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Exercise caution when investing in stocks of tyre companies, say experts

Sarbajeet K Sen/Money Today     January 25, 2014
Tyre stocks are on a roll. A sharp fall in rubber prices in the past few months and high replacement demand have ensured stellar gains for both tyre companies and their investors.

In the six months to December 16, the Ceat stock rose 186% from Rs 109.60 to Rs 313.25 on the Bombay Stock Exchange or BSE. During the period, JK Tyre rose 44% from Rs 112 to Rs 162, TVS Srichakra 41% from Rs 189.65 to Rs 266.55 and Apollo Tyres 32.5% from Rs 63.95 to Rs 84.75. MRF rose 38% from Rs 14,295 to Rs 19,772. In comparison, the BSE Sensex rose just 7% between June 17 and December 16.

Prayesh Jain, assistant vice president, research, India Infoline, says that the over 20% fall in rubber prices has been the biggest plus for the sector. "The fall in rubber prices and revival of replacement demand have been driving the rally. Rubber accounts for 55% raw material cost of tyre makers."

Rubber prices have fallen 27% from Rs 195 per kg to Rs 153 per kg since the end of July on sluggish demand. Additionally, China has withdrawn its plan to procure 2,00,000 tonnes rubber for building a reserve stock. Also, domestic producers had kept a lot of inventory in anticipation of higher prices, something that failed to materialise.

Savitree Singh, senior equity research analyst, The Market Financial Intelligence, agrees with Jain. "Tyre stocks have outperformed due to the crash in rubber prices to a three-and-half-year low." Singh, however, warns that there is little possibility of a further price fall. "If the government increases import duty to motivate domestic rubber growers, it may cause an uptick in prices. For most tyre makers, raw material costs as a percentage to sales are 60-70%. So, a price reversal will increase costs and put pressure on companies' operating margins."

REPLACEMENT GAINS

{blurb}D K Aggarwal, CMD, SMC Investments and Advisors, says tyre companies will continue to gain from strong replacement demand. "The replacement market will continue to be strong over the next couple of years as almost 90 lakh automobiles were added between 2009-10 and 2011-12," he says.

Jain of India Infoline says companies have higher pricing power in the replacement market. "While auto sales have slowed in the past one year, the high growth of the preceding three years will continue to drive replacement demand. In fact, in the replacement market, companies have much more pricing power," says Jain.

INVESTMENT OUTLOOK

With trye stocks having a good run, is there scope for more gains?

Sonam Udasi, Head of Research, IDBI Capital, says investors can buy trye stocks for medium-term gains. "One can take positions in tyre stocks with a two-year perspective. Once the economy picks up, we will see more demand from auto companies. Also, sector valuations and debt levels are not very high."

SMC's Aggarwal also says that investors need to take a long-term view. "The tyre industry's fortunes depend upon the fate of automobile industry, which is poised for growth. Considering the cyclical nature of the automobile industry, one can invest in tyre stocks for the long term," he says.

Savitree Singh of The Market Financial Intelligence advises investors to keep an eye on rubber prices. "We need to be cautious. Once rubber prices start rising in international and domestic markets, stocks of tyre companies may come under pressure. Hence, for the short term, we do not feel that there is much steam left in tyre stocks. But, to gain from the revival of the auto sector, investors with a horizon of more than one year may accumulate these stocks."


WHAT TO BET ON

If you are keen to invest in tyre stocks, experts suggest Apollo Tyres, MRF, Balakrishna Industries and CEAT.

SMC's Aggarwal says that the proposed acquisition of Cooper Tire & Rubber Co can give a big boost to Apollo Tyres. "The company plans to acquire Cooper Tire & Rubber Company in deal valued at approximately $2.5 billion. This will bring together two companies with complementary brands, wide geographic presence and technological expertise to create a global leader in tyre manufacturing and distribution. If finalised, the merger will create the world's seventh-largest tyre company," says Aggarwal.

He says they expect replacement demand to continue to drive volumes. Nearly 77% of the company's sales came from the replacement market. Also, its debt to equity ratio is just 0.6 (as on March 2013).

IDBI Capital and The Market Financial Intelligence are also positive on the counter.

Recommending Balakrishna Industries, Savitree Singh says the company has aggressive expansion plans. Also, its tyres are priced 30-35% lower than the products offered by international brands. Additionally, entry into different countries and a move from agri to non-agri segment will be positive for the company.

India Infoline and SMC Capital also recommend the stock.

Singh's other favourite is CEAT. She says the company will benefit from its focus on the profitable nontruck segment and exports. The company reported an all-time-high operating margin of 13.4% in the second quarter 2013-14 on the back of softening raw material prices and favourable product mix. She feels the company is likely to further expand margins on the back of falling rubber prices and a favourable product mix.

Prayesh Jain of India Infoline says MRF can be a good pick in view of its leadership in the personal mobility segment, strong balance sheet and decent profitability.


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