Tyre stock investors edgy on price cut, expensive valuations

Shares of Apollo Tyres Ltd, Ceat Ltd, JK Tyres & Industries Ltd and MRF Ltd have declined 5-15% in the last five trading sessions. (Image: Pixabay)
Shares of Apollo Tyres Ltd, Ceat Ltd, JK Tyres & Industries Ltd and MRF Ltd have declined 5-15% in the last five trading sessions. (Image: Pixabay)

Summary

  • Investors are concerned about profitability outlook of the sector since price cuts come at a time when the benefits of lower input costs are waning.

Tyre stocks are under pressure as manufacturers take another round of price cuts in the crucial truck, bus and radial (TBR) segment. In reaction, shares of Apollo Tyres Ltd, Ceat Ltd, JK Tyres & Industries Ltd and MRF Ltd have declined 5-15% in the last five trading sessions.

Considering an average selling price of 40,000 per pair, a price reduction of around 1.5-2% has been taken by companies like Apollo Tyres and JK Tyres, showed a recent dealers’ channel check by Nomura Financial Advisory and Securities (India). This move was in response to a similar price-cut action taken by the truck segment leader, MRF on 5 March, Nomura said in its report dated 7 March.

This is the second round of cuts in TBR tyre prices. Prior to this, prices were trimmed by 1% during July–September 2023.

Investors are concerned about profitability outlook of the sector since price cuts come at a time when the benefits of lower input costs are waning. Costs of crude and crude-based derivatives have inched higher sequentially in the March quarter (Q4FY24) so far. Tyre makers use domestically and internationally procured natural and synthetic rubber, carbon black, among others as key inputs.

Usually, the impact of rising costs on margins comes with a lag, depending on the availability of low-cost inventory. However, it is worth noting that earnings growth estimates for the tyre sector are sensitive to profitability assumptions. If raw material price increases sustain, adverse effects can be seen from Q1FY25, caution analysts.

Going by Q3FY24 management commentaries, gross margins are expected to be largely flat in March quarter (Q4FY24). Operating margins could get some cushion from tight cost control measures, but to what extent remains to be seen.

Tyre stocks have seen meaningful re-rating in the recent quarters driven by stellar margin growth. But now the focus of tyre markers seems to be shifting from margins to market share gains amid mixed demand trends. While price cuts could boost demand, earnings outlook hinges on margin trajectory.

Currently, valuations are pricey. At FY25 price-to-earnings, Apollo, Ceat, JK Tyres and MRF Ltd shares are trading at multiples of 12-26 times, Bloomberg data showed. Following the sharp run in stock prices in CY23, valuations are much above the sector’s long-term average of high single-digit to low-double digits, said analysts.

Despite significant capital expenditure plans largely behind the sector, high valuations are a concern for investors, given the looming risk of margin-led downgrades to FY25 earnings estimates.

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