Tyre stocks can create significant wealth

Tyre stocks have fallen anywhere from 29-45% from their respective 52-week highs. In the last week, many small and mid-cap (SMC) stocks started recovering. Ironically even highly leveraged ones with very weak balance sheets or severe governance issues, regained quite significantly as many retail investors seem to have a very short memory and forget the bitter experiences of huge wealth destruction in such companies in 2018.

However, the tyre stocks are yet to recoup their losses in any meaningful way. While the meltdown in the SMC space in 2018 has impacted the tyre stocks also adversely, they failed to recover now as the overall automobile sales growth moderated significantly in the last three months. Further, prices of key inputs viz natural rubber and other raw materials derived from crude oil have also firmed up (8-12%) in recent months.

However, the fear on tyre stocks is overdone – quite interestingly the replacement (after-sales) market for tyre constitute around 60% of the total sales of the tyre in the country and exports another 18%. Therefore, the sale of the tyre to OEM market (i.e. to the producers of automobiles) is only around 22% of total tyre sales. Though the slowdown in OEM sales would impact the tyre industry, its adverse impact is limited as its dependence on the OEM market is substantially lower than that on the replacement market.

In the last 10 years, the automobile population (number of vehicles on the road) has gone up 140% from 11.5 crore vehicles in 2009 to 27.7 crore vehicles in 2018. Such robust growth in population in the vehicles should generate substantial demand for tyres from the replacement segment in the future.

While some auto-component segments face a potential threat from the electric vehicles (EVs), the tyre industry doesn't have any such threat from the penetration of EVs. Disruptions caused by both demonetization and GST are also behind now for the tyre industry. While imports, especially from China, have moderated due to the imposition of anti-dumping duties, the export opportunity is also growing on account of the recent fall in the rupee exchange rate. Indian tyres are exported to more than 100 countries in the world including the US and European countries.

Even rubber and crude oil prices are expected to correct once again as there are some signs of deflationary pressures in the world economy. Global GDP growth and also growth in the two largest economies (US and China) of the world are expected to slow down, partly due to rising trade wars. This deceleration in economic growth is expected to reduce the demand for commodities including oil and natural rubber. Therefore, we can expect some weakness in their prices in the near future. Thus, this is the time to focus on quality tyre companies, which have well-established management and consistent track record of making profits, and also got strong balance with least debt or net cash for making decent equity wealth in the medium to long terms.

The writer is founder and managing director, Equinomics Research and Advisory