Tyre stocks gain grip on improved pricing

Market


Tyre stocks are in the limelight. Shares of Apollo Tyres Ltd and Ceat Ltd rose to 52-week highs this week on the NSE on the back of relief provided by easing prices of raw material, including natural rubber, carbon black, and other crude-based derivatives. Prices of natural and synthetic rubber have also come off their recent peaks, while Brent crude oil prices have declined. These components form a substantial portion of the sector’s overall input costs. Given this, softening costs could give the muted operating performance of tyre makers the much-needed fillip.

However, more importantly, the sector’s improved pricing power is said to be the main driver of excitement around tyre stocks.

Cooling off

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Cooling off

“Earlier, there used to be under-cutting of prices by leaders in each tyre category and the price trend was set by the leader. But, in the last one year or so, we have seen significant price action by all listed companies,” said Varun Baxi, an analyst at Nirmal Bang Institutional Equities. This is good for the margin outlook and a double-digit margin growth will lead to multiple re-rating for tyre stocks, Baxi said.

Gross margins of tyre companies have been under severe pressure in recent quarters. So, to contain further margin erosion, companies have taken a series of price increases. Given the lag effect in passing on the burden of elevated input costs, margins should start improving gradually. In Q2FY23, margins may see a further deterioration, but are anticipated to gradually improve from Q3FY23 onwards.

Here, the ability of tyre makers to keep raising prices has boosted investors’ confidence.

Dealer channel checks by some broking firms indicate that tyre prices across product categories are likely to see additional hikes of 1.5-2.5% in September. Tyre companies have taken around 3% price hikes in July and August as well, according to analysts.

Interestingly, market leader MRF Ltd’s narrowing revenue and margin gap with its competitors is also aiding the industry’s pricing discipline. Historically, MRF enjoyed significant margin advantage versus peers because of higher exposure to two-wheelers (2W) and dominance in the TBB (truck, bus, bias tyres) segment, IIFL Securities Ltd said.

“However, MRF’s 2W margins and market-share have come off. MRF has not been able to replicate TBB dominance in TBR (radial),” said the IIFL report dated 30 August. So, in recent quarters, other companies have taken the lead on pricing, even ahead of MRF, it said.

Meanwhile, the demand outlook for the sector is expected to be robust. Volumes are likely to get a boost in FY23 from recovery in the domestic original equipment manufacturers (OEMs) and the replacement segments. The easing of the semiconductor shortage should lead to an improvement in OEM sales and revival of replacement demand for tyre companies in H2FY23, said Mitul Shah, head of research at Reliance Securities.

On the flipside, worries of a global recession, especially in the EU, could impact FY23 volume growth for some companies such as Balkrishna Industries Ltd.

In 2022 so far, stocks of Apollo Tyres, Ceat, MRF, and JK Tyre and Industries Ltd have rallied by 12-27%. During this time, the Nifty 500 index has risen by 3%. Further meaningful upsides would hinge on the pace at which margins improve.

Apart from that, investors in tyre stocks need to monitor the sector’s leverage capital expenditure trends. A large part of the sector’s capex is likely behind for now. With improved profitability, tyre companies are expected to use free cash flows for debt repayment.

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