boost from falling crude oil prices, down 40 per cent since June.
At 44 per cent, NR accounts for the lion's share of raw material costs for these companies, with most other inputs crude oil-linked. Among other key raw materials are nylon tyre cord fabric (19 per cent) and carbon black (12 per cent).
The steep fall in NR prices from a peak of Rs 240 a kg three years earlier to about Rs 120 a kg has had a favourable effect on tyre firms' margins, with most of them experiencing an expansion here of 500 basis points (bps) and above during this period.
Earnings, too, have grown and are expected to move up further. For example, Credit Suisse analysts estimate a one per cent fall in NR prices impacts Apollo Tyre's earnings by 1.8 per cent; a similar fall in crude oil derivatives will improve these by two per cent.
The other trigger would be growth in the replacement segment, 70 per cent of industry sales. This is expected to grow from the low single digit one of 2013-14 to eight to 10 per cent in the commercial vehicle (CV) and car replacement segments.
The key, however, will be pricing discipline. This has held so far, except for a few promotional schemes in the recent festive season. In this backdrop, the three top companies that stand to gain are MRF, Apollo and JK Tyre.
MRF
The country's largest tyre maker, it has a diversified presence across product segments. And, outgrown its peers over the past five years, improving its market share to 29 per cent in FY14 from 25 per cent in FY10. It’s higher margins are a result of a larger share of the replacement market to revenues (76 per cent) and a better product mix.
Analysts at Edel Invest Research believe it will be able to maintain a better margin profile on the back of scale, strong brand recall, higher pricing power and a better product mix. With the radialisation trend, they believe the share of the higher-margin truck and bus radials will double from the current 17 per cent to 33 per cent over the next two years.
The margin has improved from 8.4 per cent a couple of years earlier to 14.9 per cent. Given lower raw material prices and pick-up in volume growth to original equipment makers, they expect net profit to grow 20 per cent annually over the next three years. The company is also investing Rs 4,000 crore over three years to expand capacity, to sustain long-term growth.
Apollo Tyres
The key trigger on the operational front for Apollo is the upturn in the CV cycle, as the segment gets the company two-third of its India revenue. With strong year-on-year growth in medium and heavy CV volumes on a small base over the past few months, the company is well positioned to gain from a revival. Analysts at JPMorgan believe Apollo will grow in double-digits from here, driven by a recovery in the domestic business. India accounts for 65 per cent of its consolidated revenue. A fall in diesel prices, half the operating cost of a truck, will boost the profitability of fleet owners, thereby improving the demand for CVs.
While higher volumes and lower costs will boost margins, the key risk for the company is pricing pressure in its European operations. Given the nearly 500 bps higher margins for European operations, a worsening situation will impact profitability of the consolidated entity, though some of the pressure could be offset by lower prices.
JK Tyre
The company is the largest one in the truck and bus radial segment, with a 34 per cent share (Apollo is second largest, with 30 per cent) and gets about 80 per cent of its revenue from the CV space. Given the trend towards radialisation, with the operational efficiency and fuel savings of radial tyres, it is expected to gain the most from this. While radials form 30 per cent of truck and bus tyre sales for the sector, they are expected to move to 40 per cent in the medium term.
Ebitda (earnings before interest, taxes, depreciatio and amortisation) margins, which more than doubled over FY12-14, are expected to gain another 200 bps over the next two years, due to higher demand for truck and bus radials and increase in operating leverage. With the net debt-equity ratio reducing from 2.6 times in FY13 to 2.1 times currently and cash flow from operations expected to meet capital expenditure needs, analysts at ICICI Direct believe the net debt levels have peaked and a major Street concern is addressed. They expect the number to improve to 1.3 times by FY16.
