Tyre firms pick up on falling rubber prices

Shares of tyre firms, including MRF Ltd, Apollo Tyres Ltd, JK Tyre and Industries Ltd and Ceat Ltd, have rallied on the back of price hikes. They have risen 6-7% in the past week on news of price hikes in the after-sales market—more so when natural rubber prices and crude (two key raw materials) have been falling.

Both augur well for profit margins of tyre makers, which suffered for the last four quarters as a rise in costs outstripped the rise in price realization.

Domestic rubber prices have dropped by around 22-23% to Rs185 per kg after it touched a peak of Rs240 nearly 15 months ago. It mirrors the international rubber price trend. What’s more, prices are expected to stay subdued for the rest of the year on sluggishness in the global auto market.

Tyre makers’ profit margins had showed a sequential improvement in the March quarter, in spite of some firms carrying high-cost rubber inventory. This is expected to continue. A Prabhudas Lilladher Pvt. Ltd report says, “We expect another 90-120 basis points improvement in gross margins over the next two quarters (June and September 2012).” A basis point is 0.01%.

That said, the risk to this forecast would be the depreciation in the rupee, which would offset part of the benefits of lower rubber prices in international markets. Firms such as Apollo Tyres import 15% of their rubber requirements, which accounts for nearly two-thirds of the raw material cost.

A jump in profitability will also depend on the growth in the auto sector, which is expected to slow to single digits in the coming 12-15 months after a rollicking 25%-plus growth rate clocked in the last couple of years. The key, therefore, is to pass on higher cost impact through price increases in the after-sales domestic market. But will this be possible if there is a slowdown in domestic markets?

So far, although international firms such as Bridgestone Corp. have reportedly hinted at production cutbacks in the second half of 2013, domestic companies seem to be on firm ground, operating at an average of 90%-plus capacity utilization.

If the rupee stabilizes at higher levels, then tyre firms would certainly stand to benefit from falling rubber prices. Further, if a drop in interest rates lifts the auto sector growth rate, as expected by analysts in the second half of fiscal 2013, it would be a bonanza for tyre makers.

Graphic by Sarvesh Sharma/Mint

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