Revenue growth to decelerate; margins peaking in tyre industry: IIFL Capital Services

28 Jul 2023 , 11:06 AM

FY22/FY23 were good for India-focussed tyre-makers from a revenue perspective, with revenue growth averaging more than 20%. Sector margins were weak in FY22/FY23, but improved substantially towards the end of FY23, implying positive margin outlook for FY24. As analysts of IIFL Capital Services look ahead, they highlight four themes. 1: Revenue growth will come off substantially in FY24/FY25 due to lower volume growth and lack of price hikes, following fall in input costs. 2: Margins/profitability in FY24 would be above average (already in estimates), with risk of peaking out. 3: MRF’s relative underperformance vs domestic peers may have bottomed. 4: FCF generation is likely to be strong, with lower capex. Analysts of IIFL Capital Services recently downgraded their view on the domestic Tyre industry to Neutral, after staying positive from mid-2022. They now prefer Balkrishna (exporter; volumes/margins at cyclical lows) over domestic-focused players. 

Strong revenue growth in FY22/FY23; expect sharp moderation in FY24/FY25: 

The Indian Tyre industry grew at 22% Cagr over FY21- 23, supported by strong volume growth (12% Cagr) and price hikes. Volume growth in FY22/23 was aided by high growth in the OE segment (cyclical recovery), while Replacement was steady. As analysts at IIFL Capital Services look ahead, they expect volume growth to moderate to high-single digit. Even as Replacement may grow, OE segment growth is likely to moderate substantially. Analysts of IIFL Capital Services do not expect tyre-makers to increase prices, especially since input costs have moderated substantially and FY23-exit margins are at above-average levels. As a result, they expect revenue growth to moderate sharply from 22% Cagr to 10% or lower. 

FY24 margin would continue at FY23-exit rate (above average), but would peak out: 

Tyre industry Ebitda margins were under pressure in FY22 and most of FY23, due to rise in input costs (rubber, crude). However, input costs moderated in mid-FY23, the benefit of which was fully visible in 4QFY23. 4QFY23 margins for key players were above historical average. As input costs have plateaued at those levels, 1HFY24 margins are likely to remain elevated. However, if input costs were to spike (Crude has started moving up) or if tyre-makers cut prices for volumes/market-share, margins may come off in H2FY24.

MRF’s under-performance vs peers may be bottoming out: 

MRF underperformed peers on revenue growth over FY17-FY22, after outperforming peers in the preceding 10 years. MRF’s market-share loss seems to have paused in FY23. This came at the cost of pricing and margins. MRF had a substantial margin lead over peers historically, but that has come off in recent years. MRF delayed price hikes vs competition to stem market-share loss.

FCF generation to improve in FY24/FY25 with lower capex: 

Industry capex has averaged 9% of revenue historically. This was elevated due to industry being in a capacity expansion phase, and due to weak revenue growth over FY11-21 (no price hikes). Between FY21 and FY23, industry revenues were up 1.5x. Large capacity expansion phase is behind us. Analysts of IIFL Capital Services expect capex to average 6% of revenue in FY24/FY25. Hence, FCF generation is likely to be quite strong. 

Analysts of IIFL Capital Services recently turned Neutral on domestic tyre-makers; they now prefer Balkrishna (exporter): 

Domestic tyre-makers’ earnings growth is likely to be very strong in FY24. This is in Street estimates and hence, priced in. Once margins peak out, earnings growth become lacklustre (FY25 onwards), mirroring sub-10% revenue growth. Analysts of IIFL Capital Services now prefer Balkrishna industries (exporter), as its volumes are currently in a down-cycle (upcycles last for 2-3 years) and margins are at 10yr lows (yet to reflect input costs benefit).