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B. Krishnakumar

DESPITE the buoyancy in the economy, the pick-up in industrial growth and the booming stock market, tyre producers may not be on a roll. Be it the financial performance or the share price returns, the tyre majors have under-performed the last couple of years. The reasons for this divergent trend are not far too seek. A sharp rise in raw material price, subdued growth in demand and capacity overhang have played a role in pulling down performance.

Demand not quite robust

The increased automobile production the last couple of years has translated into an increased demand for tyres from the original equipment market. The growth in tyre demand has not been quite robust, as the original equipment market is not a major driver of sales volume.

The original equipment market accounts for 39 per cent of the tyre market and the replacement market about 54 per cent of the tyre demand, with the balance made up by exports. The total tyre production registered a modest 6 per cent growth in 2003-04 though the automobile production was quite robust.

The realisation and profitability is also higher in the replacement market vis-à-vis the original equipment segment. Given this backdrop, it is not surprising that the increased demand from the original equipment market has not had a positive impact on the performance of tyre companies.

Only a pick-up in the replacement market demand would have a significant positive impact on companies' prospects. Within this market, the truck and bus tyre segment accounts for bulk of the volume.

This segment is the largest constituent of the tyre market both in terms of volume and realisation, accounting for about 60 per cent of the market.

Truck and bus tyre production registered a modest three per cent rise in 2003-04. Considering that the replacement market accounts for about 80 per cent of the truck and bus tyre demand, the performance of tyre companies is unlikely to improve unless there is a significant pick-up in replacement market demand.

Spiralling raw material cost

The trend in raw material prices have a major influence on the performance of tyre companies as they account for about 60 per cent of the turnover. The price of key inputs used by the tyre industry, including natural rubber, synthetic rubber, carbon black and tyre cord, have risen sharply in the recent quarters. The prices of carbon black and synthetic rubber are influenced by the international crude oil prices. Taking into account the sharp spurt in oil prices, it not surprising to notice a similar trend in the price of carbon black as well.

Natural rubber prices have almost doubled from the levels that existed a year ago. Though prices have eased to present level of about Rs 52-55 per kg, they still rule higher by about 70 per cent in comparison to the previous year.

Tyre companies have not been able to revise tyre prices to accommodate input cost rises owing to a competitive environment. The tyre industry is characterised by excess capacity with a utilisation of 89 per cent (installed capacity of 700-lakh tyres) registered last year. Moreover, the industry is volume-driven with limited scope for expansion in profit margin. As a result, companies find it difficult to hike prices, which tends to negatively impact the bottomline.

The performance of tyre companies over the past few quarters is reflective of this trend. Though the turnover has displayed growth, aided primarily by the original equipment market, the post-tax earnings of almost all tyre producers has taken a knock owing to the dent in profitability caused by increased input cost. Though tyre producers have effected price hikes in the past six months, the cumulative revision would be 8-10 per cent. The price hike is also nominal in relation to the spurt in input cost.

What is in store?

Though the tyre industry may have been through a rough patch, there are signs of improvement in the business environment. The recovery in the industrial activity, increased government thrust towards the development of roads and highways and the rising demand for higher-tonnage multi-axle trucks are positive features.

The demand for truck and bus tyres from the replacement market is likely to pick-up in the future. The optimism stems from the steady increase in commercial vehicle production over the past 15 months, the growth in economic and industrial activity and rising proportion of freight movement through roads.

The availability of higher tonnage vehicles and the improvement in the condition of highways has resulted in increased flow of freight traffic through roads, at the expense of Railways. This would result in increased demand for truck tyres from the replacement market, which is likely to have positive impact on the performance of tyre majors such as MRF, Apollo, Ceat and JK Industries.

From the cost side, prices of key inputs have displayed signs of softening. Natural rubber prices have eased from the recent high of about Rs 68-69 per kg to Rs 50-51 per kg. The price of crude oil has also receded below the $50-per-barrel mark, after having moved to a high of about $56 a few weeks ago. The price of petro-based inputs such as carbon black, caprolactum and synthetic rubber could see some correction in the next few months if crude oil price remains at prevailing levels.

Realising the signs of improvement in business prospects, the share price industry majors — MRF and Apollo Tyres — have already seen an upward move. The valuation of the companies in the industry would improve if the price of key raw materials were to seek lower levels.

Key concerns

Though the prospects for the tyre industry are likely to get better, the optimism is subject to a soft trend in the prices of key inputs such as natural rubber, carbon black and synthetic rubber and a sustained growth in economic activity and industrial production. The slowdown in economic growth would affect tyre demand while an increase in price of raw materials would dent the profitability.

The possibility of increased flow of imported tyres could be another major threat for the domestic tyre industry. Global tyre majors such as Michelin, Bridgestone, Kumho and Goodyear have production facilities in Asian countries.

Given this backdrop, the gradual reduction in import duties and the signing of free trade agreement with Asian countries (Thailand recently) could expose the domestic industry to the threat of cheaper imports.

Though there are no signs of rampant imports, such a threat is not ruled out. Though the lowering of Customs duty would also have a beneficial impact in the form of drop in landed price of imported raw materials, the scale of operation and strong financial standing places global majors in a position to flood the market with tyres at highly competitive prices.

In such a situation, companies with presence across different markets and a wide product portfolio would stand a better chance of withstanding competitive forces. MRF, Apollo Tyres, Ceat and JK Industries appear better positioned on these parameters.

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