Markets
Tyre stocks are on a roll. Should you ride along?
Summary
In the September quarter, elevated prices of inputs led to a steep margin erosion for key listed tyre makersTyre stocks were on a roll on Tuesday. Stock prices of Ceat Ltd, Apollo Tyres Ltd, JK Tyres & Industries Ltd, and Balkrishna Industries Ltd rose 4-14% on the NSE on hopes that volumes would see a strong rebound in the next few years, aided by a broad-based recovery in OEM and replacement demand.
But investors should note that input cost inflation remains a niggling worry in the near term. In the September quarter, elevated prices of inputs led to a steep margin erosion for key listed tyre makers. Natural rubber, carbon black and synthetic rubber are among the raw materials for tyre makers. Fortunately, given the robust demand, they are able to pass on the burden of higher input cost pressures to end-users to contain further margin erosion.
“So far in FY22, the tyre sector has had price hikes to the tune of 7-9% across product portfolios. Among key companies, Apollo Tyres, Ceat and Balkrishna Industries have been more proactive and have raised prices in November-December. MRF has been sluggish; it took its last price hike in September," said Varun Baxi, an analyst at Prabhudas Lilladher.
While price hikes are a sentiment positive, the quantum may not suffice to offset the entire cost pressure. “If commodity prices were to remain where they are, 3-4% additional price hikes would be required to compensate for the dip in margins," he said.
Sharing a similar view, in a report dated 21 December, analysts at JM Financial Institutional Securities said that current market prices of raw materials are above their five-year averages. So, they feel, in order to maintain healthy margins, tyre makers would have to further hike prices in the replacement segment by 3-5%.
Also, investors should note that the benefits of price hikes usually reflect with a lag of a few months, which means margins may not see a full-fledged recovery immediately.
Further, analysts caution that demand weakness in certain segments such as tractors, coupled with higher tyre prices, could weigh on sales growth. Moreover, last year’s high base poses a challenge for H2FY22. Investors also need to watch out for any disruption caused on sales by a potential third wave.
Apart from demand and margin recovery, a catalyst for tyre stocks could come from the reducing capital expenditure intensity of the industry, which would lead to an improvement in cash flows. While the long-term demand outlook appears bright, investors should brace for some near-term pressure.
