Yesterday, Sensex and Nifty lost about 0.7% each as a lack of fresh triggers and subdued global cues weighed on the sentiment. Yet tyre stocks went on to show resilience and surged with heavy volumes despite overall markets being in red. Some of the prominent names including CEAT, MRF, Apollo Tyres, JK Tyres & Goodyear India showed a sudden up move in their stock prices with CEAT share price touching the upper circuit of 20%.
All of these stocks—JK Tyre share, CEAT share, Goodyear share, MRF share, and Apollo Tyres share have been trading near their 52-week highs, and a select few of them broke that high yesterday. This increase can be attributed to the relief brought about by falling raw material prices, especially those for natural rubber, carbon black, and other derivatives derived from petroleum. While Brent crude oil prices have decreased, the costs of both natural and synthetic rubber have fallen from their most recent heights. These elements account for a sizable share of the sector's total input costs. Given this, cost softening may provide the much-needed boost for the tyre industry's sluggish operating performance.
However, more importantly, the sector’s improved pricing power is said to be the main driver of excitement around tyre stocks, along with bright future outlook. Let’s analyse fundamentals of few of them and see where the sector is headed towards.
Improving Demand Outlook and gross margins going forward can
positively affect tyre Stocks
After experiencing challenges with COVID and other market barriers, the demand prognosis for the sector is anticipated to remain strong. The domestic original equipment manufacturers (OEMs) and the replacement segments are expected to rebound in FY23,
which would likely improve volumes. Additionally, the reduction in the shortage of semiconductors could boost OEM sales. Replacement demand for tyre companies plays a major roles and higher demand is expected in H2FY23.
The recent quarters have seen significant pressure on the gross
margins of tyre manufacturers. Companies have therefore implemented a number of
price increases in order to stop further margin erosion. Given the delay in
passing on the burden of high input costs, margins should gradually start to increase.
The margins might continue to decline in Q2FY23, but starting in Q3FY23, they should
start increasing steadily.
It's interesting to note that the industry's pricing
discipline is being aided by the market leader MRF Ltd's declining sales and
profit disparity with other companies. Due to its greater exposure to
two-wheelers (2W) and market dominance in the TBB (truck, bus, bias tyres) area,
MRF has historically enjoyed a large margin advantage over peers, according to
IIFL Securities Ltd. So, it would be interesting to keep a track of further updates
in this sector.
“Earlier, there used to be under-cutting of prices by leaders in each tyre category and the price trend was set by the leader. But, in the last one year or so, we have seen significant price action by all listed companies," said Varun Baxi, an analyst at Nirmal Bang Institutional Equities. This is good for the margin outlook and a double-digit margin growth will lead to multiple re-rating for tyre stocks, Baxi said.
Companies in Tyre sector aiming higher free cash flows to
lower their debts
Investors in tyre stocks should keep an eye on the sector's leverage capital expenditure trends. For the time being, a significant portion of the tyre industry's capital expenditure is likely to be delayed. Tyre firms are anticipated to use free cash flows to repay debt as their
profitability improves. With this one prominent and preferred trye stock in the industry is Apollo tyres.
“We expect Apollo Tyres to deliver average FCF of Rs 1500 crore/year in FY23-FY25E vs negative mean FCF of Rs 600 crore during FY17-FY22. With the focus on pricing discipline and capital allocation, we expect it to become gross debt free over the next 5 years as against around Rs 6000 crore gross debt on books in FY22”, added the ICICI Securities.
Another brokerage HDFC Securities in its report last month gave an 'Add’ call on the stock for a target price of Rs 260 per share. The brokerage said it expects the stock to emerge as a major beneficiary of the favourable industry dynamics in India and continue to outperform Europe, given its lean cost structure.
Moreover, the Apollo Tyres has given stellar performance in Q1FY23 and managed to beat expectations domestically. Further, the management of the company aims to generate higher free cash flows rather than incurring expenditure on unnecessary capex in next two-three years. This is done to achieve better debt to operating profits levels, which is more sustainable and can improve shareholder’s gains.
Our View:
Investors' confidence in the tyre stocks has been strengthened by tyre manufacturers' capacity to keep boosting prices. According to dealer channel checks conducted by several broking firms, tyre prices across all product categories are anticipated to increase by another 1.5–2.5% in September. Tyre companies have taken around 3% price hikes in July and August as well, according to analysts.
Last but not least, the tyre and automobile industries' extensive interdependence will foster growth in both. Since the start of 2022, the auto industry has outperformed, and after breaking their 5-year peak in July 2022, growth in the sector is anticipated to continue. Therefore, if the situation with lower RM inflation works out in their favour, tyre stocks could become a multibagger investment.
On the other hand, concerns about a worldwide recession, particularly in the EU, may have an adverse effect on several businesses' volume growth in FY23, including Balkrishna Industries Ltd. The rate of margin improvement would determine how much further meaningful potential there is. On the Univest app, CEAT share as well as shares of Apollo Tyre, both indicate a Buy after the up move on 15th September.
About the Author
Ketan Sonalkar (SEBI Rgn No INA000011255)
Ketan Sonalkar is a certified SEBI registered investment
advisor and head of research at Univest. He
is one of the finest financial trainers, with a track record of having trained
more than 2000 people in offline and online models. He serves as a consultant
advisor to leading fintech and financial data firms. He has over 15 years of
working experience in the finance field. He runs Advisory Services for Direct
Equities and Personal Finance Transformation.
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