Rough road ahead

IPO REVIEW

Rising raw material costs and competitive pressures are keeping tyre stocks from rolling.

If you are buying into tyre stocks, overwhelmed by the burgeoning monthly auto sales numbers, you may have a tough journey ahead. As Sachin Kasera of Pioneer Intermediaries puts it, "The original equipment market (OEM) is competitive and replacement market is price sensitive."

Given this scenario, players have been struggling to keep up their profitability at a time when raw material prices seem to be going through the roof.

"The tyre industry is going through a rough phase and we have to see if the recent improvement in performance is really sustainable," adds Kasera. According to an analyst from BRICs private client group (PCG), "The valuation of Indian tyre companies currently looks stretched considering the expectation of continuation of margin pressure."

Majority of Indian tyre stocks have been laggards on the bourses since last one year. While BSE Sensex and BSE Auto index have given spectacular returns, most of the tyre majors have disappointed investors. The poor performance on the bourses is a consequence of declining profitability. 
 

STOCK PERFORMANCE
Companies	Price as on  Feb 24, '06	1-year  return (%)
Apollo	291.00	5.43
J K Tyres	121.00	46.40
MRF	3074.00	16.59
Ceat	69.00	7.11
Sensex	10222.00	52.60
BSE-Auto	4832.00	72.80

Despite the robust volume growth, improving utilisation rates and price hikes effected by most tyre makers have just managed to sustain margins.

For example, in case of tyre major Apollo, while sales growth has been robust at around 18 per cent year on year (y-o-y) in nine months ended December 2005, PBDIT (profit before depreciation, interest and tax) margins have almost remained unchanged at 8.7 per cent.

Similarly MRF reported 18 per cent growth in net sales in the same period; however profitability improved only by 180 basis points. To a large extent, manufacturers cannot be blamed as they are hardly in a position to pass on the higher cost of materials to the customers.

Ramnath S, vice president - research, SSKI securities says, "Input costs have been hitting new highs almost everyday."

Price of natural rubber forming over 30 per cent of total raw material costs, have nearly doubled in the past one year and is ruling at all time high of around Rs 80 per kg. Crude based raw materials like carbon black and nylon tyre chord fabrics are up by over 25 per cent. 
 

FINANCIALS (Figures are for third quarter fiscal 2005-06)
Rs crore	Apollo Tyres	J K Industries	Ceat	MRF
Net sales	678.80	576.11	410.69	817.18
% change	18.80	33.00	8.10	18.80
RM/Sales (%)	70.80	73.60	73.60	74.40
% chg	790bps	300bps	300bps	300bps
Operating profit	53.86	36.90	19.67	62.32
% change	27.10	138.00	43.90	32.60
OPM (%)	7.90	6.40	4.79	7.60
% change	50bps	280bps	120bps	80bps
Net Profit	16.44	2.47	1.54	13.92
% change	-2.40	126.80	35.10	23.20
NPM (%)	2.42	0.43	0.37	1.70
% change	-53bps	LTP	7 bps	6bps
Trailing 12 month P/E	14.93	15.96	-	26.78

Says Neeraj Kanwar, joint managing director, Apollo Tyres, "The outlook on costs continue to be grim. Natural calamities have had an adverse impact through the year and we don't see much relief this year in the coming year."

Going forward, escalating raw material costs may continue to depress margins. Amit Kumar, general manager -- strategic planning, Ceat Ltd adds ""Spiralling costs of raw materials remains a big concern. However in the event of softening of the costs, margins are likely to improve as price cuts won't follow immediately."

Nearly all the players hiked prices in 2005-06, in line with the increase in raw material prices. However, price hikes have not been enough to cover the cost push. For instance, over the past one year Apollo Tyres has effected a price raise of just 8-10 per cent across its products. This is because players have been cautious about raising prices as competition is getting more intense.

"Unhealthy competition exists in the Indian tyre industry for quite a few years now. The price disparity between the players is quite huge. For example, when MRF sells a truck tyre to customers at Rs 10,500, a similar product is sold by competitors for as less than Rs 8000-9000 This is what makes it difficult for the tyre industry members to pass on the increases in costs to customers," adds Philip Eapen, executive director - marketing, MRF.

Currently, there are nearly 40 companies that make tyres but the top four major players namely MRF, Apollo, J K industries and Ceat account for 80 per cent of industry turnover. While MRF is the market leader with a market share of about 27 per cent (as on September 2005), Apollo tyres has the dominant position in the commercial vehicle segment with a market share of about 26 per cent.

That's not the end of the road though. Industry experts do expect things to change for the better though not in a hurry. Currently, the demand and supply for tyres is almost matching at 48 million units.

Since no major greenfield expansions is expected, except some debottlenecking activities, there is a possibility of demand outstripping supply. While the pricing environment will improve a bit driven by buoyant demand, analysts do not expect this to translate into higher profitability immediately.

While demand for tyres is expected to continue to grow at 7 per cent over the next five years (FY06-10), pretty much in line with the growth trend in the past five years, supply growth is expected to lag behind. Kumar of Ceat Ltd paints even more encouraging picture.

He says, "The industry is likely to grow at 10-12 per cent in two to three years with industry size bulging to around Rs 20000 crore from the current Rs 15000 crore. High GDP growth, cheap and easy financing, improvement in infrastructure like roads, lucrative exports market and high demand growth from the replacement market are some of the factors that will drive demand growth."

D Ravindran, director general, Automotive Tyres Manufacturers' association (ATMA) adds, "Demand from replacement market, which forms 60 per cent of overall demand, is expected to be the main driving factor thanks to the handsome growth in the vehicle sales over the past few years."

According to SIAM (Society of Indian Automobile manufacturers), vehicle sales have clocked an annual growth of 16.3 per cent in FY03-05 and 13.2 per cent y-o-y in april- January 2006.

"A majority of demand would come from medium and heavy commercial vehicles in the replacement market apart from OEM sales for light commercial vehicle and passenger car radials" adds Kanwar.

Thus the replacement market demand is expected to grow around 8 per cent CAGR and OEM market at 7 per cent in next five years. Exports are expected to grow at a even higher rate of 10 per cent in the same period.

However according to Kasera, "Indian tyre players are still one generation behind overseas players in terms of technology. Moreover exports mainly consists of cross-ply/nylon tyres which is just 5-10 per cent of the exports market. Exports are mainly to countries that are not developed or in line with India, like the Middle East, Africa etc. China is ahead of us in tyre exports."

Most analysts are neither here nor there when it comes to taking calls on the stock. Ramnath S from SSKI Securities has a neutral stance and says, "Investors should trim their exposures or wait till there is any visibility on the easing of raw materials."

Neeraj Kanwar, joint managing director, Apollo Tyres

Can you give the break up of total revenues?

We derive 85 per cent from the domestic market and rest from exports. In the domestic market, replacement market form 80 per cent of our revenue and original equipment market (OEM) the rest.

What is your current market position?

We are leaders in the commercial vehicles sector with 26 per cent market share and second largest in the passenger cars segment after Bridgestone.

What growth do you expect in future?

We have maintained a CAGR of about 15 per cent and more in net sales for the past 5 years and we hope to continue at this rate. In terms of profitability, we hope to continue to grow at the same rate of about 22 per cent as experienced in past three years.

What are the key developments happening in your company?

We are looking at launching truck and bus radial tyres by November /December 2006. We have spent about Rs 55-60 crore on this project which has already commissioned.

This would enable us to enter the technology based platform and open huge market for exports. Then we are also looking at speciality tyres (industrial and off the road tyres) basically used for dumpers, crane tyres, mining tyres.

The project to be commissioned by April 2007 involved a capital outlay of Rs 30-40 crore in Baroda and the capacity would be about 10-15 tonnes per day.

There is huge demand for speciality tyres in the entire world including India and margins are also good. We have also invested in debottlenecking and installation of new equipment for increasing the capacity of our passenger car radials from 7000 to 10000 tyres per day.

What impact do you see on your exports following your acquisition of Dunlop Tyre International (South Africa)?

The acquisition will only add to our future growth in exports. Now we have two brands to market. While the Dunlop brand is marketed in African market, its private brand Regal is marketed in European market.

Apollo is marketed all over the world. With this, added by our truck and bus radial project, we hope the contribution of exports to increase form 15 per cent to 18-20 per cent.

What's your outlook on the raw material scenario?

Margins are currently tight.The way the raw material prices ( oil and natural rubber) are going up, we don't see it coming down in near future. International rubber price is dearer by about 10 per cent in comparison to domestic prices.

Do you plan to raise prices going forward?

Yes we will raise prices by about two per cent in march after a recent hike of two per cent in beginning of February.

How do see your margins in future?

We see margins improving with our several initiatives like strategic outsourcing of raw material from various parts of the world like China, Eastern Europe and Russia. We also do internal monitoring of overhead costs.