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Impact of volatility in natural rubber and crude oil prices on tire manufacturing industry

The primary demand for tires arises from the automobile industry which accounts for 65-70% of the global tire demand. The remaining emanates from mining and construction equipment manufacturing, aviation and industrial sectors.

The demand for tires can be categorised into demand from Original Equipment Manufacturer (OEM) and replacement market. The demand from OEM is a function of new automobiles and other mobile equipment sold, whereas the demand from replacement market is a function of usage of the automobile and other mobile equipment. The spread between OEM and replacement market has historically remained around 30:70, varying as per the demand from OEM. Although the demand from OEM fluctuates in tandem with the performance of the automobile industry (a cyclical industry dependent on general economic conditions), the demand from the replacement market remains reasonably stable.

The natural and synthetic rubber are the major raw materials for tires and together account for around 60-70% of the total raw material cost. The natural rubber is obtained from plants while synthetic rubber is developed by polymerization of petroleum derivatives (synthetic rubber prices are positively correlated to crude oil prices). The rubber mix is decided, depending upon the desired properties of tires. The natural rubber has a higher elasticity, better tensile strength and good wear resistance, however, it is highly vulnerable to extreme temperatures, oil, chemicals, etc. The natural rubber also has low durability as it softens with age. On the other hand, synthetic rubber can perform better under elevated temperature ranges, withstand oil, chemicals and has higher longevity.  But it lags in terms of elasticity, tensile strength and wear resistance in comparison to natural rubber. The raw material mix for the tire is also susceptible to natural rubber and synthetic rubber prices.

In 2008, due to the global financial meltdown, international vehicle sales registered a negative YOY growth of 12.1%. But during the period from 2008-10, there was an economic recovery, this was particularly supported by developing economies such as India and China, which registered vehicle sales at a CAGR of 40% and 39%  respectively. However, as central governments across the world withdrew stimulus packages in 2010, the global economic activity once again slowed down and thereby, resulted in a moderate CAGR of 2.7% in global vehicle sales between 2010-15. It was estimated that the global vehicle sales would register a YOY growth of ~5% in 2016 supported by demand recovery in China, India and Europe by 13.7%,7% and 4.7% respectively.

Natural rubber prices increased during 2009-11 on the back of increased demand from the tire industry and higher synthetic rubber prices (natural rubber prices are positively correlated to synthetic

rubber prices) due to a significant increase in crude oil prices. The natural rubber prices, however, started declining from 2011 onward and fell at a CAGR of 25% for 4 years, ending in 2015. The sharp decline in natural prices was due to over-supply from Malaysia, Indonesia and Thailand as new plantations (planted in booming years of the mid-2000s) attaining maturity amidst demand slowdown and low crude oil prices.  The crude oil prices increased at a CAGR of 30% during 2009-11, remained fairly stable between 2011-13 and have declined at a CAGR of 30% between 2013-15. This was because of the over-supply situation in the global market. The crude oil prices started recovering towards the end of 2016 as a result of production cuts by the OPEC countries. Moreover, improved synthetic rubber prices lent support to natural rubber prices which increased by ~5% at the end of 2016.

Impact on the revenue and profitability of major tire manufacturers

The major tire manufacturing companies (Televisory has analysed Goodyear Tire and Rubber Co., Bridgestone Corp., Sumitomo Rubber Industries Ltd. and Nokian Renkaat Oyj) witnessed an increasing trend in revenues between 2009-11, this was supported by healthy demand from the automobile sector. The demand from the automobile sector was backed by strong growth in new vehicle sales during the period (as explained above). The increase in revenue was also supported by the increase in tire prices by manufacturers to compensate for the rise in raw material prices (natural rubber and synthetic rubber). However, the gross profitability of the tire manufacturers remained range bound in the period.

Nevertheless, the revenues of all the major tire manufacturers declined consistently during 2011-15, as slower automobile sales hampered the demand from OEM market and realisations declined due to lower rubber prices. Furthermore, as the raw material prices moderated during the period, the tire manufacturing companies reduced prices to partially pass on the benefits to consumers. However, the companies still benefited from the declining raw material prices as reflected in the steady increase in gross profit margins between 2011-15. 

On the financial strength front, the companies gained on account of falling raw material prices. The EBITDA levels improved as the rubber prices declined, thereby, leading to low gearing and improved interest coverage.

In conclusion, 2017 is expected to be a mixed bag for tire manufacturing industry, with revenues expected to grow at a moderate pace, supported by mild global economic recovery. This may lead to improved tire demand and a slight improvement in rubber prices on the back of a recent recovery in crude oil prices. The world GDP growth rate is likely to improve marginally from 2.7% (2016) to 2.8% (2017). However, if the rally in crude oil and natural rubber prices continues in 2017 in line with the price hike in Q1 2017, the profitability of tire manufacturers may possibly decline in the upcoming years. 

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