Tyre Stocks May Rerate On Sustained Demand Momentum, Margin Gains

Improving volume growth trajectory of auto original equipment manufacturers (OEMs) and earnings recovery led by rising margins are positive triggers for tyre stocks. While companies with a higher exposure to global/European markets could face demand worries given the macroeconomic environment, domestic-focussed companies could see earnings upgrades going ahead.

The near term demand trajectory and Q4 earnings would be the key monitorables. Most segments within the auto sector posted a healthy growth on a YoY basis in the March quarter, led by lower base and festive demand as Navratra/Ugadi fell in March this year from last April levels. The demand momentum for auto and tyre companies is expected to continue due to multiple triggers.

CareEdge Ratings believes the easing of supply-related headwinds, particularly those related to semiconductors, the reopening of schools/colleges, the government’s push towards infrastructure, and the increasing pace of private capital expenditure, are expected to positively impact the demand for tyres from the automobile original equipment manufacturer (OEM) segment.

The other trigger for volumes is the demand from the replacement segment. While demand in the first two months of the year was sluggish, it has improved in March. JM Financial Research citing dealers says that the slowdown (earlier in the year) was on account of steep hike in tyre prices and overall rise inflation leading to demand referral and financial stress amongst fleet operators due to rise in interest rate and tightening credit availability.

Going ahead, brokerages expect replacement demand in passenger vehicles to be steady while it should recover for commercial vehicles given demand drivers including government’s thrust on infrastructure.

Easing raw material prices could be the other trigger for the listed players. Says Ravleen Sethi, Associate Director at CareEdge Ratings, “With the receding natural rubber and crude oil prices, the industry is expected to see a moderation in the cost of the raw material basket starting from Q3FY23. This, along with the lag in the passing on of earlier price hikes, are expected to benefit the bottom line of Indian tyre companies. The margins of all players are projected to record a 200-300 basis points expansion in FY24 over FY23 exit margins, which will be around 10-11 per cent on average.”

Given the triggers, there could be a rerating for tyre companies. Says Mitul Shah of Reliance Research, “We expect tyre companies to witness strong volume traction from OEM improvement as well as revival of replacement demand, while regular price hike and falling RM cost would lead to meaningful expansion in their operating margins in FY24. These factors would lead to re-rating, particularly for tyre companies with higher domestic exposure, he adds.

Tyre stocks have outperformed peers over the last one year with returns ranging from 27-66 per cent while the BSE Auto index is up 22 per cent. Apollo Tyres remains the top pick of most brokerages.