Tyre stocks may continue to underperform as margin worries weigh

Price hikes by companies have not been enough to absorb the sharp rise in input costs

Listed tyre makers could face more margin headwinds going ahead given the sharp rise in natural rubber prices, elevated crude oil prices and limited price hikes. From their lows in the December quarter last year, natural rubber prices which are currently at about Rs 192 per kg have risen by a sharp 45 per cent. The increase in the current quarter as compared to Q2 has been 17 per cent. Similarly, while Brent crude oil prices have slipped below the $80 a barrel mark, they are still 17 per cent higher than the lows in August. While natural rubber prices account for 35-40 per cent of the raw material basket, crude oil derivatives account for 40-45 per cent of input cost of tyre makers.

Leading tyre makers have increased prices to counter the 33 per cent rise in raw material basket since the beginning of the financial year (FY22). Given the sharp increase in costs especially in the first two quarters of FY22, the price hikes taken by the companies were not enough to fully absorb the cost increase. The same is reflected in the sharp decline in gross profit margins which were down 850-1,000 basis points over the year ago period.

While the worries on the raw material prices are expected to remain, the street will keep an eye out for demand trends as well as further price hikes. The supply disruption on account of semiconductor shortage has led to weak demand from passenger cars as well as two wheelers. Companies, however, expect demand in the replacement segment which accounts for over 60 per cent of revenues to remain strong.

Sanjeev Aggarwal, chief financial officer at JK Tyre and Industries expects the situation on the margin front to improve over the next couple of quarters on the back of higher demand in the replacement segment as well as price hikes to counter the inflation trend. Like its peers, the company was not fully able to pass on the sharp rise in input costs especially in the first two quarters of FY22.

While Apollo Tyres also saw a sharp 860 basis points decline in operating profit margin decline, the drop at the consolidated basis was lower given the margin expansion at its European operations driven by a better mix. The company which hiked prices by 3-4 per cent in the June quarter and 3-7 per cent in September quarter is looking at hiking prices further by 3-5 per cent going ahead. Given the demand environment, it is confident of passing on the raw material inflation, although at a gradual pace. While Ceat has taken price hikes (with a lag) to the tune of 2-3 per cent in October, analysts at Nomura Research expect the company needs to take more hikes. India’s largest domestic player, MRF is expected to take a 3-5 per cent hike over the next couple of quarters to offset the cost impact.

On the revenue front, while companies posted revenue growth of 15-30 per cent over the year ago quarter, MRF continues to lag its peers both on a year-over-year as well as sequential basis. Jay Kale and Ketul Dalal of Elara Capital believe that the underperformance was likely led by lower exposure to the high growth medium and heavy commercial vehicle OEM segment and market share loss in the passenger car radial OEM segment. The company also underperformed on the gross margin front with a 240 basis points sequential drop as compared to peers such as Apollo Tyres and Ceat who reported a 160-180 basis decline.

Given the muted demand from OEMs as well as the sharp rise in input costs, tyre sector stocks barring JK Tyre have underperformed (down 6-9 per cent) the peer index BSE Auto (up 4 per cent) and the benchmark Sensex (12 per cent) over the last six months. Given that margin headwinds are expected to stay, investors should avoid the sector for now.