“MRF becomes the first stock in India to hit a share price of Rs. 1,00,000, becoming the costliest stock on Dalal Street” is a headline that has been making the rounds lately, filling the smart people who bought the stock in the early 2000s with immense joy as they can practically retire and live off the 52x gain that the stock has given in the past 2 decades, while millennials weep in silence.
But MRF was among the less-impressive tyre stocks in terms of returns generated lately, with companies like Apollo, CEAT and JK Tyres hitting it out of the park with stellar returns:
While these stocks have been “on a roll”, we believe that this rally has probably “tyred” out (we’ll stop with the tyre puns), and all this multi-bagger-esque goodness may have run out of juice for now!
But first, what caused all this and will those reasons continue to “pump” these stocks? (okay, this was the last one, maybe)
Why Did These Stocks Rally?
The tyre industry being a key ancillary support to the automotive sector has been in focus for a few years now. With the timeliness of a few triggers, the revenue and profitability of these companies have seen greener pastures, thereby taking investors those pastures too!
Bye Bye Imports
The GoI in FY21 introduced a blanket ban on the import of tyres (where 40% of tyre demand for India is met) for tyres in the passenger vehicles, buses, trucks and motorcycle segments, making this great news for the 4 tyre stocks in discussions.
Coupled with the previous anti-dumping duties levied on China (Rs. 20,000-Rs. 35,000 per tonne of tyres sold in India), the onus fell to MRF, Apollo, CEAT and JK Tyres to fill the void. When 4 out of more than 30 tyre companies contribute to 80% of the total market revenue, its bound to have side-effects - stocks going up by 100% for example!
While COVID did puncture the plans of the tyre sector, with a de-growth of 7% and 8% seen in the volumes on average in FY20 and FY21 in the domestic industry, that quickly turned around with a 10-15% YoY volume growth seen in FY22 and FY23 on the backs of pent up replacement demand for tyres (makes up more than 50% of revenues).
Couped with auto sales growing by 21% in FY23 (the highest since COVID), revenue growth has seen a tremendous growth from even prior to COVID!
It is likely to have also have been boosted by the BS-VI Stage 2 norms announcement for tyres in June 2022 (which basically signalled that automobiles manufactured prior to 2017 must have tyres that are BS6 compliant, thereby indicating massive replacement demand incoming).
Exports also grew 50% YoY in FY22 (highest in the past 5 years) on the back of India becoming a global contender in the tyre industry, with the US being its largest customer (20% of exports went to the US).
It also helped that the US levied anti-dumping duties on China in the same period, taking that superpower out of the competition.
Raw Material Surprise
Prices of natural rubber dropped from around Rs. 170 to around Rs. 140 per kg (fell by 17% in a year) and crude oil dropped from US$ 110 to US$ 75 per barrel (fell by 32% in a year). This has been led by (i) the impact of the Russia-Ukraine conflict on supply chain disruptions easing, (ii) inflation being tamed globally, and (iii) China not having rebounded as planned, and it being a major driver of rubber and crude oil prices.
This resulted in an expansion of EBITDA margins by about 100 bps YoY in FY23 for all of these companies and even the doubling of PAT for some!
Will This Continue?
While it would be great to witness further rally in any stock we’re invested in, it might not be the case for the tyre bunch, which can be seen if we revisit each of the points we’ve spoken about earlier:
So, What Now?
All those triggers that we saw causing these rallies may just have fizzled out, and that leading to the rally possibly getting dry soon too. Almost the entirety of these gains were dependent on profitability numbers and news headlines pumping the industry and these stocks onto a pedestal, with no actual valuation re-rating to show for it!
Just look at these 1-year forward EV/EBITDA numbers:
With these stock currently trading in and around its historical averages, and no near-term triggers to bank on, we may have just seen the capped upside on these stocks at the levels they trade at now, with no material upside left on the table.
Although the industry itself has great longer-term prospects, with Rs. 35,000 crore said to have gone into capacity addition across the industry, set to take the turnover from the current Rs. 75,000 crore to over Rs. 1 lakh crore in a decade, and export opportunity possibly doubling from now in the decade to come, it may all have already been priced in!
All in all, one must “tread” lightly around these stocks and if you’re among those MRF investors, be glad in the knowledge that you’re a part of history and your neighbour most definitely hates your guts.
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