Tyre Industry: Smooth drive

Dear Sir/Madam,

Tyre sales to grow irrespective of short term fluctuations in automobile sales

Automobile sales is the growth driver for tyre industry. But the short term fluctuations in the automobile sales do not affect tyre sales on year on year basis. This is due to strong replacement market (RM) sales for key Commercial Vehicles (CV) segment. CV segment constitutes nearly 70% of tyre sales on value terms even though in number terms it constitutes only 25%. RM and export sales contribute more than 80% to CV segment. Thus, one of the major segments is not affected nearly by 56% in value terms due to short term fluctuation in automobile sales. We find the tyres produced to vehicles regi stered (a multiplier to show the demand for tyres in the country) growing for CV from 2.99 in 2001 to 3.17 in 2006 despite fluctuations in CV sales. In case of Passenger Vehicles (PV), the same has gone up from 1.13 to 1.25 in this period. RM and export sales contribute more than 60% to PV tyre sales.

Robust growth in last two years for automobile industry to have positive effect on tyre industry

We expect high growth in automobile sales in the past two years to increase demand for tyres in the comin g years and improve RM sales. Indian automobile industry has been clocking high growth in the past few years, thanks to high economic growth and improved disposable income. Automobile sales and exports, except tractors, from the country have grown at 15% in FY06 and at 16.3% for April-January 2007 period. Tractor sales for April-December 2006 period rose by 25.6%.

Series of price hikes reflect reduction in unhealthy competition

From April 2006, tyre producers have hiked the prices to the tune of 15-20%. Tyre companies could increase the prices of tyres by 2-4% only in FY05 and FY06. This was despite continuous increase in key raw materials like Rubber, Carbon Black and NTCF. Stiff competition in the sector to increase market share, even at the cost of reduction in margins, has eroded margins. Producers have passed on the increase in raw material prices and margins are also improving from April 2006. The reason for change in the trend is due to lack of capacity. The present capacities are running at above 90% utilization. Apart from this, the players in the industry are planning to invest in capacity expansion to meet the demand, which would require large outlay of funds and high competition would affect the capex plans.

Margin and PAT expansion on cards

With increase in tyre prices and softening of raw material prices, the margins of tyre producers are improving. Given the low operating margin of 5-8% at which the tyre producers were operating in the past 2-3 years, margin growth of 100 to 200 basis points itself multiplies the profit at net level for these players, which is very low at 0.5-2% at present. We believe, the margins in the industry are still not reasonable. We expect unhealthy competition to come down further among the players to suppo rt capex, which can be a surprise element.

Rubber price expected to remain subdued

Global Natural Rubber (NR) demand growth was subdued in 2006. This was caused by steep rise in prices and resultant shifting to Synthetic Rubber (SR). We expect the volatility in NR price to reduce going forward as this leads to increased shift towards SR. We have considered average rubber price of Rs94 for FY08 and FY09 in our estimates. Domestic stock position for rubber is comfortable, which is expected to keep rubber in the estimated price band.

Crude-based raw material prices also expected to stabilize

SR, Carbon Black and Nylon Tyre Cord Fabric (NTCF) are crude-based products and have strong correlation to crude oil prices. Crude-based raw materials constitute around 30% of operating expenses. In the past 6 months crude oil price has stabilized around $60 per barrel, barring the recent spike. We expect this to bring stability in crude-based raw materials.

Our Top Picks

Apollo Tyres - BUY CMP Rs279

Apollo Tyres (ATL), the leading CV tyre player in India is expanding capacity at a rapid pace both organically and inorganically. With automobile sector booming and international automobile majors setting shops in India, we expect ATL to be a major beneficiary. We expect ATL’s topline and bottom line to grow by 14.3% and 26.2% respectively between FY06 to FY09. We expect EPS to grow by 15.2% from FY06 to FY09. We find the recent fall in ATL’s share price a good opportunity to enter. Initiating coverage with BUY and a target price of Rs397.

CEAT - BUY CMP Rs117

CEAT, a diversified tyre major, is ramping up its production facilities to benefit from the uptrend in automobile industry. It has planned to modernize its existing facilities and double its OTR capacity, which will boost volumes in FY08 and FY09. We estimate top line and bottom line to grow by 12.1% and 454.5% respectively from FY06-FY09. The proposed sale of part of land at its Bhandup facility is expected to boost its capex plans of putting up T&B radial tyres in the next two years. Investment portfolio to the tune of Rs95 per share is expected to act as a cushion for the company. Initiating coverage with BUY and a target price of Rs135.

JK Industries - BUY CMP Rs115

JK Industries (JKIL), a pioneer in the T&B radial tyres with nearly 70% market share, is expected to benefit from the high growth in this segment. JKIL has hived off its investment portfolio into a separate company. We expect re-rating to the stock as JKIL will become a focused tyre play. With softening in natural rubber prices from the recent peak and buoyancy in automobile sector we expect JKIL to perform better going forward. We expect JK IL’s topline and bottom line to grow by 13.5% and 55.9% respectively between FY06 to FY08 (September ended). We expect EPS to grow by 80.0% from FY06 to FY08. We value JKIL based on 10x of its FY08 earnings of Rs13.5. Initiating coverage with BUY and a target price of Rs135.

Click below for the detailed Result Update:
http://www.indiainfoline.com/content/rep/Investment_Ideas/2007/4/2042007/Tyre Industry.pdf


Warm Regards,

J Radhakrishnan
India Infoline Ltd.

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