Why Tyre Stocks are Rising

While the Indian stock market faced a setback last week for two consecutive sessions, one sector defied the bearish sentiment: the tyre sector.

Shares of Ceat, Apollo Tyres, Balkrishna Tyres, JK Tyre, and MRF tore through their 52-week highs, leaving the struggling Nifty index in the dust.

This wasn't just a blip on the radar by the way; the rally is seen throughout January, with JK Tyre and CEAT already boasting year-to-date returns exceeding 18%.

MRF and Balkrishna Industries have climbed over 12% and 7%, respectively, this month.

This remarkable performance comes after a stellar 2023 for the sector, leaving investors scratching their heads.

MRF, the undisputed king of the road, wasn't just content with joining the party. Already holding the title of the country's priciest share, on 17 January 2024, it tore up the rulebook, surpassing its own Rs 1 lakh milestone set in June 2023.

A 10% surge propelled it to a historic Rs 1.5 lakh per share, becoming the first Indian stock ever to reach this astronomical peak.

So let's find out why tyre stocks are rising.

#1 Steady RM Cost

Natural rubber, the kingpin of this sector, has been chilling on a relatively stable plateau lately thanks to increased domestic production and lower imports.

The steady trend in raw material costs provides tyre companies with a level of predictability in their cost structure. This predictability is crucial for effective financial planning and management.

When input costs remain stable, companies can maintain healthier profit margins, which is an attractive proposition for investors.

This cost stability contributes to overall financial resilience and increases investor confidence in the industry's profitability.

#2 Premiumisation Boost

In a bid to gain market share in the premium tyre segment, CEAT, on 20 January 2024, has launched a range of premium steel radial tyres, which will be sold directly to consumers.

Premium tyres have been a focus area for a few quarters, and the category is moving well.

Apart from that, last year, JK Tyre and Apollo Tyre also launched premium tyres.

The strategic focus on premiumisation, involving the production and sale of high-end, more expensive tire products, is contributing to enhanced profitability.

By offering advanced features and technologies, companies cater to a market segment willing to pay a premium for superior performance and quality. This has been one of the reasons why tyre stocks have been in focus.

Companies that excel in premiumisation gain a competitive advantage in the market. They differentiate themselves from competitors by offering unique and superior products.

This competitive edge can result in increased market share, higher pricing power, and greater resilience to economic fluctuations.

#3 Replacement Demand Growth in the CV Segment

The commercial vehicle (CV) segment, often considered a key indicator of economic activity, is expected to see moderate year-on-year growth in the range of two to 4% during FY24, bringing it close to pre-pandemic volumes.

This improvement is attributed to a higher base, driven by enhanced economic activity, increased momentum in infrastructure-related projects supported by government initiatives, a robust availability of freight, and the impetus from a new vehicle scrappage policy, which encourages the adoption of cleaner vehicles and stimulates replacement demand.

The gradual upswing in replacement demand within the Commercial Vehicle (CV) segment is instrumental in allaying concerns regarding the growth of Original Equipment Manufacturers (OEMs).

Replacement demand, known for its stability and lower cyclical nature, provides tyre companies with a dependable revenue stream.

This trend is significant for sustaining the industry's growth and ensuring a more consistent performance in the face of economic fluctuations.

#4 Judicious Capex Plan

Recently, tyre companies have been incurring massive capex plans. JK Tyre recently announced an Rs 11 bn capex plan for capacity expansion over the next two years.

Apart from JK Tyre, CEAT has also lined up a Rs 7.5 bn capex plan mostly to be deployed in increasing the production capacity of agri-radial tyres at its Ambernath plant in Maharashtra.

In a similar vein, MRF aims to capitalise on emerging opportunities by expanding its footprint in international markets.

With plans to invest between Rs 10-15 bn, the company intends to fund this initiative entirely through internal accruals.

Tyre companies are adopting a more cautious approach to capital expenditure compared to previous business cycles.

This careful strategy ensures companies do not overextend themselves and maintain a balanced focus on growth and financial stability.

What Next?

Looking ahead, the tyre industry in India is navigating challenges posed by disruptions in transit times and freight rates, a consequence of the Red Sea incident impacting both tire exports and raw material imports.

Notably, freight rates to the West Coast have seen a doubling, with a 40% surge to the East Coast. While there has been some impact on container availability, operations have managed to continue without significant disruption.

The Red Sea, a vital channel for shipping to key global destinations from India, underscores the importance of addressing these challenges strategically.

The industry is adapting to shortages of containers and extended circulation times during voyages, recognising the need for proactive measures to avoid delays in shipments in the coming weeks and months.

Amid these challenges, a forward-looking approach is evident in the industry's strategic production and sale of a diverse range of tire products tailored to different vehicle requirements.

This approach has proven effective in boosting profit margins, especially within the passenger vehicle segment.

Looking to the future, the tire industry anticipates continued growth and resilience, leveraging its adaptability and responsiveness to market dynamics.

Conclusion

Going forward, the management of these companies expects growth to continue in the current financial year based on strong market demand and moderating input prices.

To add to this, the government's massive Product Linked Incentive (PLI) boost towards the automotive sector and the global trend of China Plus One also work in favour of the industry.

Besides, a huge export opportunity is knocking at the doors of the Indian tyre industry. Several factors are at play in its favour.

Nevertheless, given the inherent nature of the industry, it is crucial to acknowledge that any disruptions in the supply chain or an increase in raw material prices could significantly impact profit margins.

It is important to note that tyre companies are highly susceptible to raw material prices.

Volatile prices of raw materials can affect the margins. To add to this, the profit margins of tyre companies are very low, and the demand for their products is subject to the demand for automobiles.

That is why, investing in top tyre companies must be done with great caution. Do your due diligence, check the fundamentals of these companies and invest in them only if they are fundamentally strong.

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