Stocks of replacement market favourites in tyre industry are set to benefit from benign raw material prices as higher utilisation, particularly at factories making tyres for trucks and buses, helps offset likely slowing demand from automakers.Apollo Tyres is among preferred picks because of attractive valuations and its leadership in truck-bus radial (TBR) segment, where utilisation level is more than 90 per cent.
CEAT and MRF, too, are set to benefit.Tyre stocks have outperformed BSE Sensex, with their shares gaining 6-16 per cent in past three months.The fall in crude oil prices could improve their gross margins.
Crude oil prices have come off about a third from top, and impact of favourable commodity prices should start reflecting from last quarter of current fiscal year.The crude oil derivative used in manufacturing of tyres constitutes around 30 per cent of total raw material cost.
Hence, decline has a direct bearing on their gross marginsrevenue minus cost of raw materials.If tyre companies are able to fully harness benefits from fall in crude oil prices, their gross margins could improve 200-300 basis points.
According to Nomura, every $10 fall in crude oil prices potentially adds 110 basis points to margins at tyre companies.
In past few years, tyre companies have maintained pricing discipline.
Therefore, they have been able to raise prices when commodities headed north.Tyre companies are also prime beneficiary of replacement demand, which constitutes about 60-65 per cent of total industry sales.
Operating margins in replacement market are superior compared with sales to automakers, and typical life for a set of tyres is around three-four years.
So, a vehicle sold in 2014-15 will be up for replacement in 2019.To be sure, softening volume growth in auto segment may heighten competitive intensity in replacement market.
However, utilisation levels of tyre makers are in range of 75-95 per cent, and those levels should offset any margin compression due to competition.The truck-bus radial (TBR) facility of Apollo Tyres is running at full capacity.
Hence, company is putting up new capacity to cater to domestic demand.
Tyre companies are investing about Rs 25,000 crore on greenfield and brownfield capacity in next three years.
But that would not create excess capacity in system as new capacity addition implies net 8 per cent volume growth in next three years in line with volume growth over last decade.Apollo Tyres could be prime beneficiary of capacity expansion as it derives about three-fifths of its revenue in medium and heavy commercial vehicle segment, and has a 27 per cent share in TBR market.