scorecardresearchFalling raw material costs lift Tyre stocks; analysts expect margin recovery

Falling raw material costs lift Tyre stocks; analysts expect margin recovery

Updated: 09 Jan 2023, 07:59 AM IST
TL;DR.
Domestic brokerage firm Motilal Oswal Financial Services believes that moderation in raw material (RM) prices will boost the margin recovery of tyre manufacturers. WTI crude futures fell 8.09% to $73.77 a barrel. Brent crude futures dropped 8.56% to $78.56 a barrel.
Motilal Oswal has upgraded its FY24E earnings per share (EPS) for Apollo Tyres (+4%), CEAT (+12%), and MRF (+3.5%) to partly reflect the correction in RM costs.

Motilal Oswal has upgraded its FY24E earnings per share (EPS) for Apollo Tyres (+4%), CEAT (+12%), and MRF (+3.5%) to partly reflect the correction in RM costs.

A sharp decline in crude oil prices, along with a drop in rubber prices, has resulted in an increase in tyre stocks during last week. Shares of the major tyre companies returned between 3 and 7% in the last five trading days, with the majority of them nearing 52-week highs and some hitting lifetime highs.

Last week, crude oil prices plummeted noticeably. WTI crude futures fell 8.09% to $73.77 a barrel. Brent crude futures dropped 8.56% to $78.56 a barrel. From their November highs, both WTI and Brent crude prices have corrected by about 15.37% and 16%, respectively.

Natural rubber prices also fell to a two-year low in the previous week due to lower demand from China and higher supply, according to media reports. Crude oil derivatives such as carbon black, synthetic rubber, and nylon tyre cord fabric together make up nearly half the cost of producing a tyre.

For the last two quarters, the profit margins of tyre companies have been badly hit by a steep rise in commodity prices. However, this trend is set to change in the coming quarters on the back of a sharp fall in raw material prices.

Domestic brokerage firm Motilal Oswal Financial Services believes that moderation in raw material (RM) prices will boost the margin recovery of tyre manufacturers.

"We expect the margin to recover from H2FY23, with a softening in underlying RM prices. As per our estimates, for every 10% change in natural rubber/synthetic rubber/carbon black prices (over its FY22 average), EBITDA margin will change by 160bp/80bp/100bp," Motilal Oswal said.

"We are building in a margin expansion from Q3-FY23, with the full benefit seen in FY24. On an FY22 base, we expect the blended gross margin to expand by nearly 190 bps in FY24 (+300 bps over FY23E). "Our gross margin estimate implies a mean reversion to about 36.8% (its 10-year average) by FY25," the brokerage firm said.

Motilal Oswal has upgraded its FY24E earnings per share (EPS) for Apollo Tyres (+4%), CEAT (+12%), and MRF (+3.5%) to partly reflect the correction in RM costs.

Apollo Tyres offers the best blend of earnings growth and cheap valuations versus its peers, Motilal Oswal said.

Meanwhile, on January 4, the Automotive Tyre Manufacturers Association (ATMA) said the Indian tyre industry will be able to scale a turnover of 1 lakh crore in the next three years on the back of new capacities available.

The industry has completed an investment of 35,000 crore in the last three years in new capacity creation and debottlenecking.

"The new capacities will go on stream over the next couple of years to meet the growing demand in an economy that is poised to remain as the fastest growing for the next few years," the Automotive Tyre Manufacturers Association (ATMA) said in a statement.

Demand is expected to grow stronger given an uptick in economic activities and the big push envisaged for infrastructure growth. "The new capacity will help the industry notch a turnover of 1 lakh crore in the next 3 years from 75,000 crore currently," ATMA said.

Shares in JK Tyre, MRF, Ceat, Balkrishna Industries, and TVS Srichakra gained between 3 and 7% in the first week of the current month. Additionally, Apollo Tyres' shares have jumped to an all-time high of 340 apiece.

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of MintGenie.

Article
Commodity prices and stock market
First Published: 09 Jan 2023, 07:59 AM IST