A 23% correction in rubber prices from its peak levels over a period of time is expected to augur well for tyre manufacturing companies. International rubber futures have corrected around 25% during the last four months, the most since the global financial crisis in 2008 and they are currently trading at 240 yen/kg on the Tokyo Commodity Exchange.
This has been based on the concern that the biggest buyer, China, may reduce demand on account of slowdown. At the same time, Bridgestone Corporation, the world?s largest tyre maker, recently indicated that it may extend output cuts in the second half. Domestic rubber prices mirror the global trend in the rubber prices. As a result, we have seen a similar correction in the domestic rubber prices to the tune of 23% from its peak currently quoting at its lowest level of R185/kg, said Surjit Arora of Prabhudas Lilladher.
Following this, gross margins are likely to improve by 90 to 120 bps over the next couple of quarters. Tyre companies have already started reaping the benefits of the lower rubber cost, with gross margins expanding by 220 bps in Q4FY12. ?With a recent 5%-6% correction over the last few weeks, we expect a further 90-120 bps improvement in gross margins of the tyre companies over the next two quarters ie. Q1FY13E and Q2FY13E,? he said.
According to him, the rubber prices likely to remain soft. Global surplus may reach 402,000 tonne in the second half, from a 134,000-tonne deficit in the first six months. Quoting a Bloomberg survey, he said Rubber Futures, which entered a bear market last month, will drop to 200 Yen/kg from the current 240 Yen/kg by the end of the year, the lowest since October 2009.
Sensitivity to rubber prices continue to be high. Rubber accounts for 45% of the raw material cost for the tyre companies. If one were to assume rubber prices at R200/kg for a few Indian companies, a 1% reduction in rubber prices leads to 8%-11% positive impact on the EPS of the companies. However, we need to consider that there could be a price cut in the OEM segment (25% of the topline for the tyre companies). In this case, the positive impact on EPS could be 4%-7% for the companies, Arora maintained.