On one hand, input cost pressures are easing. This is likely to boost the sector’s margins. On the other hand, demand in the crucial replacement segment softened in the March quarter (Q4 FY23).
Investors in tyre stocks are facing a dilemma. On one hand, input cost pressures are easing. This is likely to boost the sector’s margins, which were languishing in recent quarters. On the other hand, demand in the crucial replacement segment softened in the March quarter (Q4 FY23), latest dealer channel checks by brokerages showed. This is said to be a fallout of steep price increases taken by tyre makers over the past few quarters to beat cost inflation. Higher interest rate and tightening credit supply also impacted demand from fleet operators, said analysts at JM Financial Institutional Securities Ltd.
Not just domestic demand, there is moderation on the exports front as well. Note that exports have been a crucial growth driver for the tyre sector lately. “Export tyre volumes had remained steady at 13-16 million tyres per annum over the four fiscal years through FY21, but almost doubled in FY22 to 30.5 million," said Ravleen Sethi, associate director, CareEdge Ratings. This was driven by factors such as increased adoption of the ‘China-plus-one’ strategy and strict anti-dumping duties against Chinese products. “Tyre exports did well in the half year ending September (H1FY23), but came under pressure in H2FY23. Exports are expected to be impacted in the coming quarters due to geopolitical issues and adverse macroeconomic conditions," added Sethi.
A bleak demand scenario has had a bearing on investors’ sentiment towards the sector. Shares of listed tyre makers such as Apollo Tyres Ltd, Balkrishna Industries Ltd, Ceat Ltd, JK Tyres & Industries Ltd and MRF Ltd have declined by 4-18% in CY23 so far.
“Weak replacement demand has weighed on the performance of tyre stocks in CY23 so far," said Varun Baxi, an analyst at Antique Stock Broking Ltd. He feels that even though in the near-term, muted domestic and export demand is a dampener, for tyre stocks, a bigger trigger has been margins recovery helped by softening raw material costs. “So, once margins start to improve, that would reflect in stock performances too. In Q4FY23, we expect the sector’s margin to see a 150 basis point sequential rise and the benefit could continue in Q1FY24 as well," he added. One basis point is one-hundredth of a percentage point.
Remember in CY22, most tyre stocks were on a roll, with some such as Apollo Tyres clocking as much as 42% gain. A combination of factors fuelled this rally. The sector saw price hikes after a long gap. According to JM Financial, in the last 10-12 quarters, tyre makers have raised prices by as much as 30%. Additionally, there was pricing discipline among the companies, and at the same time, input costs also started to come off.
The good part is that prices of key inputs, such as natural rubber and synthetic rubber, continue to fall. The JM Tyre RM Index shows raw material basket consumption costs for tyre manufacturers have further declined by 2% sequentially in Q4FY23 (6% year-on-year). This was primarily led by the drop in the price of crude derivatives (by 2-9% QoQ) and domestic natural rubber prices. With this, the JM Tyre RM Index has declined by about 13% from the peak in Q1FY23.
It goes without saying that a further drop in raw material prices would augur well for the sector’s profitability and provide some respite if competitive intensity rises.
Additionally, the capital expenditure intensity has cooled-off and that bodes well for the sector’s medium-term free cash flow trajectory. But if demand does not recover, then companies could opt for price cuts to boost volumes. Hence, investors need to be mindful of demand trends.
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