Volumes hold key to tyre companies' prospects

Margins to continue as robust, near-term demand likely soft

The rally in tyre stocks, which are up six-16 per cent over the past week, seems to suggest that the Street has shrugged off the impact of the weakening yuan and the expected increase in imports from China. While the imports of truck radial tyres from China are already up 80 per cent year-on-year, depreciation of yuan can push it up further.

So, why is the Street unperturbed? One reason is that it believes that as in the past, an anti-dumping duty could be levied on imports. The government relaxed anti-dumping duties on Chinese imports in September 2014, which led to a surge in tyre imports from China thereafter. Imports of truck and bus radial tyres rose 60 per cent year-on-year in FY15, helping Chinese players increase their replacement segment market share to 25 per cent from 15 per cent.

Analysts at Deutsche Bank say the yuan depreciation might not incrementally increase the risk of dumping and expect that an anti-dumping duty on Chinese tyre imports could be re-imposed by end-FY16. Given that countries like the US have imposed anti-dumping duty in June 2015, analysts expect similar action from the Indian government. The process, however, could be a long drawn one, feel Credit Suisse analysts, as it will be difficult to establish that the domestic industry is getting hurt (prerequisite for imposing the duty) given strong margins. Nevertheless, ICRA expects the industry revenues to grow seven-eight per cent during 2015-16, up from 5.8 per cent during 2014-15.

While the Street will keep an eye out for any action on Chinese imports, margins for most tyre majors should sustain at current levels. Most tyre majors saw margin gains upwards of 500 basis points in the June quarter with some such as JK Tyre, Apollo Tyres (domestic business) recording their highest operating profit margins. Analysts expect natural rubber prices to remain soft. Prices of crude oil derivatives too are expected to stay soft.

The worry, however, is on the sales growth front. Volumes and realisations for key players were down in the June quarter due to subdued demand and competition by Chinese players. Indian companies have had to cut prices to remain competitive. Even overseas operations of Apollo (Vredestein) and JK Tyre (Mexico) are experiencing similar issues on volumes and realisations. Given that truck radials are the fastest growing segment with growth north of 25 per cent over the last two years, companies (market leader Apollo Tyres, JK Tyre) that are expanding capacity in this segment will benefit.

These companies are seen benefiting from higher demand from replacement and OEM segments as well as perception that Indian radials are of better quality as compared to Chinese products. Notably, debt for most tyre companies has already peaked out or is trending down given strong profitability. Given the backdrop, most analysts have a buy on tyre companies.