Are Tire Makers in for a Big Deflation?
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The past 12 months have been pretty good for the tire market and for those who had invested in it. Shares of passenger and light truck tire makers like Goodyear (NASDAQ: GT) Bridgestone, Michelin, Cooper (NYSE: CTB), Continental, and General are all up around 50% to 75% over last year at this time.
The boom is largely a result of increased auto sales around the world — with the notable exception of Europe — and stability in rubber prices. But what looks to be a moderation in U.S. vehicle purchases, coming at the same time the market is being flooded with cheap new tires from China, could strain sales and cut profitability in the near term.
Things had been rolling along nicely
As it helped stabilize the U.S. economy, the auto industry’s recent rebound here has also helped sell a lot of tires. Americans bought 14.5 million cars and light trucks last year, up 45% from the market’s bottom in 2009. And thanks to an improving economic picture and increased access to credit, sales have been annualizing at an even brisker pace so far this year.
Not surprisingly, tire makers who supply original equipment to automakers have seen a solid spike in sales as a result. But the improved mood and increased activity have also raised demand for higher-margin replacement tires. Combined with weak prices for natural rubber — the biggest cost in producing tires — the sector has soared.
Potential headwinds began to appear earlier this year, though, as weakening demand during the first quarter proved a challenge for several tire makers. Goodyear and Cooper, for example, each reported that revenue for the period fell about 12.5% from the prior year. Michelin’s first-quarter sales dropped more than 8%. Hankook fell nearly 2%. Even Bridgestone, which has much less exposure to Europe's troubles, saw only a slight increase.
Despite the negative turn, however, profits held better than expected because rubber prices declined. Cooper reported a record first-quarter operating profit and net income that more than doubled, attributing both to raw material costs falling by $90 million during the quarter. Goodyear posted higher operating and net income for the same reason. Bridgestone and Hankook also reported increases in profits while Michelin — hit hardest by declines in Europe — said it expects "stable operating income" due to favorable raw material prices.
Slower U.S. auto sales could further depress demand
But, some observers have started to suspect American car sales may not cooperate as much going forward. Ford, Chrysler, and Nissan were all up solidly month over month in May, but General Motors, Honda, Toyota, and Hyundai saw only minimal increases and Volkswagen actually declined.
Even more worrisome, the overall pace for the month was only slightly above the average for the first four months of the year. This indicates growth has slowed.
Adding insult to injury, those mixed May results came only after a slew of automakers employed big discounts and other marketing tactics to spur demand. Nissan had very positive sales numbers, for example, but it had to cut the list price of seven models and pay dealers up to $500 for each vehicle moved to realize them. Honda and Chrysler were also among those boosting incentives to levels not typically seen until manufacturers try to clear out old models much later in the year.
The slowdown even seems to have hit the used car market, where prices have begun to drop. This gives prospective new car buyers less value on their trade-ins — and potentially less reason to trade up — and could further hamper replacement, as well as original equipment, tire sales.
On top of that, more tires from China are available here
In recent years, Chinese passenger and light truck tires haven’t been much of a factor in the United States because a stiff import tariff kept their prices too high to be attractive in the very competitive aftermarket segment. (Chinese tires are not a factor in the original equipment market outside their own country.)
The tariff expired last September, however, and the impact has already been staggering. A surge during the fourth-quarter pushed 2012 China tire imports to nearly 30 million units, 32% higher than the year before. And the trend has only accelerated in 2013, with first-quarter imports up around 70% year over year.
The trade publication, Tire Business, estimates that of the 350 or so tire brands currently available to U.S. consumers, 50 are owned or controlled by Chinese tire makers and another 100-plus are private brands produced entirely or predominantly in that country. It further projects that if the pace of growth exhibited in the past year continues ,Chinese tires will represent 18% of the U.S. aftermarket this year — up from 15% last year, even though overall aftermarket shipments have declined.
The publication also notes that 50 of 120 tire exhibitors at the most recent Specialty Equipment Market Association Show in Las Vegas were from China, and counts nearly a dozen major introductions and distribution deals announced since that show.
The bottom line
Europe remains the biggest drag on the global tire industry. Goodyear, for example, has said it expects 2013 tire unit volumes to be unchanged from last year, largely as a result of weak conditions there. A slowdown in the U.S., still the world’s largest auto market, would hurt even more. Among those who could be nipped by that is Cooper, which realizes 70% of its sales domestically.
While rubber prices have been the saving grace for tire manufacturers so far this year, the three countries controlling 70% of the market — Indonesia, Thailand and Malaysia — have initiated plans to reduce supplies and boost prices. If they succeed, there will no longer be a safety to help tire manufacturers get past demand that looks to be waning.
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