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Business News/ Market / Mark-to-market/  Will tyre makers now reduce prices?
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Will tyre makers now reduce prices?

The market capitalization of tyre stocks has nearly trebled in the last one year, but much depends on the extent to which tyre markers reduce prices

The falling raw material price has raised several questions on the prospects of tyre firms. Photo: MintPremium
The falling raw material price has raised several questions on the prospects of tyre firms. Photo: Mint

Shares of tyre companies have been rallying along with automobile stocks over several months. Weak commodity prices, falling crude prices and more importantly plummeting rubber prices have fired optimism in these stocks.

But the falling raw material price has raised several questions on the prospects of tyre firms. Will tyre manufacturers drop prices too as pressure mounts from consumers? And, if they do, will it hurt the revenue growth and profit margin of companies?

What’s pertinent is that in the past, with every rise in rubber price, tyre companies were quick to raise tyre prices. Data from four leading listed tyre firms shows there was a nine percentage point expansion in gross margins in the last eight quarters. This came from the sharp drop in raw material costs, which comprise over two-thirds of the total cost of producing a tyre. Therefore, with falling raw material prices, further margin expansion could be a possibility in the near term.

However, on the flip side, consumer expectations are high about a cut in tyre prices. A note by the Indian Foundation of Transport Research and Training is hopeful of a 10-15% cut in tyre price given the steep fall in natural rubber and crude oil prices. In the last one year alone, the rubber price has dropped by 30% to about 130 per kg. But tyre makers are yet to toe the line.

The moot question is if tyre prices are cut, will margins still improve? Some analysts have raised concerns about tepid sales volume in the original equipment and replacement market in the last two quarters. Weak monsoon and wobbly consumption-related spending may see the trend of weak demand for tyres continue in the near term. Hence, a price cut would imply moderation in revenue, which in turn may exert pressure on gross margin (revenue less raw material cost). Much depends, of course on the extent of price reduction in tyres.

This in turn may squeeze the operating margin of tyre manufacturers further, given that there has been an increase in staff costs and marketing expenses in the last couple of quarters. Meanwhile, benefits of operating leverage may take a while to set in, as sales volume is not high.

The September quarter saw companies like Apollo Tyres Ltd and MRF Ltd post better year-on-year operating margin, but a few like Ceat Ltd incurred higher advertising expenses to combat replacement market competition. Meanwhile, higher expansion related debt may pull down net profit, too, as interest outflow will be higher.

According to Mitul Shah, an analyst at Karvy Stock Broking Ltd, “lower commodity price would help tyre companies on margins front, while demand is not picking up as per expectation. If there is a rural slowdown amidst a monsoon deficit, price cut and discounts by tyre makers may nullify benefit of lower material to some extent."

True, lower raw material prices augur well for tyre firms in the near term. That is why the market capitalization of tyre stocks has nearly trebled in the last one year. But much depends on the extent to which tyre markers reduce prices.

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Published: 03 Dec 2014, 08:57 PM IST
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