The pros outweigh the cons for tyre firms

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Rubber prices in India have corrected over the last couple of months, in line with the trend in global prices. After an 11% decline since July, rubber prices are at a 52-week low.

This is good news for tyre makers because rubber comprises about 40-45% of the total raw material cost incurred to make tyres. But then, there is some offsetting bad news too. The sudden spurt in crude prices may play spoilsport as it has risen nearly 20% since July and crude-linked inputs comprise about a fourth of the raw material cost.

For now, the bets on the Street are in favour of improving profitability of tyre firms in the coming quarters as the pros outweigh the cons.

To begin with, the fall in domestic rubber prices is a fallout of the international price trend that has been southbound for long now. Last week, farmers and industry in some Asian regions even planned a protest rally as rubber prices fell below the cost of production. Rumours of weak demand from China, the largest importer and consumer of rubber, have led to a speculative price drop too. Thailand rubber prices have plummeted to about 48 baht, a fourth of the levels seen five years ago. This is unlikely to reverse suddenly.

This augurs well for tyre makers, whose profit margins were constrained on account of low demand for tyres due to macroeconomic factors such as goods and services tax (GST) and demonetisation.

Lately, the rising demand for automobiles is a bright spot. Analysts have forecast strong double digit sales growth over the next 12-18 months across all major segments—passenger cars, two-wheelers and commercial vehicles. Obviously, demand for tyres is likely to grow from both the original equipment segment and replacement market.

This is not all. The problem of low-cost tyre imports mainly from China and Korea that had distressed domestic manufacturers is also alleviated as the government finally reinstated the anti-dumping duty.

So, higher sales and lower costs should boost profits for tyre manufacturers in the forthcoming quarters.

Bharat Gianani, analyst, Sharekhan Research says, “Lower rubber prices due to expected weak demand in China along with strong demand for automobiles in domestic markets should buoy profit margins of tyre companies in the next two quarters.”

Take the September quarter results. The operating margins of leading tyre makers in the listed universe were lower when compared to the year-ago period as they reflected the high-cost inventory of rubber from earlier quarters. However, raw material prices declined by 400-500 basis points sequentially. This should augment margins going ahead.

It looks like the Street has already taken cognizance of these factors. Stocks of leading tyre firms like MRF Ltd, Apollo Tyres Ltd and Ceat Ltd have risen by 13%, 12% and 33% since April. Yet, a jump in operating margin as forecast would sustain investor faith in tyre stocks, unless crude prices rally further and play spoilsport.