Should you bet on tyre stocks?

Recently, Amit Tewari, a 43-year-old Delhi-based insurance agent and an avid stock investor, ran into an old friend who owns a tyre dealership in West Delhi. His friend, who had been moaning about poor sales over the past two years, sounded upbeat about the prospects of his business this time. This made Tewari wonder whether the time was right for betting on tyre stocks.

Stock analysts are turning positive about the prospects of tyre companies. “As the economy picks up, volume growth of tyre companies should return to the long-term average of 8-10% compounded annually,” says Jasdeep Walia, senior analyst at Kotak Institutional Equities.

Apollo Tyres

Apollo Tyres has operations in India (accounts for 62% revenue), Europe (27%) and Africa (11%).
Strengths: It’s the second largest player in the Indian tyre industry. It is the leader in the truck-bus segment with a market share of 27%. It has a 19% share in car tyres. In Europe its subsidiary Vredestein is positioned in the ultra-high performance and winter car tyre segments, where margins are high.

Opportunities: One opportunity in India is the growing use of radial tyres. The market share of these tyres, which currently stands at around 25%, is expected to rise to 40% in the medium term.

The company’s board has approved an investment of $340 million for the expansion of truck and bus radial tyre capacity at its Chennai plant. Also on the anvil is a greenfield facility in eastern Europe that will cost 500 million euros. While these capex initiatives may affect the company’s return ratios in the medium term, they will fuel growth over the long term.

The current weakness in the price of rubber, which accounts for more than 60% of the company’s raw material cost, has led to improved margins in India. Volumes in Europe are on an upswing due to the economic revival there.

Threats: Any increase in the price of rubber will affect the company’s margins. A mild winter in Europe has the potential to affect winter tyre sales. According to a recent report from Ambit Capital, the increased focus of multinationals, such as Michelin and Bridgestone, on the Indian market could result in loss of market share for domestic players such as Apollo in the truck and bus radial segment. The report adds that it will be difficult for Vredestein to clock high volume growth until its new plant becomes functional in the second half of 2016-17.

Valuation: On 12-month trailing (TTM) valuation parameters (see table), the current levels are lower than the five-year averages. Remember that this is a cyclical stock, so earnings tend to fluctuate. Only investors with the requisite risk appetite should invest in the stock with at least a five-year horizon.

Goodyear India

Goodyear India is the leader in the farm category, with tractor tyres accounting for 60% of its sales by tonnage
Opportunities: Tractor sale in India is expected to grow at 7-9% over the next five years. The passenger car segment is also expected to witness a modest recovery in 2014. In the passenger radial segment, the company is focusing on SUVs, where it can bank on its global portfolio to meet high-end requirements.