Automotive tyres -- Deflated by many factors

B. Krishnakumar

THE OVERALL corporate sector, and the tyre segment, in particular, are not likely to have happy memories of 2000.

The market capitalisation of almost all companies in the tyre sector took a beating. The share price of the market leader, MRF, declined from Rs 2,362.7 to a low of Rs 852.1 but recovered to Rs 1,193.70 now. Goodyear declined from Rs 127.75 to a low of Rs 43 and rules at Rs 48.05.

Though the decline in the share price of tyre companies could be partly attributed to the overall decline in the market, some industry-specific developments also contributed to the decline in the valuation of tyre stocks. A look at the key factors that affected the industry will provide further insight into what is in store for the tyre producers.

Click here for Table

Demand dries up

After a robust growth in 1999, the tyre companies had to contend with dwindling demand in 2000. Led by a sharp rise in commercial vehicles output, the demand for tyres rose sharply in 1999. Together with the recovery in the industrial sector, this pushed up the demand for tyres. The truck and bus tyre segments were the chief beneficiaries of the improvement in the commercial vehicles output.

As a result, tyre production rose sharply in the first half of the previous fiscal. The truck and bus tyre production touched an all-time monthly high of 7.81 lakh units in September 1999. Apart from the truck and bus segment, the output of other tyres also picked up sharply in the first half of the previous year. The robust growth in demand also helped the tyre-makers hike the product price to accommodate the increase in the rates of key inputs such as natural rubber, carbon black, nylon tyre chord and synthetic rubber.

However, the recent economic slowdown, coupled with the sluggishness in the automobile sector, affected the performance of tyre companies. The offtake of commercial vehicles slowed down considerably in this fiscal. For the seven month period ended October 2000, the commercial vehicles output declined by 9.5 per cent.

Given that the commercial vehicles segment is the major source of demand of the tyre segment, both in terms of volume and value, the slowdown in demand from this sector (trucks and buses) negatively impacted the performance of tyre producers. Apart from the commercial vehicles, the other segments of the automobile sector, such as tractors and passenger car, have also been witnessing a downtrend in the recent months.

The tractor output declined 17.1 per cent for the seven months ended October 2000 compared to the corresponding previous period. Apart from tractors, sales of passenger cars too hit a plateau this year. Passenger car production declined about 8.29 per cent in this period. The slowdown in the tractor and passenger car segments affected the growth in the tyre production.

The total tyre output posted a modest growth of about 3 per cent in April-October 2000. Much of the growth in tyre production was contributed by the two-wheeler segment, while in the truck and bus segments (basically commercial vehicles) the output declined marginally to 7.15 lakh units from 7.18 lakh units. The passenger car output inched up by about 9 per cent. The growth is attributable to replacement demand.

Rising input costs

Tyre manufacture is highly raw material-intensive. As a result, the profit margin is thin. The average operating profit margin is around 11 per cent and the net profit margin 3 per cent. Raw material costs account for close to 46 per cent of the total turnover. Natural rubber, synthetic rubber, carbon black and tyre chord are the principal raw materials used in tyre manufacture. Natural rubber constitutes about 24 per cent of the total cost. Carbon black accounts for about 12 per cent of the total input cost, while synthetic rubber and nylon tyre cord account for about 26 per cent each of the total cost.

Click here for Chart

Fortunately for the tyre industry, the price of natural rubber has remained flat in recent times. The steady trend in production, coupled with the slowdown in the tyre industry, kept rubber prices under check. The natural rubber price continues to hover around the Rs 3,000 a quintal mark. However, the prices of carbon black, synthetic rubber and nylon tyre chord have been rising in recent months.

The upward spiral in the crude oil price pushed up the prices of carbon black, synthetic rubber and nylon tyre chord. For instance, the price of carbon black firmed up by about 25 per cent compared to a year ago. Given that close to 60 per cent of the raw materials for the tyre industry is petro-based, the recent firmness in crude oil and petro-based products has affected the profitability of tyre producers. While input costs have been rising, tyre producers have been constrained by the competitive pressure of raising product prices to accommodate the impact of rising raw material cost.

Though the tyre producers raised prices in 1999, the input prices rose this year as well. However, the slowdown in the automobile output and the industrial sector resulted in sluggish demand for automotive tyres. This has limited the scope for any further price increases.

Radial capacity build-up

In the meantime, the tyre industry has seen a steady capacity build-up, especially in the radial tyre segment. Almost all major tyre producers including MRF, Apollo and Ceat have expanded tyre production facilities in the last five years. However, the demand for tyres has not quite been robust.

According to the latest estimates, the country's total installed capacity stands at about 530 lakh tyres with an average capacity utilisation of 78 per cent. With the demand drying up this fiscal, the negative impact is being reflected in the performance of tyre producers.

Goodyear India, in fact, incurred a loss of Rs 12.60 crore for the quarter ended September 2000 compared to the Rs 6.46-crore profit recorded in the same period in 1999. Apollo Tyres has seen its net profit decline 68 per cent to Rs 6.25 crore from Rs 19.66 crore recorded in the quarter ended September 1999.

Lopsided duty structure

Apart from the rising input costs, the anomaly in the indirect tax structure has affected the prospects of the domestic tyre producers. At present, all categories of new tyres can be imported freely. But so can second-hand and used tyres, though subject to a floor price of $175 for truck and bus tyres and $25 for passenger car tyres.

The liberalisation of tyre import norms has exposed the industry to the threat of imports. Though imports have not assumed menacing proportions on account of the floor price restriction, any further relaxation would mean further trouble for local tyre producers.

Moreover, under the Bangkok Agreement, imports from countries such South Korea, Sri Lanka and Bangladesh enjoy a further concession of about 5 per cent. As a result, tyre imports from South Korea and China increased significantly in the recent years.

To compound the problems, the import duty on raw materials is either equal to or marginally higher than that for tyres. The import of natural rubber is not freely permitted. While natural rubber is currently in the restricted list of imports, the Government has imposed anti-dumping duty on nylon tyre cord and synthetic rubber. This has compounded the existing problems of tyre producers. The recent depreciation in the value of the rupee (against the dollar) has also played a role in inflating the price of petro-based inputs.

On the one hand, imports from China and South Korea have been increasing, and on the other, the imposition of anti-dumping duty and the lopsided duty structure have affected the profitability of domestic producers. The impact is already getting reflected in the declining profitability trends of tyre companies in recent months.