Will the duty cut take the heat off tyre firms?

Will the duty cut take the heat off tyre firms?

The much-awaited duty cut on rubber imports will offer twin benefits for the tyre industry—it corrects the inverted duty structure in the tyre sector and will, in the longer term, temper rubber prices. So far, the import duty on rubber (the main input in tyre making) at 20% was higher than the 8.5% on tyres (finished good). Consequently, as rubber prices rocketed to a new high of 208/kg, it hurt the profits of major tyre makers in India. And, it became cheaper to import tyres instead of rubber. Media reports corroborate this—there has been a 20% rise in Chinese tyre volumes in the trucking segment and a 36% rise in passenger tyres, to service the auto boom in the country.

Also See Profitability Concerns (PDF)

The question is: will the lowering of import duty bring better profitability for tyre makers? Share prices of leading tyre companies such as MRF Ltd, Apollo Tyres Ltd and Ceat Ltd reflected positive investor sentiment as they rose 2-3% on the news. But tyre firms are unlikely to see relief in profit margins in the near term. For, despite lowering of duty, most tyre firms such as Yokohama India Pvt. Ltd, Michelin India Tyres Pvt. Ltd, Apollo and MRF have all announced price hikes. Naturally so, as rubber prices have run up nearly 25% since April while tyre makers could increase prices by only 12-15%.

The average price of rubber for the December quarter is estimated at 185/kg compared with around 165/kg in the previous sequential quarter. This would mean a 5-6% expansion in recipe cost (all inputs) for tyre makers—an adverse impact on profit margins. Already in the last quarter, Apollo’s operating profit margin (OPM) fell to 10.3% from 16.4% a year ago, while MRF’s margin fell by 690 basis points to 9.8%. One basis point is one-hundredth of a percentage point. Smaller firms were hit badly—Ceat and JK Tyre and Industries Ltd reported wafer-thin margins of 4% and 6.2%, respectively.

The move to allow 40,000 tonnes of imports at 7.5% duty is welcome as it will bring down speculation in the domestic markets and soften rubber prices in the medium to long term. Industry experts say that about 10-15% of the prevailing rubber price of around 208/kg is attributable to hoarding by traders.

Meanwhile, the duty reduction marks a correction in the inverted duty structure anomaly that the tyre makers have been shouting vociferously about for the last few years. A low 8.5% duty on imported tyres made Chinese/Korean tyres 30-40% cheaper in the passenger replacement market than Indian ones. The gap could be bridged. Over a longer horizon, the duty reduction will lower the landed cost of rubber and bring down cost of production; rubber accounts for almost half the cost of producing a tyre.

But for the next three months, rubber prices may not cool off. Rubber price reduction hinges on the demand-supply gap, which is expected to be around 60,000 to 80,000 tonnes in the domestic market during 2010, given the buoyant auto demand. Globally prices are ruling firm as severe rainfall had affected the rubber crop in leading rubber producing countries such as Thailand, Indonesia and Malaysia. On Friday, New York rubber prices rose for the sixth consecutive month, gaining 4.5% last week alone. Rising crude prices could increase pressure on tyre makers as synthetic rubber prices could move up, too. If anything, the continued auto boom would be the only consoling factor, which would allow tyre makers to protect margins by passing on the hike in raw material costs.

Graphics by Yogesh Kumar/Mint

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