Indian Tyre Sector. A smooth ride OEM DEMAND OUTLOOK

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1 SECTOR RESEARCH September 04, 2017 Indian Tyre Sector A smooth ride OEM DEMAND OUTLOOK Passenger cars and UVs: Sustained strength We expect passenger car demand to stay strong over the medium term on the back of 1) strong rural demand premised on higher farm incomes, infra spend pickup & normal monsoons, 2) cushion of low interest rates ensuring reduced cost of ownership, 3) likely soft fuel price trend given our modest crude price outlook 4) an upcoming model launch spree. M&HCV: Weakness to persist We expect demand for CVs to remain weak due to 1) advancement of buying in Q4 FY17 due to change in emission norms, 2) fleet operators yet awaiting clarity on GST roll out impact on logistics sector, 3) impact of higher vehicle prices on fleet operator profitability post BSIV implementation given no commensurate improvement in freight rates, 4) expected improvement in rail transport viability vis à vis road transport from the impending dedicated rail freight corridors and 5) lower replacement demand given weak CV sales during FY13 and FY14 (4 5 years of replacement cycle). The impact of these factors would be partially offset by 1) improvement in mining and infrastructure activities to support tipper demand (17% of M&HCV sales) and 2) growing demand from the consumer durables sector. LCVs: Strong momentum to sustain Demand for LCVs should remain strong on the back of rising last mile connectivity demand given the upsurge in organized retail segment. Notwithstanding the impact of dedicated rail freight corridor on the demand for M&HCVs goods carriers, last mile connectivity would be a business need. Falling interest rates would allow financers to improve their penetration in the segment. Analyst: Prayesh Jain, Tushar Rathod Two wheelers: Growth likely to improve Motorcycle demand growth is likely to pick up following an expected strength in the rural India market on the back of normal monsoons. Demand for scooters, however, would continue to outpace the demand for motorcycles given the under penetration of the segment in rural India. Lower interest rates along with growing finance support from OEM arms should further fuel demand growth. Figure 1: Demand outlook FY13 FY14 FY15 FY16 FY17 FY18E Pass vehicles 1.3% 6.1% 3.9% 7.2% 9.2% 10 12% M&HCV 23.1% 25.3% 16.0% 29.9% 0.0% 0 5% LCVs 2.0% 20.2% 2.8% 11.5% 4.2% 10 12% 3Ws 4.9% 10.9% 11.0% 1.0% 4.9% 5% 0% 2Ws 2.9% 7.3% 7.9% 3.0% 6.9% 8 10% Source: SIAM, IIFL Research Figure 2: 2Ws dominate in terms of volume, CVs dominate in value terms 52% 11% 7% 4% Volume 26% Source: ATMA, IIFL Research Truck LCV Pass Tractor 2W 21.4% 16.1% 28.6% Value 30.4% 3.6% Truck LCV Pass Tractor 2W 1

2 REPLACEMENT DEMAND OUTLOOK Replacement cycle for commercial vehicles is around 12 months. With a life of about 10 years (4 5 years with the first owner and another 4 5 years in second hand market), CVs generally undergo around 8 9 replacements over their lifetime. Considering strong trend in M&HCV vehicle sales in the past couple of years, replacement demand should gather some momentum in FY19 following weak trends in FY17 and FY18E. Further boost would come from the recent imposition of anti dumping duty on Chinese radials. In any case, demonetization and GST have significantly dented imports of Chinese tyres. Hence, overall, we expect a strong near term replacement demand trend in the CV segment. Passenger car and two wheelers generally see replacement cycle of four years. With a life of about years, tyres of these vehicles are replaced 3 4 times over their lifetime. During FY18, vehicles sold in FY13 would see their first replacement while vehicles sold in FY09 should witness their second replacement. During these fiscals, vehicle sales saw muted trends, indicating a moderate increase in near term replacement demand. However, FY19 could see much stronger trends. With CVs accounting for bulk of the demand, we expect overall replacement demand to be stronger vis à vis recent past. Overall demand for tyres is expected to pick up and see a growth of 7 9%, with OEM demand likely to grow in the region of 8 10% and replacement demand likely to see 6 8% growth. Figure 3: Projected trend in tyre demand from passenger cars 18% OEM yoy Replacement yoy 16% 14% 12% 10% 8% 6% 4% 2% 0% FY17P FY18E FY19E FY20E Source: ATMA, SIAM, IIFL Research Figure 4: Projected trend in tyre demand from two wheelers 16% OEM yoy Replacement yoy 14% 12% 10% 8% 6% 4% 2% 0% FY17P FY18E FY19E FY20E Source: ATMA, SIAM, IIFL Research 2

3 Figure 5: Projected trend in tyre demand from commercial vehicles 9% 8% 7% 6% 5% 4% 3% 2% 1% OEM yoy Replacement yoy 0% FY17P FY18E FY19E FY20E Source: ATMA, SIAM, IIFL Research Assumptions for replacement market: Pass vehicles replacement cycle of four years, two 100% replacement and third 50% replacement Two wheelers replacement cycle of four years, two 100% replacement and third 50% replacement M&HCV replacement cycle of 1 year, nine 100% replacement OUTLOOK ON RUBBER PRICES Figure 6: Benchmark Tocom Rubber futures c2 & Crude oil Monthly JRUc2, CLc1 Price USD Bbl Auto Cndl, JRUc2, Trade Price, , , , , , 3MA, JRUc2, Trade Price(Last), 8, 20, 100, Exponential, , , , , Line, CLc1, Trade Price(Last), , 47.60, +0.22, (+0.46%) Source: Reuters, IIFL Research (TOK) Outlook: Natural Rubber (NR) prices fell sharply in the first half of 2017 on reports of increase in Rubber output in producing countries amid softening of Crude oil prices. With prices falling nearly 50 % from their peak in the last 7 months, it seems Rubber prices may have reached a near term bottom at Rs /kg levels. Price INR Kg Auto MACD, JRUc2, Trade Price(Last), 12, 26, 9, Exponential, , 7.7, Value 7.7 JPY RSI, JRUc2, Trade Price(Last), 14, Wilder Smoothing, , Value JPY Crude oil prices are hovering above US$47/bbl with limited downside due to OPEC efforts to reduce inventories and shore up prices. However, compliance issues among OPEC member countries amid rising US output would likely prevent sharp gains. We expect Crude oil prices to continue in the US$45 55/bbl range. Expecting strong tyre demand amid robust economic and industrial growth in China, USA and India, we expect Rubber prices to stay firm and even rally towards Rs /kg levels in the coming months. 3

4 Figure 7: India Production and Consumption of NR and SR Type FY17 FY16 % Change PRODUCTION Natural Rubber (NR) Ribbed Smoked Sheet (RSS) 473, , Solid Block Rubber 106,560 92, Latex Concentrates 83,200 71, Others 27,865 21, Total 691, , Synthetic Rubber (SR) Styrene Butadiene (SBR) 96,637 76, Poly Butadiene(BR) 116, , Others 9,550 11,039 (13.5) Total 222, , Total NR & SR 913, , CONSUMPTION Natural Rubber (NR) Ribbed Smoked Sheet (RSS) 486, , Solid Block Rubber 451, , Latex Concentrates (drc) 82,100 86,530 (5.1) Others 24,265 22, Total 1,044, , Out of which Auto Tyres 707, , Synthetic Rubber (SR) Styrene Butadiene (SBR) 278, , Poly Butadiene(BR) 184, , Others 135, , Total 598, , Out of which Auto Tyres 417, , Total NR & SR 1,642,655 1,547, Out of which Auto Tyres 1,125,063 1,040, Source: Rubber Board According to Association of Natural Rubber Producing Countries (ANRPC), a sharp fall in NR prices should place global supply of NR near m MT in 2017 vs. output of m MT in In 2016, supply deficit was in the range of 200,000 MT. Trade estimates of global NR consumption in 2017 are near m MT hinting at a supply deficit of 120,000 MT. With better growth prospects this year, supply deficit could be larger than that of ANRPC stated that for the first seven months of 2017, the global production of natural rubber (NR) amounted to million MT, whereas the world consumption recorded at million MT. This has resulted in supply deficit of 648,000 MT. Supply deficit in 2016 was near 200,000 MT whereas in 2017 it could be in the range of 120,000 to 300,000 MT on prospects of robust growth. Global Production and Consumption figures Figure 8: Country-wise production of NR ( 000 MT) % growth Thailand 4,469 4,473 (0.1) Indonesia 3,208 3, Vietnam 1,032 1, China (2.5) Malaysia (6.7) India Others 1,620 1, World Total 12,401 12, Source: Rubber Board 4

5 Figure 9: Country-wise consumption of NR ( 000 MT) Country % growth China 4,863 4, India 1, USA (0.5) Japan (2.0) Thailand Indonesia Malaysia Brazil Rep of Korea (1.7) Others 2,555 2, World Total 12,600 12, Source: Rubber Board Figure 10: India consumption of NR and SR MT FY17p FY16 Growth (%) Natural Rubber Auto Tyres & Tubes 707, , General Rubber Goods 336, , Total NR 1,044, , Synthetic Rubber Auto Tyres & Tubes 417, , General Rubber Goods 180, , Total SR 598, , NR & SR Auto Tyres & Tubes 1,125,063 1,040, General Rubber Goods 517, , Total NR & SR 1,642,655 1,547, Source: Rubber Board Margins for tyre companies to remain flattish Volume growth of 7 9% for the industry is expected to bring operating leverage benefits to tyre manufacturers. However, higher raw material costs would eat into these gains. Growing competitive pressures would limit passing of higher raw material costs onto consumers. Consequently, we expect operating margins for tyre manufacturers to remain steady over the next couple of years. Figure 11: Margins for tyre companies to track close to 5-year average % FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E Source: Bloomberg, IIFL Research Apollo Tyres 5 yr avg 5

6 Figure 12: Margins for tyre companies to track close to 5-year average CEAT 5 yr avg 18 % FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E Source: Bloomberg, IIFL Research Figure 13: Margins for tyre companies to track close to 5-year average MRF 5 yr avg 25 % Figure 14: Peer comparison Rs mn FY17 FY18E FY19E Apollo Tyres, CMP Rs253 Sales 130, , ,814 yoy growth (%) OPM (%) PAT 9,819 7,175 9,271 yoy growth (%) (10.2) (26.9) 29.2 EPS (Rs) P/E (x) MRF, CMP Rs64,395 Sales 134, , ,693 yoy growth (%) OPM (%) PAT 12,947 12,911 17,776 yoy growth (%) (0.2) 37.7 EPS (Rs) 3,053 3,045 4,192 P/E (x) FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E Ceat, CMP Rs1,709 Sales 58,910 65,133 74,041 yoy growth (%) OPM (%) PAT 3,699 3,411 5,027 yoy growth (%) (19.6) (4.3) 43.8 EPS (Rs) P/E (x) Source: Company, Bloomberg, IIFL Research Source: Bloomberg, IIFL Research 6

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