High NR cost drags down Indian tyre firms stock prices
Rising input costs, mainly that of natural rubber, coupled with slackening demand from the automobile sector, have hit the margins of Indian tyre companies and that is clearly reflected on their dismal performance on the bourses.
A study, which has been undertaken to evaluate the performance of the tyre companies’ stocks between September 1, 2010, and August 30, 2011, indicates that shares of these companies have plunged 15%-75% compared with a 9% fall of the Bombay Stock Exchange (BSE) index, Sensex (value-weighted index comprising 30 stocks).
Stocks of major tyre companies — Apollo Tyres Ltd and MRF Ltd — have fallen by 19% and 13% respectively, while those of JK Tyre and Industries Ltd and CEAT Ltd plunged 49% and 44% respectively during the period. The auto index of automobile companies, including Tata Motors, Maruti Suzuki and Mahindra & Mahindra, has fallen by around 5% during the period.

Sharp decline in profits

According to the latest research report from credit rating agency ICRA, even as the industry benefitted from the strong revenue growth during 2010-11, higher input costs, especially that of natural rubber, led to a sharp 19% decline in operating profits and 37% decline in net profits. Industry-wide, operating margins declined to 9.2% in fiscal 2010-11 as against 14.4% in fiscal 2009-10.
Besides grappling with high input costs and slackening automobile demand, domestic players are expected to face additional pressure with the lifting of anti-dumping duty (ADD), effective from August 2011, on truck and bus radials (TBRs) imported from China and Thailand, said the ICRA report. While this move is expected to be contested by the industry players, the lifting of ADD makes the imported TBRs cheaper by around 15-20%, limiting domestic demand and pricing power.
“The stocks of the tyre companies are on the decline as their profits at the operating level have been narrowing thanks to rising input cost, mainly natural rubber, and that has caused a 400-500 bps drop in margins of the tyre companies,”  Yaresh Kothari, an analyst, Mumbai-based Angel Broking Ltd, told Rubber Asia.  Natural rubber contributes more than 40% of the cost of a tyre.

Impact of high NR price

According to the Rubber Board of India, average natural rubber price (RSS4) in September 2010 at the Kottayam market was Rs 16,645 per 100 kg. However, in April 2011 rubber prices touched Rs 24,300 per 100 kg, an increase of 46%. In the financial year 2011, rubber prices soared by 37%.
Initially, to maintain the numbers on the balance sheet, the tyre companies had increased prices of their products in tune with the rising input costs. However, the tyre producers could not raise their product prices commensurate with the rising prices of natural rubber. Hence they had to compromise on their profit margins as they could not pass on the entire price hike to their customers. “Since last two quarters, the profit margins of the tyre companies have come down between 1% and 2%,” says Kothari.
“With the threat of imports limiting the ability of tyre makers to fully pass on the increase in costs, we expect operating margins of tyre companies to decline by 50-80 bps in 2011-12,” adds Sridhar Chandrasekhar, Head, Crisil Research.

Fall in automobile sales

Overall sentiment for tyre companies remained gloomy over the past few months. Auto companies are struggling to increase sales figures as rising fuel prices and interest rates have dampened buyers’ sentiments.
According to the latest figures released by Society of Indian Automobile Manufacturers (SIAM), domestic car sales in August this year fell by 12.5% to 144,000 units compared with 160,000 units in the same month of last year due to slow demand as the double-digit inflation and high interest rates affected consumers’ buying potential.
SIAM does not seem much optimistic about future sales as it has revised its sales outlook for this fiscal to 10%-12 % from 16-18 %, which was predicted earlier. Analysts expect another downward revision by SIAM as there is no pick-up in demand.

Is the worst over?

Most analysts, however, say the worst is over for the tyre companies at least in the near term as natural rubber prices have shown some softening. During the first four months of FY11-12, prices of natural rubber declined by 11%. According to market pundits, prices are expected to drop in the future.
“Domestic natural rubber prices are expected to decline from current levels of Rs. 215/kg to levels of Rs. 190/kg by the fourth quarter of 2011-12, in line with a decline in international prices. Higher supplies from major rubber producing countries like Thailand and Indonesia and a moderation in auto demand will lead to a decline in international prices,” says Chandrasekhar.
“The decline in NR prices will lead to an improvement in the operating margins of tyre companies in the fourth quarter of 2011-12. However, for the whole year (2011-12), average NR prices will be higher by 11-13%, which will put pressure on the margins of tyre companies,” he adds.