Rolling on

PENNY WISE

JK Tyre is expanding its manufacturing capacity to strengthen its position in the radials segment.

India's third largest tyre maker JK Tyre & Industries is a strong player in the commercial radial tyre industry with a 78 per cent market share. While the radialisation in the passenger car market in the country is over 90 per cent, it is below 6 per cent in the truck and bus segment.

The JK Tyre management believes that this number will expand to 13 per cent in the next four years. A dominant player in radials, JK Tyre is looking at the future demand of commercial radials""which are high value and high margin""and is expanding its capacity.

Radial expansion
JK Tyre makes radials and bias tyres for commercial vehicles (CV) and passenger vehicles. The company makes 8.7 million tyres at four plants across the country and will add capacity to increase the output to 12 million tyres in four years.

It is taking the expansion route as its plants in Banmore (Madhya Pradesh), Udaipur (Rajasthan) and Mysore (Karnataka) are operating at 90 per cent capacity for over a year now. It intends to add off-the-road (OTR) and speciality tyres to its portfolio in this fiscal as they fetch better margins.

JK Tyre is the leader in truck and bus radials and to maintain its lead, the company is expanding capacities at a cost of Rs 1,200 crore which will be implemented in two phases.

In the first phase the company intends to invest Rs 480 crore to double its commercial vehicle (CV) radial capacity from 3.7 lakh to 8 lakh tyres. The investment also includes Rs 120 crore to be used in setting up an OTR facility for Bharat Earth Movers.

The second phase to start at the end of 2009 will enhance radial capacities for passenger vehicles to 70 lakh and CVs to 12 lakh tyres at an investment of Rs 720 crore.

Operational gains
With facilities running at full capacity, there was little leeway to improve profits by increasing the top line. So, the company brought in productivity improvements and cost reduction to improve profits.

Efficiency gains in various plants has helped JK Tyre to make savings (as a percentage of costs) of Rs 66 crore (2.6 per cent) and Rs 52 crore (1.9 per cent) in the last two fiscals. For year ended September 2007, the company has targeted cost savings of Rs 45 crore. These savings have helped it post better numbers for FY07.

Higher margins
Due to lower natural rubber prices and operational improvements the company was able to improve its operating margins in the September 2007 quarter. While natural and synthetic rubber prices were lower by 5 per cent and 6 per cent respectively for the quarter, NTC fabric another critical input was down 6 per cent y-o-y.

Carbon black prices were, however, higher by 4 per cent y-o-y. Lower input costs helped the company improve its operating margins in the last three quarters from 7.9 per cent to 11 per cent.

While the company benefited from lower input costs over the last two quarters, rising crude oil and natural rubber prices might play spoilsport in the future. Analysts believe that it is difficult to predict the price movement of crude oil and natural rubber which account for over 60 per cent of raw material costs.

"There is volatility in the prices and unless they stabilise it will be difficult to put a number to operating margins for the sector over the next few quarters," said Sachin Kasera of Pioneer Intermediaries.

Thus far, JK Tyre and other tyre makers have been able to pass on price hikes to the replacement market, while auto manufacturers are tough negotiators, unwilling to take price hikes. However, margins will be squeezed if crude prices continue their march upwards and trend of sluggish sales continue.

Lower sales
While operating margins were up, sales in the September quarter are down 3.3 per cent y-o-y. The dip in sales is due to a 7.5 per cent fall in volumes to 54,000 tonne on account of a slowdown in the CV tyre sales to manufacturers and sluggish CV replacement demand.

Kasera says that the lower offtake of CV tyres will continue for two-three quarters. In value terms, CV tyres account for nearly 80 per cent of the Rs 19,000 crore Indian tyre market. Nearly 60 per cent of this is accounted for by replacement orders.

The JK Tyre management expects that lower operating cost of new vehicles and regulations forcing truckers to replace old vehicles will boost demand from CV manufacturers. It hopes that better infrastructure and road travel will create demand for the replacement segment.

However, Chinmay Desai, research analyst, Finquest Securities believes that the muted tyre demand in the replacement segment over the past few quarters could be the result of retreading of tyres by truckers who wish to prolong the life of the tyre. If that trend continues, the company will have to focus on the export market and sales to manufacturers.

Exports
JK Tyre is the largest Indian exporter of tyres and earned revenues of Rs 500 crore in FY07. To increase its share in the export market, the company is outsourcing a part of its requirement to Chinese manufacturers.

This way it will be able to use capacities to cater to the domestic requirement while at the same time leverage its strong brand name in the overseas market.

Valuation
While the stock price of JK Tyre has barely moved in the last month it has been volatile over the last six months touching a high of Rs 165 on July 31 and a low of Rs 102 in April this year. At Rs 120, the stock discounts its FY07 earnings of Rs 21.7 by 5.6 times and its estimated FY08 earnings of Rs 29 by 4.1 times. At these multiples, it seems like a cheap stock.