International prices of natural rubber have risen 25% in the past three months, but tyre makers won’t be overly concerned. That is because benign crude oil prices are expected to largely offset the impact of higher rubber prices.
For tyre manufacturers, natural rubber and crude derivatives each account for around 45% of the total raw material costs. Indian tyre companies import a large part of their natural rubber requirement from South East Asia. Analysts say, prices of international natural rubber rose in August due to high demand from China amid supply constraints. In-line with the global price trend, the price of natural rubber in India increased as well.
On the other hand, global crude oil prices remain on a soft footing at around USD42/barrel. From around USD60/barrel in fiscal year 2020, crude oil price has declined significantly. Carbon black, synthetic rubber, nylon tyre cord fabrics are crude derivatives used by tyre markers. Their prices follow the crude oil price with a lag of one-two quarters. Dim outlook on movement in crude oil prices bodes well for margins of tyre companies.
“The earnings sensitivity to a decline in prices of crude derivatives is higher than the change in natural rubber prices. We believe any increase in natural rubber prices would be more than offset by a decline in crude oil prices favourably impacting gross margins by 150- 200bps for tyre companies. Margins of all tyre companies were at multi-year highs in FY16-17 when crude was sub-USD 50/barrel and natural rubber was sub-Rs135/kg,” analysts at JM Financial said in a report on 14 September. One basis point is one hundredth of a percentage point. Natural rubber prices were at Rs133/kg in early September.
Easing input cost is a positive, but a weak rupee plays the spoilsport here. Managements of Apollo Tyres Ltd and Ceat Ltd told analysts that the rupee’s depreciation could limit gains from soft crude prices.
“In the last 15 months, prices of tyres have remained steady. So, any slight increase in costs can easily be passed on to end-consumers, shielding margins in the near term,” said a report published by BOB Capital Markets Ltd in August.
Of course, overall earnings also depend on how demand improves. For now, demand from the replacement market is helping offset part of the weakness in the OEM (original equipment manufacturers) segment; however, overall demand is weak owing to the pandemic.
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