Tyre companies have become hot these days. This is due to their extraordinary profitability growth. Top tyre companies have witnessed an average of 42 per cent annualised growth in their net profits in the last three years. The stocks of these companies have also raced along almost in sync. Has the tyre sector picked up pace or is it something else? You can easily answer the question by just looking at the revenue growth. The revenue growth of tyre-makers has been at a sluggish pace of just 3 per cent annualised in the last three years.
In recent times there is no real growth in demand as such in the industry. The rising profits have come on the back of a fall in rubber prices, the key raw material for tyre companies. Rubber prices have fallen by almost 75 per cent since their peak in April 2011, thus improving the operating margins by 750 basis points on an average in the last three years. Therefore, all the earnings growth has come from the fall in rubber prices and not from business scalability.
Apart from the slow demand, Indian tyre manufacturers have faced tough competition from cheap tyre imports from China. Due to tough competition and discounts, Indian companies have not been able to capture the full benefit of a fall in rubber prices.
Now rubber prices seem to have bottomed out and there is very little probability that they will go further down. Therefore, if you are attracted to the high earnings growth of tyre companies, you should resist the temptation. Further growth will only come when tyre-makers are able to witness a rise in sales quantity and are able to tackle the disruption caused by Chinese imports. Go for tyre companies only if you think the tyre business is going to grow or you find them at a deep discount to their intrinsic value.
Ask Value Research 
New episodes every Friday 
New Process Alert 
Seems like you've uploaded a wrong QR code. Please upload the QR code downloaded from MF Central platform.
