Volume estimates up; rise in rubber prices a worry; Apollo Tyres downgraded to Reduce; TP raised for MRF and CEAT
With economic activity picking up, we expect the OEM segment to grow by 6.2% CAGR and the replacement segment to grow by 5.5% over FY2020-25e.
We have revisited assumptions on tyre companies under our coverage due to our increase in volume assumptions for truck OEM demand and the impact of sharp rise in raw material costs. Replacement demand is quite strong and companies have been able to increase prices in the replacement segment to offset RM headwinds. We believe OEM demand will likely see a multi-year upcycle. Hence, we raise fair values of companies to incorporate higher volumes.
Expect domestic tyre industry volumes to grow by 6% CAGR over FY2020-25E We expect domestic tyre industry volumes (in units) to grow by 6% over FY2020-25e led by (i) strong recovery in OEM volumes and (ii) stable replacement demand trends. In terms of segments, we expect PCR and M&HCV segments to grow by 5% CAGR over FY2020-25e and the 2W segment to grow by 6%. Over the past two years, tyre industry demand has been impacted by weak OEM demand, especially in the M&HCV segment (49% of the segment by volumes).
With economic activity picking up, we expect the OEM segment to grow by 6.2% CAGR and the replacement segment to grow by 5.5% over FY2020-25e. As per our channel checks, replacement segment demand continues to remain strong, especially in the farm equipment and M&HCV segments, and with OEM segment demand recovering, we expect tyre industry growth prospects to remain strong in the near term.
Sharp surge in NR price a concern Over the past two quarters, international rubber prices (on average) have increased by 72% led by (i) strong recovery in Chinese demand (China accounts for 43% of the global NR demand); and (ii) production-related issues. As per ANRPC, global rubber production will decline by 9% y-o-y in CY2020e. As a result, we expect global NR inventory to decline to 3.5 mn tons in CY2020e from 3.7 mn tons in CY2019.
NR accounts for around 35% of RM cost of domestic tyre companies. As per our calculations, a 10% increase in natural rubber prices would require a 2% price hike by the tyre companies. As per our channel checks, the companies have taken a price increase of 1-3% in December to partly offset RM pressures. Overall, we believe that gross margins of domestic tyre companies have peaked in the last quarter and will likely decline over the next two quarters driven by hardening of RM prices and an inferior product mix (higher mix of OEM segment).
Increase our FV for CEAT and MRF Overall, we have marginally increased our volume assumptions for the domestic business and Ebitda margin assumptions due to cost-cutting initiatives partly offset by RM headwinds. We have downgraded Apollo Tyres to REDUCE rating (from BUY earlier) due to fair valuations and kept our FV unchanged. We have increased our FV for CEAT to Rs 1,250 (from Rs 1,200) and maintain ADD rating. We have increased our FV for MRF to Rs 68,000 (from Rs 63,325) and maintain SELL rating due to expensive valuations.