Tyre stocks wobbled as news of US sanctions on crude oil imports from Iran and rising crude oil prices hit the Street on Monday. The impact of rising crude oil prices on tyre companies’ profits, though not immediately, is now a growing concern.
Crude oil derivatives such as carbon black, synthetic rubber and nylon tyre cord fabric together make up nearly half the cost of producing a tyre. Certainly, the sudden 3.5% rise in the price of crude oil within three days, and 35% since January, signals a squeeze on profits for tyre makers.
Besides, the threat to costs comes when the auto industry is steering through rough terrain. Auto sales in the country during FY19 grew at a sluggish 5.2%. In FY18 it grew at 14.2%. Production cuts by automobile manufacturers has resulted in lower demand for tyres, among other components.
Added to this, replacement-market sales that normally compensates for falling demand from auto manufacturers has been subdued in the last two quarters. The replacement market comprises two-thirds of the tyre market and commands higher profit margins.
Besides, reports that customers are deferring replacement of tyres and uncertainties regarding regulations pertaining to vehicle standards are portentous for tyre companies.
In such an environment, it becomes difficult to pass on the rise in costs to consumers, resulting in margin contraction. Lower sales volumes also pull down gains from operating leverage. A report by Reliance Securities Ltd indicates a 110-200 basis point drop in March quarter Ebitda margin from the year-ago period, primarily due to lower sales volume. Ebitda is earnings before interest, tax, depreciation and amortization. This, in spite of a drop in cheaper Chinese tyre imports, which have been hurting incumbents.
That’s not all. Industry leaders such as Apollo Tyres Ltd, Ceat Ltd, and JK Tyre and Industries Ltd have borrowed money to fund expansions. Unfortunately, with lower revenue growth, most companies have shown a drop in interest cover (see chart), which is the number of times by which Ebitda covers the interest paid.
All the above roadblocks have already dragged tyre stocks 25-40% in the last one year. This, despite a rise in the benchmark indices. The negative sentiment prevailing in the auto industry is also weighing on tyre stocks. The only consoling factor has been the relatively stable rubber prices, which is the main input in producing tyres. Yet, the rise in crude oil prices is one more addition to the wagon of woes for tyre makers.