Tyre makers likely to see demand revival on govt's rural boost; CEAT, Apollo, JK Tyre in focus

Rajoriya believes the commercial vehicle segment is likely to remain under pressure due to muted economic activity which will have an adverse impact on commercial vehicle tyres. He expects steady demand from the replacement market which should help the sector to outperform the broad Auto space.

With the tractor space expected to register robust growth during the year, Rajoriya expects that Goodyear India would be best placed to capture the growth opportunity given its 33 percent market share in the tractor tyre segment.

CEAT is also better positioned amongst tyre companies given that the company derives about 58 percent of its revenues from the replacement market which is likely to witness steady demand, Rajoriya said.

"The company also has a well-diversified product portfolio and does not have overdependence on any particular segment. CEAT derives 31 percent of its revenues from both truck and bus and two-wheelers and three-wheelers segment while passenger vehicles, LCV, farm and specialty segment account for 14 percent, 11 percent, 6 percent and 6 percent of revenues respectively," Rajoriya said.

Vinod Nair, Head of Research at Geojit Financial Services believes the demand situation for tyres will improve.

"The tyre sector has witnessed subdued growth in FY19 on account of weak auto sales and got extended to this year due to COVID-19. In the last 3 years, the sector has registered a volume growth of 2 percent CAGR, lower to its 5-year historical average at 4 percent. We believe that the demand situation will improve going forward owing to the lower base and normal monsoon," he said.

"The major tractor manufacturing OEMs are expecting healthy sales for the upcoming quarters. However, PV and CV (OEM) demand will remain subdued for FY21 and pick-up expected from early FY22 onwards. Sanctity of the sector will be maintained with the demand driven by the replacement market as the lockdown restrictions ease-out throughout the country,' Nair said.

Nair has a buy rating on Apollo and JK Tyre with a target price of Rs 126 and Rs 70, respectively, based on FY22 EPS.

Mitul Shah, Vice President Research at Reliance Securities is also positive on the sector but he added that higher CAPEX, high debt and higher interest burden would continue impacting return ratios of these companies over medium-term.

"Tyre industry would witness better traction post lockdown as replacement demand would revive from rural as well urban, despite muted OEM sales. Moreover, the high margin replacement segment contributes around 60 percent of the revenue for the majority of the tyre companies. Therefore, it would benefit the profitability of the companies," said Shah.

Tyre manufacturers have tailwinds from the government policy also.

The government has recently put import restrictions on tyres, while also making its prior approval mandatory for foreign investments from countries that share land borders with India to curb "opportunistic takeovers" of domestic firms, following COVID-19 pandemic, a move which will restrict FDI from China.

On June 12, the government imposed curbs on imports of certain new pneumatic tyres used in motor cars, busses, lorries and motorcycles in a move to promote domestic manufacturing.

The decision assumes significance as domestic tyre manufacturers have been demanding restrictions on imports. The industry has time and again raised concerns over rising imports of tyres from countries like China.

The restriction was on tyres used in station wagons, racing cars, scooters, multi-cellular polyurethane tubeless tyres, and bicycles.

Imports of these tyres were worth $260.72 million in April-February 2019-20 as against $330.72 million in 2018-19.

While there are tailwinds for the tyre sector, challenges have not faded away.

Rusmik Oza, Executive Vice President, Head of Fundamental Research at Kotak Securities expects FY21 to remain impacted for the sector and recovery to play out in FY22.

"In the case of tyre companies, it is the mix of replacement against OEM which is the matrix to follow. Since nearly 60 percent of tyre demand comes from the replacement market there is cushion from any fall from the OEM segment. On the OEM front, we expect a recovery to be gradual with higher optimism in two-wheeler segments followed by cars and then commercial vehicles. We expect demand for tyres to remain muted in the near-term. However, tailwinds from cheaper raw material will help reduce the impact on margins," said Oza.

"Our price targets for most tyre companies are hovering around the current prices. Hence, we do not expect much returns from tyre companies in the short-term. Valuations on FY21E look very high and reasonable on FY22E. However, RoEs of most tyre companies are very poor so in relation to the return ratios, we cannot ascribe higher valuations to the stocks. If the stocks correct materially then CEAT could be a good stock to add or buy," said Oza.

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