Go The Distance With Tyre Stocks In Your Portfolio!
The year 2019 has been unbelievably strong and has surprised even the most optimistic of the investors. The rally is not only in the equity prices on YTD basis. If we take a broader perspective, the prices are higher on YTD basis for crude oil, metals, fixed income securities and precious metals as well. In its note, Deutsche Bank mentioned that 37 out of 38 assets it tracks finished the first three months of 2019 with positive returns. Investors worldwide are on a roll with so many assets showing recovery in prices. The price rise is even more appreciated after a dismal performance in 2018. What is interesting is this price rise in several assets is happening even as the world economy is expected to face a slowdown in 2019.
Amidst all the positive action in the equity world, the tyre stocks have not impressed investors yet. On an average, the performance of the tyre stocks in the recent rally has been disappointing and that is one of the reasons why we think it may be a good idea to closely look at this set of stocks from a long-term investment perspective.
When compared to their 52-week highs, the tyre stocks are down anywhere between 26 per cent to 45 per cent. This is when the Sensex is at an all-time high and 29 stocks out of BSE 500 index have made fresh 52-week highs and almost 136 stocks out of BSE 500 index are just about 10 per cent short of their 52-week highs.
The momentum seen in other sector stocks is missing in tyre stocks for sure. One of the many reasons why the tyre stocks have not done well is the moderate growth seen in automobile sales in previous three months. It is further expected that the coming six months could be challenging for the automobile sector and the growth will thus be a concern for tyre companies as well.
Another important factor negatively impacting the tyre stocks profitability is the firming of natural rubber prices. Natural rubber is the key input for tyres. The prices have firmed up to 12 per cent in recent months. Natural rubber, along with other raw materials that are derived from crude oil, have shown an uptrend in prices in recent months. Crude oil is up by more than 30 per cent on a YTD basis. The raw material price rise has impacted negatively the tyre stocks.
If we take stock of the situation facing the tyre industry, apart from the slowing automobile growth and high rubber prices, there is hardly any concern. Investors cannot ignore the huge replacement market or the after-sales market for Tyres which constitute almost 60 per cent of the total sales of the tyre in India. What is worth noting is that 18 per cent of the total sales for the tyre industry in India comes from exports.
Hence, the dependency on the OEMs is minimal. The visible slowdown in OEMs will impact the overall growth of the tyre industry, but it will not impact the replacement market and the exports market for tyre manufacturers.
The huge growth in the number of vehicles on the road in India will ensure that the replacement market is not only surviving but thriving with decent growth. The replacement market will ensure that the demand is intact for the tyre manufacturers.
Also, with weakening rupee, the export market will also deliver in terms of growth for tyre manufacturers. With Indian tyres being exported to more than 100 countries, the growth will depend on the currency rates and various policies adopted by the Indian government.
One of the factors that can work in favour of the tyre stocks going forward is the peaking of crude oil and natural rubber prices. With the key input prices (raw material) expected to move southwards, the tyre stocks can reflect better profitability in the coming quarters. With a slowdown expected in global GDP growth, chances are that the demand for crude oil will also slow down. China especially is expected to face severev slowdown in the coming year. The slowdown in growth in the US and China is expected to keep a check on crude oil prices.
"One of the factors that can work in favour of the tyre stocks going forward is the peaking of crude oil and natural rubber prices. With the key input prices (raw material) expected to move southwards, the tyre stocks can reflect better profitability in the coming quarters"
Mustafa Nadeem, CEO, Epic Research.
One must understand this (tyre) space has very specific companies with very good BS and offers good growth to the portfolio. Most of them have doubled in this rally since 2014. This correction is now in place for over a year and many stocks are now available at very attractive prices. For the coming year, we believe there may be a rebound and the trend continuation can be seen. Despite overall weakness and volatility we have seen last year, many stocks have shown some good strength comparatively.
For the coming year, we believe this space can see some rebound and stocks with good earnings and market share will likely see some appreciation in stock prices.
There are some very good tyre stocks that are available from the small-cap and mid-cap space. They offer a lot of growth and have been wealth creator in the past few years. This space also does not have a potential threat from EVs. Secondly, the overall trend of these stocks seems to be corrective in the short term and maybe seeing some bottoming out formation in the coming weeks. A 50% retracement in a bullish trend is simply an opportunity for investors to enter the primary trend. Other factors such as BS, market share, earnings growth also matter a lot.
Conclusion
Almost everything and anything is up in the first three months of 2019, be it gold, nickle, zinc, copper, crude oil, Sensex, Nasdaq and other global equity indices. One of the tricks in playing equity markets smartly is identifying investment opportunities before others do, and also when the environment is tough for businesses, that is, when the valuations are depressed for stocks, including quality stocks. If one takes efforts to find out quality tyre stocks, chances are one may find some value in the known names in the tyre industry.
Any investment includes an element of speculation and risk. If one were to speculate that the crude oil prices will come down based on poor economic growth projections worldwide and focus on the strength of the replacement market for the tyre stocks can be a great investment idea. Quality tyre stocks with good management track record and strong balance sheets can be a part of any portfolio at this juncture. The demand outlook for OEMs will take time to improve. In the long run, the demand outlook is expected to be steady for automobile sector as the challenges faced by the automobile industry are more of short to medium term nature. The demand for automobiles is also challenged due to electric vehicles posing a threat for traditional automakers. However, the emergence of electric vehicles will not pose any challenge to the demand for tyres.
Overall, the revival in demand for automobiles in two to three-year period, steady demand for replacement markets and reviving exports markets augur well for tyre stocks going forward. Not to forget the improvement in profitability that can happen once the crude oil prices calm down. 2019 could be a year for investment in tyre stocks!