Tyre stocks hurt by high rubber prices; are they a bargain?

By Arnav Pandya

Tyre companies have been smarting under the impact of rising tyre prices over the last many months. The impact is magnified because the consumption of raw materials is a very significant part of the income of the tyre companies and hence this needs to be watched very closely. This situation can also present a good investment opportunity for the savvy investor.

Impact

One of the major components in the manufacture of tyres is rubber and the rise in rubber prices over the last year is visible in the profit and loss statements of the companies. To get an idea of the actual situation consider the statements of some of the largest tyre companies in the country. Raw material cost (consisting of rubber, carbon black, other chemicals etc) is the biggest component of the entire financials with it being larger than all other heads like employee cost, purchase of traded goods, depreciation and other expense put together. This gives it an overweight position in the entire financial position for the companies. 

The lower the raw material cost the better it is for the company because it has additional amounts to meet various other expenses. To get a better idea of the situation the raw material cost to net sales ratio gives an indication as to how much of sales are actually spent on the raw material itself. A very high figure is not good news and lowering this can benefit companies through higher profits. 

Actual position

Here is a look at various companies and how they stack up on this front. For J K Tyres then its net sales increased from Rs 4,570 crore in 2009-10 to Rs 5,945 crore in 2010-11 while its raw material cost rose from Rs 2,723 crore to Rs 4,386 crore in the same period. The rise in the raw material cost was a massive 61 per cent. This was reflected in the raw material cost to sales ratio that jumped from 59 per cent in 2009-10 to 74 per cent in 2010-11. This meant that nearly three fourths of the income of the company was spent just on raw materials.

Ceat Tyres saw its consolidated net sales rise from Rs 2,850 crore in 2009-10 to Rs 3,602 crore in 2010-11. Its raw material cost too rose significantly during this period by nearly 59% from Rs 1,733 crore to Rs 2,750 crore. This pushed up the raw material cost to sales ratio from 61% in 2009-10 to 76% in 2010-11. This figure is extremely high which leaves little room for other expenses and that is also the reason why the impact on profit has been severe for the company

Apollo Tyres is one of the larger players and it has been trying hard to keep control on the raw material cost and the results are evident from the figures. The consolidated figures of the company saw its sales rise from Rs 8,121 crore in 2009-10 to Rs 8,867 crore in 2010-11. This was accompanied by a raw material cost rise of 35% to Rs 5,295 crore from 3,934 crore. The raw material cost rise was larger than the sales rise which led to the raw material to sales ratio jumping from 48% to 59%. This figure is still lower than many other players but it had an impact on the profits that dipped during the year.

MRF too was in a similar position and for the company that follows a September year end the figures for the 6 months to March are available. During this time sales rose from Rs 3,421 crore to Rs 4,547 crore while raw material cost rose 48% to 3,367 crore. This led to a situation where from 66% the raw material cost to sales ratio jumped to 76%. This sharp impact had its effect on the profit of the company.

Going forward

The last time raw material costs spiked for the tyre companies was in 2007-08 when the ratio for many companies crossed the 70% mark.Fundamentally demand continues to be strong and while auto sales slowdown will have a slight impact on the companies the replacement demand should help the situation. Overall raw material cost will play an important role in  the performance going forward.

There are two ways to look at the impact on the stocks of the companies that are operating in the tyre space. If the raw material cost continues to remain high then companies with a lower raw material to sales ratio will outperform others on the financial performance front which can get reflected in the share price movements. On the other hand if there is a sharp drop in the raw material cost then all the companies will gain but those with a higher cost might end up with a bigger gain if they manage to rein in this expense. 

Disclosure: The writer does not hold any shares in the above mentioned companies

Disclaimer: This does not represent any recommendation to buy or sell shares in the companies mentioned above. Readers are requested to consult their financial advisor before taking any financial decision.