Manufacturers are expected to benefit from a strong demand environment and an imminent price hike.


The tyre industry has emerged from the side-wings even as the auto boom story continues its dream run. The stocks have zoomed since the past few sessions, as the strong auto sales indicate favourable supply-demand dynamics for tyre manufacturers to retain pricing power. They will also be able to transmit rising raw material costs, thereby protecting operating margins that were under pressure in the previous quarter from higher rubber prices dropping between 300-500 bps for companies sequentially.

Net sales (in the quarter ended June 2010) for Apollo Tyres increased by 39% sequentially q-o-q and raw material prices were up 22% and inclusive of other finished goods and adjusting for stocks, input costs were up 15% this quarter pulling operating margins down 415 bps to 10.48%. Similarly for JK tyres, against a rise in net sales of about 22% q-o-q, input costs increased by about 18% and operating margins were down by nearly 580 bps to 6.27%.

MRF saw sales jump up 9% this quarter compared to the previous quarter while input costs increased 14% pulling operating margins (9.07%) down 240 bps. Ceat saw near flat growth (near 2%) on a sequential q-o-q basis, while raw material costs increased by 3.2% even as stock adjustment and lower purchases of finished goods kept input costs flat in the period. Ceat bucked the trend of shrinking margins with its operating margins (5.28%) expanding marginally by 16 bps in the period.

The demand environment is quite strong from both original equipment makers (OEM i.e. auto manufacturers) and in the replacement market. There is a clear domestic capacity crunch as most tyre manufacturers are working at a capacity utilization well over 90% and as such analysts believe that the pricing power companies is clearly evident in the replacement market and also with OEMs, given the anti-dumping duty on Chinese and Thai tyre manufacturers applied in February 2010. Analysts believe that companies look set to recover their stressed margins by passing through the impact of higher rubber costs through price hikes which are imminent.

A Credit Suisse research report points out that longer term trends including the change in sales mix because of higher passenger car tyres and slow but steady pick-up in radial truck tyre sales (both of which are higher margin compared to the current mix) lend credence to the view of sustainability of higher profitability in the sector. The report sees demand increasing by about 12% per year in terms of tonnage compared to 7% in the last three years, even as supply is expected to lag significantly for the next couple of years when most of the expansion will come online with the crunch being sharper in the truck and bus segment. Capacity additions are expected in the car radial tyre segment in FY11 but demand is expected to outstrip supply beyond that.

The key risk to the pricing power comes from cheap imports from China and Thailand which analysts reckon are about 15-20% cheaper inspite of the anti-dumping duty given that import price of rubber in China is about 7.5% against 20% in India. These imports have grown sharply in the last year and the import restriction on truck radial imports was removed in May 2010. A greater impact of higher imports is expected on the OEM market rather than replacement market.

With enhanced capacity expected to come online soon from its Chennai facility Apollo Tyre, which has superior operating parameters to its peers is seen as a key beneficiary going ahead according to analysts.