Once upon a time (meaning, when I was a teenager) talking about the weather used to be considered a boring conversation. Not anymore. We live in an age where wildfires are destroying entire towns in Greece, California and Australia. A 250 km/hour storm is hitting Florida's biggest cities as I type this.
Extreme weather has hit sugar crops in Brazil and rubber crops in Thailand. Thailand, the world's largest rubber producer, saw its production fall by 1-2% due to incessant rains and a fungal disease. This year, the situation got worse with Typhoon Yagi, which killed over 800 people across South East Asia, and caused flooding in Thailand just as the peak rubber tapping season started in September.
The typhoon also wiped out farms across China, the Philippines, Laos, Vietnam, and Myanmar - a crucial region accounting for 80-90% of the world’s output.
Even as supply is under threat, demand is up. Strong auto purchases globally and a stable US economy have driven rubber prices higher, by over 70% in international markets and 50% in India, in one year.
The tyre industry consumes 70% of all rubber, and has been reeling under these price increases. The industry is struggling with margins and profitability.
In this week's Analyticks:
- A nail in the tyre: Soaring rubber prices hit margins for tyre companies
- Screener: Auto parts players with rising operating profit margins
Rubber prices jump, as supply tightens
Tyre companies can't seem to catch a break right now. Even as rubber prices surged, crude oil prices jumped past $80 per barrel as well as Israel went on a war footing in the Middle East. Crude oil is the key raw material for synthetic rubber, an alternative to natural rubber.
The stimulus package in China, the world’s largest rubber consumer, is expected to drive demand up, pushing prices of rubber even higher. In India, domestic prices are at a 13 year high due to weak tapping activity in Kerala due to floods, and labour shortages.
Kotak Institutional Equities in a recent report, noted, “Overall, the stockpile of global natural rubber is expected to decline to 2.1 million tons in CY2024E from 2.8 million tons in CY2023, which may increase rubber prices unless the demand trend weakens.”
For tyre companies, margins are at risk
The margins of tyre manufacturers negatively correlate with the prices of natural rubber. Crisil estimates tyre raw material costs might increase by 4-6% in FY25, keeping margins subdued beyond FY25.
Demand is also not in full swing. The Indian auto sector is a mixed bag, despite the many new launches, with passenger car demand slowing down while two-wheelers register double-digit growth.
But the industry earns around 70% of its revenue from the replacement segment, which seems promising. Here’s what companies said recently:
“We expect FY25 volume growth in replacement segment to remain healthy.” – CEAT management
“Passenger car replacement should be doing well because overall replacement cycle is getting shortened.” - JK Tyre management
“So, the replacement demand overall should be at high single digits, so we will recover some of the lost ground.” – Apollo Tyre management
Tyre producers have increased prices by 2-3.5% this fiscal, offsetting some of the impact of raw material prices. Kotak highlights the need for 5% more in price hikes to reach Q4FY24 margins. That's not easy given the slowing demand in some segments and MRF’s aggressive pricing strategy in TBR (Truck, Bus and Radial), TBB (Truck Bus Bias) and two-wheeler segments. These account for 70% of industry revenue. So margins will likely stay under pressure.
A silver lining for tyre companies
A bit of good news for tyre company CEOs is that the link between company profitability and rubber prices is not as strong as it used to be. Price-indexed gross margins for tyre companies are now 4-5% higher compared to two years ago.
MRF's falling market share, better managed capex plans across competitors, premiumisation, rising import duties for boosting domestic production and better export opportunities have helped tyre margins hold up despite rising raw material costs.
Almost all major tyre companies right now have strong fundamentals and mid-valuation levels. Still, due to falling margins, brokers estimate a decline in FY25 profits, despite strong revenue growth.
The trees grow slowly, limiting supply
Rubber trees require 5-7 years to mature enough for tapping, which limits the supply in the short term. Even with some delinking of rubber prices from tyre margins, the high prices will take a toll.
While a big drop in global tyre demand could ease raw material costs, this is hardly the solution tyre companies want. Margins will remain under pressure for now, likely dragging on the bottom line for several quarters.
Screener: Tyre stocks lag the auto parts industry in operating profit margin growth
Auto tyres stocks lag the auto parts industry in operating profit margin growth
This week, we look at the impact of rising rubber prices on the operating profit margins of auto tyres & rubber products stocks and compare them to that of auto parts & equipment stocks. This screener shows stocks from the auto parts and tyres industries with the highest QoQ growth in operating profit margins in the latest quarter.
Of the total number of 36 stocks in the screener, only three stocks belong to the auto tyres & rubber products industry. The most notable stocks in the screener are Greaves Cotton, Banco Products (India), Sharda Motor Industries, Subros, SJS Enterprises, Pix Transmissions, JK Tyre & Industries, and Balkrishna Industries.
Greaves Cotton saw the highest growth of 6.6% QoQ in its operating profit margins in Q1FY25. This auto parts & equipment company’s operating profit margin improved on the back of lower raw material costs, employee benefits, and depreciation expenses. However, the company’s revenue declined by 4.3% QoQ to Rs 656.7 crore during the quarter due to a reduction in the engines and cables & levers segments.
Auto tyres & rubber products stocks, however, witnessed a slower growth in operating margins due to a sharp rise of 11.9% in rubber prices from April 1 to June 7. JK Tyre & Industries’ operating profit margin grew marginally by 1.4% QoQ in Q1FY25, helped by the company’s effort to offset the rise in rubber costs by reducing the cost of sales and product premiumisation.
You can find some popular screeners here.
