Stocks of tyre companies have been touching their 52-week highs on weakness in natural rubber prices. This is a key raw material which accounts for about 30% of revenues for players such as Apollo Tyres.
Prices of natural rubber which were at Rs 144 a kilo at the start of August have fallen 10% to Rs 129 a kilo currently. They have been on an uptrend since trading at under Rs 100 per kilo in the March quarter, 2016 going up to an average of Rs 125 a kilo in the June quarter.
The fall in natural rubber prices have a large favourable impact on financials of tyre companies reflected in higher operating profit margins. Barring Apollo Tyres, most tyre companies witnessed a year on year improvement in margins, due to a decline in raw material prices over the year ago quarter.
Higher other expenses dented margins of Apollo Tyres both on year on year and sequential basis. Post June quarter results, analysts had expected margins to moderate given the rise in natural rubber costs which impact with a lag of a quarter. The other key raw materials for the segment are synthetic rubber, tyre cord fabric, steel cord and carbon black---- all crude oil derivatives and have favoured tyre makers given the fall in crude oil prices. Further fall in input prices is a clear positive.
Another near term trigger would be the imposition of anti-dumping duty on Chinese imports. The government had started an enquiry into the import of truck and bus radial tyres, the biggest segment by revenue within the tyre space to see if there is a case to slap a duty. While truck and bus radials have grown 64% in FY16, they are up 32% in the June quarter.
Chinese tyres have a 30% share in the truck and bus radial market and quote at prices which are 25% lower than Indian tyres. While healthy margins of Indian players has been key reason for government delay on taking regulatory action, any import duty could help Indian firms bridge the price gap. Given the rising Chinese imports, Indian companies have had to cut prices to stay competitive, and have turned to volume driven leverage to improve their revenues and margins.
Given the lack of pricing power, the other area companies will gain will be rise in volumes. Some have have started to diversify their product portfolios to cater to other segments of the auto sector. Both JK Tyre and Apollo Tyres are looking at the two wheeler space (in JK's case three wheeler as well) which should boost volumes in a fast growing space, though the segment is overcrowded. In addition to this most companies will benefit from demand pick up from the replacement segment (50-70% of sales) as well as higher off take from the auto makers.