Will rubber prices make tyre makers tread cautiously?

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Sejal Doshi, Chief Executive Officer at Finquest Securities, says that the tyre sector is witnessing a decent growth and is very much dependent on the auto sector. He adds that in the last four years the auto sector has been growing at around 16%.

Excerpts from CNBC-TV18's exclusive interview with Sejal Doshi:

Q: In the light of the capacity additions that most of these tyre manufacturers are making and the kind of demand that is coming in from the auto industry, how are these companies stacked up in the light of the growth that is expected from them?

A: I think this is the right time for the tyre sector. We have been seeing that the growth in the tyre industry is very much dependent on the parent that is the auto sector and in the last four years we have seen the auto sector growing at around 16%.

But the important thing is that tyre is a replacement demand, constitutes 65% of the sales, while the balance has been constituted by the OE segment and the exports. The OE segment has grown in double digits but the replacement demand, which constitutes major things hasn't grown and considering the 16% growth, which has happened in the last four years, we feel  that this is the right time that the replacement demand will also start kicking in.

Normally, the replacement demand emerges after two or two-and-half-years, considering the retrading of the tyres also. So we feel that growth is bound to be on the cards and see demand growth coming from the replacement as well as the OE segmen and we feel that the kind of capacity addition happening will be able to sustain growth.

Another factorial change, which has happened in the tyre sector, is essentially that rubber, which constitutes major cost of the raw material, was on an upswing for the last couple of years and that has impacted the tyre sector's profitability badly. But now we are seeing that rubber prices are stabilising and that provides some cushion.

Secondly, all the tyre players, who are working on a low capacity utilisation see the demand-supply gap narrowing and the pricing power returning to them. In the last year they had four or five price hikes, which helped them turn margin accretive, which is why we saw a good set of numbers coming across in the last financial year.

Going forward, we feel now with the demand-supply gap narrowing, capacities are coming up; but that is coming over in a phased manner and only few players like JK Tyres are ready with higher capacity. So whatever capacities will come probably in the second half of 2008 will see pricing power continuing and margins relatively stabilizing, which will drive profitability of these tyre players.

Q: How will the interest rate concern bring down demand for the auto industry, which might have a domino impact on the sales of the auto sector through the OEM route? You talked about the replacement demand going up. What will be the key drivers that will push up the replacement demand for tyre manufacturers?

A: Essentially, in the OE segment, the concerns are there on the interest rates and we are seeing slowdown in the auto offtake itself. But that constitutes hardly 25-30% of the total tyre sector demand, which is why it won't have a more major impact than the slowdown in the total demand for the tyre sector, but definitely replacement demand has had bigger lag effect than what it should have been. We feel that the driving factors are the ban on the overloading and the kind of penetration that we have seen in the radial tyres in the CV segment. So that will probably kick in the demand from the replacement side.

For the last two to two-and-half-years, the double-digit growth was seen in the auto segment and we have witnessed a single digit 9-10% growth in the overall tyre demand. So, retrading can be postponed, as the life and imports are certainly a threat but not in a bigger way. So it is a matter of timing when that inflection point is coming and the replacement demand should start kicking in.

Q: In light of the rising raw material prices, which companies do you see most benefiting in 2008 and on operating level? From the entire gamut of companies, which are you most bullish on?

A: Essentially, the margin impact will be same across the board, because most of the players have got similar operating leverages; but may be, players like Ceat will have more margin expansion as compared to the other inefficient players. But going forward, in terms of stock-picks, we will still prefer JK Industries and Apollo Tyres as they appear to be beneficial, because JK has already put in capacity and Apollo is a quality player.

Disclosures:

A: We have come out with a report; so may be these are stocks, which we may be recommending to clients or we may have some positions and our clients too may be holding.