JK Tyre a long-term play on firm auto sector demand

With vehicle sales in top gear, the auto ancillary companies would continue to see strong demand both from new sales and replacement market. JK Tyre and Industries, one of the leading tyre makers, is set to benefit from the rising demand.

Business:
JK Tyre is engaged in manufacturing and distribution of tyres, tubes and flaps for the automobile and transportation industry in India and abroad. The company offers bias tyres for trucks, buses, light commercial vehicles, passenger vehicles and tractors.  It also provides radials for trucks and cars apart from some other specialty products such as ‘off the road’ tyres.

JK Tyre is the largest manufacturer of truck and bus tyres in India. The company has 5 plants in India located across Rajasthan, Madhya Pradesh and Karnataka and 3 manufacturing locations in Mexico. JK Tyre acquired the Mexican tyremaker Tornel in 2008 and derives around 20% revenues from there with remaining 80% coming from the domestic operations.

The Tornel acquisition has given the company greater access to emerging markets in Central and South America which will help increase its revenues from international operations.

The company currently produces around 163 lakh tyres per annum with 97 lakh of these manufactured in India and remaining in Mexico. The domestic operations are running at full capacities facing difficulties in meeting the original equipment manufacturer (OEM) and replacement demand. Hence, the company is in process of major expansion at the cost of Rs 960 crore to be completed in the next 2 years. The company is setting up a plant at Chennai which would be capable of producing 25 lakh passenger car radials and 4 lakh truck and bus radials per annum, taking its domestic annual production capacity to 126 lakh tyres. Also, it is increasing the capacity for truck radials at its existing Mysore plant.

Investment rationale:
The domestic auto industry has seen exceptional growth in recent times led by introduction of various new models, entry of foreign manufacturers and revival in the economy. India, which has become global hub for auto manufacturing, provides the auto ancillary companies a further boost.

The domestic tyre industry has many players but is highly concentrated with top 10 accounting for 95% market share. JK being among top three producers stands to benefit more from this rising demand.

The use of truck and bus radials in India is quite low and the management expects the number of commercial vehicles using the same will more than double in the next 4-5 years.

Also, the company wants to triple the share of direct OEM supplies to its strong clients like Tata Motors and Ashok Leyland, once additional capacities come on line. The replacement market for truck tyres constitutes around 70% of total truck tyre sales while the replacement demand for passenger car vehicle tyres and radials is around 40%. 

The expansion plans would lead to total passenger car radial capacities to increase to 70 lakh and truck radial capacities to 12 lakh per year. This would equip the company to meet the demand and, in turn, get better realisations and margins.
Concerns:
Tyre Industry is highly raw-material intensive. Raw material costs account for around 72% of the production cost with natural rubber itself constituting 43% of the expenses. Natural rubber prices have nearly doubled in the last one year to Rs 169/kg whereas the hike in product prices has been around 12%. This would impact the margins of the company this fiscal.

However, with natural rubber output expected to increase by 7-8% this fiscal, prices seem to be stabilising and may cool off a bit in coming months.
Also, domestic tyre manufacturers which are unable to meet the total OEM demand for truck radials are likely to face margin pressure due to cheaper Chinese imports which have been recently allowed.

Valuations:
Led by the strong volume growth in OEM segment and large replacement market, the revenues are expected to grow at compound annual growth rate of 11% over fiscals 2010 to 2012. The effect of additional capacities on stream would be reflected fiscal 2012 onwards. However, profit margins are expected to decline after the strong numbers in fiscal 2010.

The increased raw material prices would mean the net profits would take a hit in fiscal 2011 before resuming normal growth path from thereon. At current market price of Rs 166.50, JK Tyre trades at 3.95x its fiscal 2011 expected earnings per share of Rs 42.13 and 3.56 times its fiscal 2012 (estimated) earnings of Rs 46.76. Considering the company’s strong brand presence, high volumes growth and ongoing expansion plans, investors can keep a watch on the stock from medium to long term perspective.

Disclaimer: The writer does not hold any share in the company