Skidding Margins

Raw materials account for over 60 per cent of the total cost of production in the tyre industry. Hence the profitability of this processing industry is directly linked to its raw materials management.

The tyre industry grew by 23.6 per cent in 1995-96, and it is estimated to have grown by around 18.6 per cent in 1996-97. Simultaneously, it witnessed a sharp rise in the cost of raw materials. This, coupled with the constricted supply of short-term finance, led to an erosion of profit margins.

From 58.1 per cent in 1994-95, raw materials accounted for 62 per cent of production costs in 1995-96. In effect, against a sales growth of 23.6 per cent in 1995-96, raw materials cost rose by 31 per cent.

 

Both the devaluation of the rupee and rising demand were responsible for the sharp increase in the price of raw materials like natural rubber and carbon black, both important constituents. Take rubber, for instance. Rubber prices rose by 48.9 per cent in 1995-96 from an average of Rs 43.36 per kg in 1994-95 to Rs 59.09 kg in 1995-96. So the share of natural rubber in production costs went up from 24.4 per cent in 1994-95 to 29.6 per cent in 1995-96.

This affected tyre majors like Apollo Tyres and Ceat Ltd, for instance. While Apollo witnessed a 118 per cent rise in rubber costs, Ceat recorded an 83.3 per cent rise in the same against a 21 per cent growth in sales turnover in 1995-96.

In fact, natural rubber prices have been steadily increasing over the years. The prices have mainly gone up because of the governments upward revision of the benchmark price of natural rubber. For instance, the benchmark price in February 1994 was Rs 2,490 per quintal. So prices in calendar year 1994 jumped by 22 per cent from an average of Rs 2,546 per quintal in 1993 to Rs 3,107 per quintal in 1994. It then jumped to Rs 5,059 per quintal in 1995 to an average of Rs 5,122 per quintal in 1996.

Similarly, rising carbon black and fabric costs meant that tyre manufacturers had to cough up a part of the gains from growing volumes. Carbon black went up to Rs 27,330 per quintal in 1995-96 from Rs 22,590 in 1994-95. So the top ten tyre majors witnessed a 30.6 per cent rise in the cost of carbon black and a 22.8 per cent rise in fabric in 1995-96. The fabric to sales ratio remained unchanged at 16.6 per cent. But the cost of carbon black as a percentage of net sales rose by 0.6 percentage point to 5.9 per cent.

The industry also showed an injudicious utilisation of human and power resources. While the cost of power and fuel increased by 6.5 per cent in 1995-96, the wage bill rose by 18.3 per cent the same year. However, the power and fuel to sales ratio actually fell from 5.12 per cent in the previous year to 4.65 per cent in 1995-96. Similarly, the wages to sales ratio fell marginally from 6.8 to 6.7 per cent. This is because the sales growth was higher than the rise in wage and fuel costs.

If rising raw material costs affected the bottomline on the one hand, on the other, the funds crunch squeezed profit margins as well. As against a 10 per cent increase in 1994-95, the interest burden of the top ten companies rose by 25 per cent in 1995-96. For Apollo Tyres, funds were costlier by 76.5 per cent while MRFs interest burden rose by 53 per cent.

So the gross profit margin (GPM) of the tyre majors retreated sharply from 5.2 per cent the previous year to three per cent in 1995-96. For instance, the GPM of Ceat declined from 7.86 per cent in 1994-95 to 3.84 per cent in 1995-96 while that of Apollo Tyres came down to 5.5 per cent from 6.04 per cent. Dunlop, with a 31.5 per cent decline in sales income at Rs 511 crore recorded a negative profit margin (excluding other income of Rs 169.26 crore).

And overall operating margins fell by two percentage points to 9.1 per cent. Burdened by burgeoning raw materials costs, companies like Ceat, Apollo Tyres, J K Industries, Dunlop and Goodyear reported lower operating margins.

For instance, in 1995-96, Apollo Tyres witnessed a marginal fall in OPM at 11.48 per cent from 11.75 per cent the previous year. As against a 63 per cent rise in net sales, raw materials costs increased by a hefty 81 per cent. Expenditure on natural rubber went up by 118 per cent and by 84 per cent for carbon black. A significant 76 per cent rise in the cost of funds further ate into the company's GPM. This fell to 5.5 per cent from 6.04 per cent. So gross profit rose at a slower pace of 53.1 per cent as against a 63 per cent growth in sales income.

Similarly, Ceat experienced a 21 per cent growth in demand but the 47 per cent increase in raw materials costs ate into its margins. Its expenditure on natural rubber soared by 84 per cent, on carbon black by 45 per cent and fabric by 50 per cent. So the OPM declined to 13.94 per cent for the 18-month period ending March 1996 from 19.3 per cent for the previous 15-month period. The GPM fell from 7.86 per cent the previous year to at 3.84 per cent in 1995-96.

However, tyre majors like MRF, Vikrant Tyres and Falcon Tyres actually showed an increase in operating margins. The softening of rubber prices in the first half of 1996-97 proved beneficial for MRF, which has a September year-end. So sales growth for 1996 was higher at 33.6 per cent against a 25.3 per cent rise in raw materials costs. This increased MRFs OPM to 12.1 per cent over an OPM of 10.8 per cent in the previous year. Similarly, Vikrant Tyres took advantage of its 16 per cent growth in sales turnover to improve its profit margins.

The profit margins during the first half of 1996-97 also remained subdued. The OPM remained unchanged at around 8.9 per cent while the GPM declined from 4.4 per cent in the first half of 1995-96 to 4.1 per cent in the first half of 1996-97. But the industry is likely to benefit from lower rubber prices during the second half of the current year. From an average price of Rs 51.22 per kg in 1996, rubber prices have declined to an average of Rs 46.96 per kg in January 1997, Rs 42.86 per kg in February 1997 and to Rs 40.50 per kg in March 1997. Whether this has improved margins will be seen once the companies declare their 1996-97 results.