Tyre cos a good bet despite record rubber price?

MUMBAI: Analysts are bullish on Indian tyre makers as higher demand from the after-sales market is seen offsetting a margin squeeze due to unprecedented input cost rise and a likely slower demand growth from original equipment makers due to higher interest rates.
They expect the high-margin replacement market to yield higher volumes and sales, though not all of it may translate into earnings.
Natural rubber prices make up about half the cost of a tyre and the industry has been grappling with falling profit margins as rubber prices soar to a record high on a global supply crunch.
Auto sales in India grew a record 31 percent in 2010, driven by a burgeoning middle class and easy access to financing.
Though the rising fuel and vehicle costs and a likely increase in interest rates may slow the momentum in the auto sector, analysts said tyre makers will continue to benefit from the robust replacement market.
BUY-APOLLO TYRES, JK TYRE TOP PICKS
Apollo Tyres, India's second largest tyre maker, has emerged as the top pick for investors while smaller rival JK Tyre is also seen as a steady stock.
"Just observe the rise in rubber prices over the past eight years and how Apollo has still maintained its operating margins at an average 12-12.5 percent during the period," said Vijay Sarthy, analyst at Spark Capital.
He expects the company to raise tyre prices in short-term to pass on rise in rubber cost.
Out of 16 analysts covering Apollo Tyres, 11 have a 'strong buy' and 'buy' recommendation on the stock, Thomsonreuters data showed. All four analysts covering JK Tyre have a 'strong buy' rating.
"We are positive on the valuation front but in the near term due to the volatility in the commodity prices the stocks will be rangebound," said Vaishali Jajoo, auto analyst at Angel Broking .
Analysts also said Apollo Tyre's global reach will give it an edge over its rivals.
"We like Apollo Tyres in the tyre sector. All other players are domestic players whereas Apollo Tyres is now having significant presence in Europe and also in South Africa," said Deepak Jain, assistant vice president and research analyst at Sharekhan .
Apollo Tyres through its Netherlands-based subsidiary Apollo Vredestein sells tyres in Europe. It has manufacturing units in South Africa as well.
Jain said Apollo's international operations contribute almost 40 percent of its EBITDA. This is helping the company as cost of raw materials to sales there is less than half of what it is in India.
"Valuations-wise, JK Tyre and Ceat are at a larger discount to Apollo but institutional people prefer Apollo as it is a low-risk stock and on the longer term, gives slightly better returns," Jajoo said.
RUBBER TO DEFLATE PROFIT
"While sales and volume growth would happen, it may not translate into much of an earnings growth for tyre companies," Sharekhan's Jain said.
Galloping rubber costs have tyremakers worried and with little choice but to raise prices. But tyremakers such as Ceat and JK tyre have said that they would not be able to raise prices as much as required to protect their margins.
"In the last 10-12 months, they have been increasing the prices which have gone up by almost 12-13 percent on the realisation front," said Angel Broking's Jajoo.
"But they have not been able to absorb the full cost inflation. So they may need a further hike in the prices which some of them have already declared," she added.
Firmness in the global market and local rubber futures were indicating a further rise in domestic spot rubber prices, said George Valy, president of The Indian Rubber Dealers Federation.
On Wednesday, the spot prices in India were at a record 22,000 rupees per 100 kgs as against 24,122 rupees in Bangkok, Thailand, the world's biggest exporter.
Shares of tyre makers have have taken a beating in the last three months, as rubber prices went out of control.
Apollo Tyres for instance has gained over 18 percent in the last 12 months, outperforming the broader BSE index. The stock has lost 24 percent in the past three months.
Top tyre maker MRF rose over 7 percent over the past one year, but the stock fell 11 percent in the last one month.
"Higher rubber prices are bound to create pressure in the current quarter and operating margins could be lower than the last quarter. We view this as a temporary problem though," said Sarthy of Spark Capital.

(Source: http://economictimes.indiatimes.com/markets/stocks/stocks-in-news/tyre-cos-a-good-bet-despite-record-rubber-price/articleshow/7268738.cms)