Widely read:
India’s leading tyre company was started in 1946 as a toy and balloon manufacturer. It later forayed into manufacturing tyres, tubes and conveyor belts. Now its core business is manufacturing, distribution and sale of tyres. In addition, it is also present in segments like pre-treads, paints and coats, and toys. MRF manufactures the complete range of tyres meant for heavy duty trucks to two-wheelers. These are rolled out of six manufacturing facilities (all TS 16949/ISO 9001 certified).
A cyclical industry
The Indian tyre industry has an annual turnover of Rs 28,000 crore. The top 10 companies account for 90 per cent of the market. MRF’s market share ranges from 20 to 60 per cent in various segments.
Earlier, bias tyres accounted for a larger share of sales. But now, in sync with global trends, the market is shifting towards radial tyres. In the passenger car segment, radials account for 99 per cent market share; in light commercial vehicles, 18 per cent; and in heavy commercial vehicles, 12 per cent.
Altogether 39 tyre companies operate in India of which 14 are listed.
Strengths
Market leader. MRF recently became the first Indian tyre company to have exceeded the turnover mark of Rs 10,000 crore. It accounts for around 25 per cent market share in the overall tyre business.
About 70 per cent of MRF’s revenue comes from the replacement market, original equipment manufacturers (OEMs) account for 20 per cent, and exports for 10 per cent. Margins in the replacement segment are higher than in the OEM segment. Since a significant portion of MRF’s revenue comes from the replacement market, its profitability is higher than the industry average.
Rapid expansion. The company’s new plant at Medak became operational this year. It expects its seventh plant at Trichy (on which it has incurred capital expenditure of Rs 900 crore) to become operational in the first quarter of 2012. This plant, which will focus mainly on truck radials, is expected to add 15 per cent to the top line.
Strong distribution network. MRF has opened T&S (Tyres & Service) one-stop shops across the country. These outlets stock the entire range of MRF tyres and also provide services like computerised wheel alignment, wheel balancing and tyre changing. The company has 180 offices and a network of 3,000 dealers countrywide. A strong distribution network is a competitive advantage in India’s highly competitive tyre market.
Foray into new segments. Recently MRF entered the aviation segment wherein it gets orders from HAL and the defence sector.
Low reliance on exports. Since only 10 per cent of its revenue is derived from the export market, the ongoing global turmoil will not have much of an impact on MRF.
Retreading. Retreading refers to putting a new tread on a used tyre. The company claims that its re-treads give 70-80 per cent of the mileage that a new truck tyre gives while costing only 25-30 per cent as much.
Concerns
Rising input costs. Over the past three years, rubber prices, which account for around 70 per cent of input cost, have risen significantly from Rs 60 in 2008 to Rs 240 in 2011. Though it has corrected by 18-20 per cent from the highs, pressure on margins remains owing to manufacturers’ inability to pass on the entire cost increase. If prices correct further, the company’s margins could improve in future.
Severe competition. In India’s competitive tyre market, most products are commoditised, barring a few in the radial and off-the-road segment. Players command low pricing power. Profit margins, especially in the OEM segment, tend to be low.
Dumping from China. A sharp increase in imports from China is adding to the tyre industry’s woes. Though low on quality, Chinese imports have been increasing due to the price differential that ranges from 10-40 per cent. This has had greater impact on the replacement market where margins are otherwise healthy.
Removal of anti-dumping duty. Anti-dumping duty on TBRs (truck and bus radials) imported from China and Thailand has been removed by the Excise and Service Tax Appellate Tribunal in August 2011 following an appeal from Bridgestone, which imports radials from its Chinese plants. Consequently, as rubber prices soared, it became cheaper to import tyres instead of rubber. This affected the domestic tyre industry adversely.
Slowdown in auto sector. Monthly auto sales data clearly points to a slowdown in the auto industry, especially in the passenger segment. This will in turn affect the sale of tyres to OEMs.
Opportunities
Backward integration. A lag of seven years exists between the planting of a rubber tree and production. While demand has gone up, supply cannot be ramped up quickly. This accounts for the spike in rubber prices over the last three years. Management expects prices to remain elevated for another two years. To guard against price volatility, MRF is scouting for rubber plantations in Cambodia, Thailand and Vietnam. Through backward integration, it hopes to exercise better control over its margins.
Radialisation. Compared to other major economies, radial tyres still enjoy a small market share in India. But now demand for them has reached an inflection point. After the passenger car segment, the heavy commercial vehicle category is adopting these tyres in a big way as they tend to be more economical in the long run. Almost all the capacity expansion targeting the heavy vehicle category is happening in radial tyres. Radialisation will also improve margins as radial tyres sell at a premium compared to bias tyres, enabling the industry to offset rising raw-material costs.
Replacement market. In recent times, demand from the OEM segment has moderated. However, strong sales to the OEM segment in the previous three years should translate into higher replacement demand in the coming year.
Financials
MRF posted a net profit of Rs 619 crore in FY11 against Rs 354 crore in FY10 despite the steep rise in input costs and dumping from China. This was primarily because of a significant change in its depreciation policy (WDV to SLM). The exceptional item representing excess depreciation reversed is to the tune of Rs 404 crore. Otherwise, Profit before tax and exceptional item stood at Rs 489 crore, lower than the previous year’s Rs 534 crore.
Dividend yield stood at 0.72 per cent. The company has never skipped dividend payment in the past 13 years.
The company’s working capital management has shown a sharp improvement: the number of receivable days has halved from 60 days 10 years ago to 31 days in 2010.
Its debt to equity ratio stood at 0.65 and interest coverage ratio at 9.48 on September 30, 2011 despite investments in two new plants. Its liquidity position is stable with current ratio at 1.95 and quick ratio at 0.90.
A foreign currency convertible bond (FCCB) issue of $15 million (around Rs 75 crore) is due for retirement in mid 2013.
Valuation
The tyre sector, whose fortunes are closely tied to those of the auto sector, is highly cyclical in nature. When investing in cyclical stocks, one must time the entry right — at the bottom of the cycle. The current P/E of 4.71 is very close to a level from which MRF’s share price has rebounded on all occasions in the past 10 years .
What makes the case for investing in this stock stronger is the price-earnings to growth ratio (PEG) which currently stands at 0.09.
In view of the fact that the interest-rate cycle has peaked and in the next two quarters we might see interest rates coming down, a fundamentally sound but cyclical stock like MRF becomes attractive. Investors with a horizon of three to five years may invest in this stock in a staggered manner around its current price level.
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