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Monday, June 8, 2009

Sector Analysis - Tyre Manufacturing & Best Stocks

The tyre industry, which was reeling under a slowdown in demand till December ‘08, is likely to show signs of improvement in the coming quarters. With the price of rubber, a key raw material, easing off and uptick in demand from passenger cars, tyre makers are likely to register a better growth this year.

The positive signs have already started reflecting in the industry, which is estimated to have grown 4.27% in terms of tonnage production for ‘08-09. This shows that there has been a sharp growth in the quarter ended March ‘09 as the industry had registered production growth of just 2.19% in the first nine months of FY09 as against a growth of 7.4% during April-December ‘07.

INDUSTRY STRUCTURE
The tyre industry is pretty consolidated with the top six companies accounting for 87% of the industry’s tonnage production, largely dominated by Indian firms. MRF, with 22.4% market share, is the leader, marginally ahead of Apollo Tyres’ 21.4% in terms of tonnage production .JK Tyre & Inds is the third largest player and has consolidated its position in the off-the-road tyre (OTR) category, which is essentially custommade products with high margins.

Domestic tyre makers derive a little more than half of their sales from the replacement market (55%), followed by OEM tyres (29.8%) which are essentially tyres sold directly to automobile firms. The balance is accounted by exports.

Besides exporting, many Indian tyre companies are also setting up manufacturing footprint overseas as part of a global expansion drive. For instance, Apollo Tyres, which acquired Dunlop in South Africa three years ago, has recently struck another deal. It snapped Dutch firm Vredestein Banden to increase the penetration in the European markets. Similarly, JK Tyre & Inds acquired a Mexican company Tornel in ‘08 to make further inroads in the North and South American tyre market.

FINANCIAL
The tyre industry had a smooth ride till FY08, in line with a booming economy. The industry’s tonnage production registered a compounded annual growth rate (CAGR) of 8.02% between FY03-FY08.

An analysis of the top six companies in the tyre sector shows that the aggregate sales growth has slipped from double-digit growth during Q408 to 7% for the quarter ended March ‘09. This is attributed to a decline in demand from the automobile sector and general slowdown in the Indian market. Though auto sales have improved over the last four months, it is yet to reflect in tyre sales due to the lag effect.

Profits have declined 19% for the six companies compared to robust growth of 76% recorded for the quarter ended March ‘08. This is largely due to slower topline growth and higher increase in non-operational costs such as interest expenses on borrowed capital and depreciation.

But, raw material prices, which account for close to two-thirds of the total production costs, have eased off. Rubber prices declined 20% to Rs 97.85/kg in May ‘09 from Rs 122.62/kg last year. As a result, the input price pressure experienced in the first half of ‘08-09 moderated in Q3 and Q4 of FY09. This allowed the top firms to maintain operating profit margin (OPM) of 11% despite slower sales growth.

Although input cost pressures have come off their peak, interest outgo still remains an issue with interest cost moving up 30% during the quarter despite the central bank announcing cuts in key benchmark rates which is yet to be passed on fully by the banks. Higher depreciation allowance, which grew 19%, was another factor, which ate into net margins. This indicates addition of more fixed assets by these top tyre companies. Further, since this is a noncash expenditure, it provides companies with the much needed liquidity.

Among the individual players, MRF is the only firm, which managed to grow net profit. The South-based tyre maker registered a 5% growth in net profit to Rs 68 crore for the quarter ended March ‘09. Other players like Apollo Tyres, JK Tyre & Inds and Ceat registered a decline in profit on account of lower sales growth and higher non-operational expenses.

Given the problems being faced by the industry, the government has announced excise duty cut in two tranches. The first cut in December ‘08 brought down excise duty from 14% to 10%, which was subsequently reduced to 8% in February ‘09.

This has had a positive impact on tyre scrips in the stock market. In the recent bull-run, which started in March ‘09, most auto companies have outperformed the market benchmark index, the Sensex. Moreover, in tandem, major tyre companies have also outperformed the Sensex.

OUTLOOK
Demand from the OEM segment is likely to improve due to the increase in demand from passenger cars but overall demand could remain under pressure in the short term unless the replacement market picks up. As per estimates of credit rating agency CARE, the industry is likely to post production growth of 6.81% in FY10 which is projected to result in a CAGR of 8.21% between FY08-FY13. This assumes strong replacement demand going forward.
On the bottomline front, reduction in rubber prices and expected decline in interest rates will act as a silver lining in the coming quarters and if demand supports the topline growth, it could translate to healthy earnings growth for the companies.

Investors can adopt a wait and watch policy for stocks of Ceat and JK Tyre & Inds. But MRF and Apollo Tyres are the companies to watch out for in the industry, as these stocks are available with an attractive valuation.
Source: EconomicTimes

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