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Tire manufacturing industry, analysing the cost and margin trends

The global market for tire manufacturing stands at $180 billion. Michelin anticipates the long-term demand to rise at the rate of 5 to 10% a year in developing markets and 1 to 2% a year in mature markets. Moreover, in terms of volume, sales are expected to reach 2.5 billion units by 2020, this will be propelled by an increase in automobile manufacturing. The automobile market, in turn, is expected to strengthen due to growing urbanisation and rising personal disposable incomes.

Bridgestone is the largest player in the market with revenues close to $27.1 billion, followed by Michelin (revenues of $22 billion) and Goodyear (revenues $16 billion). Bridgestone, Michelin and Goodyear together hold approx. 40% of the global market share as shown in the below chart. Merger and acquisitions, entry barriers such as huge capital investments and brand loyalty are the major reasons for concentration in the industry.

The sales of tires can be classified into demand from original equipment manufacturers (OEM) and replacement market (RC) also known as aftermarket sales. Sales in OEM segment are dependent on the sale patterns of new vehicles, whereas RC sales depend on the usage patterns of consumers.

Televisory analysed the data of Good Year, JK Tyre and Michelin and observed that on an average RC accounts for 68% of the sales, while OEM constitutes 32% of the total sales (displayed through the below pie charts), which is also an average for the industry as a whole. The demand from RC market is expected to stay strong due to a large number of vehicles on-road. Furthermore, any sale in OEM segment leads to an assured RC segment demand in the next 4-5 years.

        

In addition, raw materials account for almost 75% of the production costs with natural and synthetic rubber being the key raw materials. A reduction in the raw material cost is passed on to consumers as an advantage or vice versa. Crude oil has a direct influence on the price of synthetic rubber. Additionally, any movement in the price of synthetic rubber subsequently affects the natural rubber prices. The rubber prices were at an all-time high in 2012 and thereafter maintained low levels as can be seen from the below data. The fall in crude oil prices along with the excessive production of natural rubber in Asian nations such as China and Thailand kept the rubber prices in economic range. However, rubber prices bounced back in 2016 as the major rubber producing companies in Thailand, Indonesia and Malaysia agreed to cut down the supply by 0.6 million tonnes (Source: Business Standard). The impact got transferred to the final prices of tires. Goodyear raised its prices by 8%  (February 2017) and other companies such as Copper Tire & Rubber, Carlstar and Nexen Tire are expected to follow the suit. 

The production expenses have the greatest bearing on cost in the tire industry, at around 70% of revenues whilst other operating costs constitutes 20% of revenues. An analysis of the financial statement of Michelin, Goodyear and JK Tyre revealed that the production costs of Goodyear were higher than its peers, this was due to high production and general overheads. However, its operating expenses were comparatively lower due to limited selling and advertising expenses.

The net sales of Michelin rose by 8.4% in FY 2015 primarily due to the acquisition of Sascar (€256 million additional), currency effects (€1.5 billion) and rise in sales volume (€624 million). On the contrary, Goodyear and JK Tyre faced a decline in their revenues in the same year. The principle reason for the fall in Goodyear’s revenue was currency translation, especially in the EMEA region. The revenue for JK Tyre contracted due to an 8.7% fall in demand from SCV segment coupled with rising imports of truck radial tyres from China.

Although Indian manufacturers are accelerating the production of radial tyres, the radialisation volume of truck/bus segment stands at only 44%. The scope of expansion in the truck/bus radial segment has led to a heightened competition both from domestic and international players.

On an analysis of the profit margins of the companies (stated in the below graphs), Televisory found that Goodyear had the lowest net margin owing to loss of deconsolidation of Goodyear de Venezuela amounting to $646 million. Goodyear’s net margin was unusually high in 2014 due to $1.8 billion net income tax benefits. This was owing to release of the valuation allowance on deferred tax assets in the US. All the major players capitalised on the cost advantage due to fall in rubber prices and thus, their production costs kept declining. JK Tyre being an Asian firm benefitted most from cheap imports of rubber through Asian countries with its production cost plummeting 6.3%. Michelin being a global player with a larger asset base had depreciation expenses equivalent to 6.7% of its revenues, while JK Tyre with its manufacturing restricted to India and Mexico had depreciation expenses of 3.7%. Therefore, Michelin’s drop from EBITDA to EBIT margin was more than that of JK Tyre. However, JK Tyre’s dependence on debt was more as indicated by its higher interest expenses amounting to 3.3% of its revenue, thus lowering its net margin. These interest expenses, however, provide for a significant tax shields, this can often be a complimentary part of the capital structure. 

        

Thus, Michelin has been consistent in maintaining its net margin at around 5.5%, while JK Tyre has exhibited an increasing trend in its net margin. Goodyear and Michelin began offering tires online directly to customers in 2016, this is expected to contribute positively to their sales volumes. JK Tyre adopted a low-cost automation plan at its manufacturing plants and has been judiciously investing in R&D in order to sustain technologically. However, in terms of global expansion JK Tyre has a long way to go and its manufacturing and distribution costs might therefore increase accordingly. In an industry, where material costs cannot be directly controlled by the manufacturers, optimising manufacturing and distribution capacities are the key to success.

 

 

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