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Demand outlook remains positive; price hikes - a key monitorable

We conducted tyre-focused channel checks. Replacement market demand for PCR/2W remained strong during 3Q, while sales in truck and bus (TB) segment were muted owing to financial stress amongst fleet operators and hike in tyre prices. However, most dealers are optimistic about demand in coming months. In most cases, dealer have increased inventory to above average levels in anticipation of upcoming price hikes.

The JM Tyre RM Index suggests that the RM basket consumption cost has remained flat QoQ for 3QFY22, as increase in crude derivatives prices was offset by decline in international NR price. In, 4Q RM consumption cost increased 3% QoQ. However, the tyre companies have already hiked prices by a total of 10-13% during CY21’YTD. Our analysis suggests that in order to maintain healthy margins, tyre companies would have to further hike prices in the replacement segment by 3-5%. As the price hike lags RM cost inflation, we believe that 2HFY22 margins are likely to remain below sustainable levels. We expect margin to recover back to sustainable level by 1HFY23 as strong underlying demand in replacement market is likely to support tyre companies to take the required price hike in the coming months. Contracts with OEMs enable tyre companies to directly pass on commodity inflation. In addition, cost optimisation initiatives are likely to support sustainable margin delivery.

APTY is our preferred pick (c.50%+ upside from CMP) as we expect it to be a key beneficiary of domestic demand on its a) 75%+ exposure to the replacement segment, b) superior brand positioning/quality perception, c) wide-spread dealer network and d) increase in OE penetration. We maintain BUY on APTY/CEAT. Inability to hike prices, further increase in RM prices and any relaxation on import restrictions are key risks.

* TB tyre demand weak, strong for PCR/ 2W; majority dealers optimistic on outlook: As per our checks, in replacement market, demand for PCR/2W tyres remained strong during 3QFY22. In TB segment, demand continues to remain weak. Various reasons highlighted by the dealers were financial stress amongst fleet operators (lower profitability and increased fuel cost) and hike in tyre prices. However, most dealers are optimistic about the demand outlook in coming months. Some dealers also highlighted that competition is intensifying as more dealerships are opening in their region (750 new dealers added by APTY since Apr’20).

* Raw material remains range-bound at elevated levels: International natural rubber (especially Bangkok) price corrected 19% during 2QFY22 after significant surge during 2HFY21 and has remained range bound during 2HCY21 at USD 1.9/kg (still higher than 5-yr avg. of USD 1.7/kg). Domestic NR price continued to increase gradually by mid-single digit in the past 4 quarters and remains at elevated levels of INR 176/kg. Brent crude price at USD 74/bbl (+45% YoY) remained volatile during 3QFY22 (after significant uptick over the past 4 quarters). Crude derivatives prices have followed the trend with 3Q prices of carbon black /nylon tyre cord fabric /SBR /PBR declining by 54% /40% /19% /25% YoY.

* Hike in tyre prices to cushion impact of RM inflation: As per the JM Tyre RM Index, RM basket consumption costs for tyre manufacturers remained flat QoQ for 3QFY22, as increase in crude derivative prices (3%-9% QoQ) is offset by decline in international NR prices (-19%). As per current price trends, 4QFY22 consumption cost has increased by 3% QoQ driven by a similar inflation across raw materials. This implies a total increase of c.48% from the lows of 2QFY21. During CY21’YTD, the tyre companies have taken up to 12% price hike – APTY (11-13%), CEAT (10-12%) and MRF (10-12%). We believe, in order to maintain sustainable margin levels, tyre companies would have to take further hike of 3-5% in the replacement segment. Dealers have highlighted that they expect more rounds of price hikes in near-term, which would be absorbed by the market due to the absence of competition from imported tyres.

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