Japan tyres: demand remains firm

by SR on June 12, 2012

Japan tire stocks: what’s not to like?

  • Conclusion: firm demand, higher prices, lower input costs – buy tyre stocks. Especially Bridgestone, which has seriously underperformed its peers in Japan year-to-date and remains the worlds’s largest tyre suppliers along with Michelin, which has far too much exposure to Europe for my liking.

Let’s take a look at demand first. JATMA just released sales figures for May 2012. The red line below shows cumulative sales of tyres in Japan for the period January to May 2012. As you can see, demand is well ahead not only of 2011 (the blue line) but also 2010, which is the purple line. Sales are still lagging the very strong 2008, but overall demand is growing satisfactorily. That’s Japan. Europe is a different issue, but as that region is not a major source of either sales or profits for the Japanese tyre suppliers, this is not a major problem. I would argue that you should be looking at a stock like Bridgestone in preference to that of a company like Michelin or Pirelli that has heavy exposure to European demand. In the US demand for OEM (new car) tyres is predictably strong while replacement demand seems to be slightly down so far in 2012. So, if 30% of tyre volumes (i.e. OEM tyres) are growing by 20% YoY and 70% of tyre volumes are falling 5% YoY (i.e. replacement tyres) the overall impact for is likely to be a slight plus (2-3% YoY) for a company such as Bridgestone, which has a powerful presence in the US. The point to note is that prices are still rising – see the next section.
Japan monthly tire sales (cumulative year-to-date) in millions of units

Prices are still rising

In Japan, raising prices is a difficult undertaking and it does not happen often. Nevertheless, Japan is only 30% of Bridgestone’s business these days and in Europe and North America prices are still edging up. For the US market we have the monthly CPI for tires to which we can refer. The chart below speaks for itself.
US tire consumer price index

Input costs are falling

Even as tyre price are rising, price for synthetic rubber and natural rubber – which make up more than half the raw material costs of a tyre – have fallen sharply recently as shown in the two charts below. The decline in natural rubber, which is far more volatile and thus has a more significant impact on tyre company profits, has been particularly significant. “But look”, you might say, “there’s a reason for lower raw material prices and that’s because market participants expect lower demand for those commodities.” On the face of it, this is a reasonable argument. The reality is that demand for tyres is firm and supply of branded products has become very tight due to several years of very cautious investment in production capacity during and after the 2008-2009 global financial crisis.

Natural rubber price (RSS3) in USD/lg

Brent crude oil daily price chart in US dollars per barrel

China auto market is still weak

You may be forgiven for wondering how this is relevant. In a previous post I argued that natural rubber prices are driven not by a genuine shortage of natural rubber but by speculative money flows that use natural rubber as a call option on the China auto market, which rightly or wrongly they perceive as the major source of demand for rubber at the margin. That is, when the China auto market does well, natural rubber prices go up. As I said in the post just mentioned: “What this means is that Bridgestone is partly a put on the China auto market. That’s because lower rubber costs are a significant positive for Bridgestone whereas a weak China auto market is only a modest negative due to Bridgestone’s relatively low exposure to that country (maybe 3-4% of revenues, mostly OEM).” Here’s an updated chart comparing natural rubber prices and the Chinese auto market. To me that suggests that natural rubber prices should come down further. Of course, if you believe in the much-vaunted “second half recovery” for the China auto market, you should perhaps believe the opposite.

China auto sales vs natural rubber prices

Tyre stocks performance

So I think there’s a fairly straightforward story here and yet the two major Japanese tyre suppliers have underperformed Topix year-to-date, substantially so in the case of Bridgestone. Sure, you can draw subtle distinctions between these different suppliers, but ultimately the same dynamics – sales growth, product pricing, input costs – drive all of them and Bridgestone is arguably best positioned in each area. Yet Bridgestone’s share price is down 7% year-to-date while that of Yokohama Rubber and Toyo Tire are both up 18%. Now that’s just silly.

Japan tyre stocks performance vs Topix year-to-date in 2012

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