Japan tyres: OEM tyre sales close to post-GFC highs

by SR on March 14, 2012

The Japan Automobile Tyre Manufacturers Association (JATMA) announced February tyre sales data for Japan on 12 March 2012. Total tyre sales rose 6.8% YoY to 9.45m units (+20.1% MoM). Key point: the high absolute level of production of tyres for new cars (OEM tyres) in Japan keeps overall capacity tight and is likely to keep upward pressure on pricing for replacement tyres, which is positive for the industry. (Related stocks: Bridgestone 5108; Sumitomo Rubber 5110; Yokohama Rubber 5101; Toyo Tire 5105; Michelin; Pirelli; Goodyear; Cooper Tire; Hankook; Nexen.)

  • OEM tyres close in on post-GFC high.Now close to the 4.83m units posted in March 2010, which suggests continued tight capacity and thus strong pricing.
  • Another good month for replacement tyres. A surge in sales relative to February, but I’m a little concerned about tough comparisons.
  • Tyre stocks look like a safer bet. Worried about machinery after the recent run-up? Me too. Look at auto parts or tyre stocks instead. We also explain why tyres are actually a bit like handbags.
  • Auto production solid. Japan auto production in February likely rose 14% MoM, slightly better than seasonally normal, confirms continued strength in auto parts demand.

Japan                                                                                                  tyre                                                                                                  shipments                                                                                                  %                                                                                                  YoY

OEM tyres not lucrative, but a swing factor all the same

OEM tyres recorded sales of 4.7m units for the month, rising 14.2% month-on-month and up 17.4% year-on-year. Comparisons from March onwards for OEM tyres will of course be very easy, so we can expect some big numbers going forward. Incidentally that +14.2% figure is good but not great – the long-term median change for February over January is about +12%. OEM tyre sales are now close to the post-global financial crisis high of 4.83m units recorded in March 2010. (Click for a larger image.)

Japan                                                                                                 OEM                                                                                                 tyre                                                                                                 sales                                                                                                 (million                                                                                                 units)

Now, OEM tyres are notoriously not very profitable. In fact, many suppliers have had increasing difficulty in even avoiding losses over the past few years due to rising raw material costs that customers (in Japan at least) have been reluctant to accept. That has changed due to the widespread adoption of escalator clauses and cost-plus contracts that allow tyre suppliers to pass on costs without going through a time-consuming process of negotiation with customers, although there it typically takes 3 months or so to recoup those higher costs.

The sense of supply tightness in the tyre market has in my view been one reason for the adoption of these clauses in Japan, a territory that has traditionally resisted such arrangements. Auto manufacturers want tyres for their cars and they want tyre companies to work with them on tyres for new models, sure, but they usually took the view that absorbing raw material prices is the responsibility of the tyre supplier. This might have been reasonable in an environment in which raw materials prices creep up by a percent or so every year, but it became increasingly unfair in a world where the price of rubber or steel cord might leap 30% in 12 months.

For tyre companies the key issue is that when capacity is tight they have a certain amount of freedom to de-emphasise OEM tyres in favour of more lucrative replacement tyres. Tight capacity caused by high demand for OEM tyres is also positive in the sense that it makes it unnecessary to cut prices. So in general companies like Bridgestone should benefit from this environment even if they are not awash in excess capacity that would allow them to grow revenues by 20% year-on-year.

Replacement tyres have a(nother) good February

Replacement tyre sales for February reached 4.75m units, falling 2% YoY. That’s not great, but it’s a good deal better than the 7.7% YoY contraction posted in January 2012. As you can see from the figure below (click for a larger image), cumulative shipments for the first two months of CY2012 are still behind the same period in 2011. Still, it’s early days yet.

Japan                                                                                                  replacement                                                                                                  tyre                                                                                                  sales,                                                                                                  cumulative                                                                                                  total                                                                                                  by                                                                                                  year                                                                                                  (million                                                                                                  units)

 

I’m a bit concerned as to whether replacement tyres can post year-on-year growth in Japan. Again, look at the running total chart above. See the way that replacement tyres suddenly accelerated from April 2011 onwards. This is a bit perplexing, as it took place after the Tohoku earthquake. There was some concern that tyre supply might be seriously restricted by the damage caused by the post-earthquake tsunami to Toyo Tire’s factory in Sendai and worries that Sumitomo Rubber’s Shirakawa factory might be affected by the Fukushima nuclear reactor problems. That might have triggered some hoarding I suppose. Another factor might be that consumers who postponed buying a new car and were unable to do so might have decided to buy new tyres to see them through another year with their existing vehicle, but that seems a bit of a stretch. Either way, the strength in replacement tyres in 2011 makes the hurdle for year-on-year growth higher in 2012. Here’s another way of looking at the same data. (Click for a larger image.)

Japan                                                                                                  replacement                                                                                                  tyre                                                                                                  sales                                                                                                  by                                                                                                  month                                                                                                  and                                                                                                  year                                                                                                  (million                                                                                                  units)

On to seasonality. The chart below (click for a larger image) shows that month-on-month growth in replacement sales in February was strong, but this seems to indicate a shift in the seasonal buying pattern rather than a discrete positive event. That is, for the past four years February replacement tyre sales have posted a very strong increase of around 20% compared to January, whereas up until 2008 February usually recorded a much smaller month-on-month increase of 5-10%.

Japan                                                                                                  replacement                                                                                                  tyre                                                                                                  sales                                                                                                  %                                                                                                  MoM                                                                                                  for                                                                                                  the                                                                                                  month                                                                                                  of                                                                                                  February                                                                                                  1995-2012

Tyre stocks still looking interesting

I’m worried about machinery stocks and other classical cyclicals. Demand from the US has been strong for 12-18 months already – how long can it continue? Europe is a dead duck. China is quiet. Japan is going to move with the rest of the world, as domestic demand is morbid and as we point out in this post, overseas demand for components used in machinery is looking wobbly. So where does the big order flow come from? Ultimately demand will recover but I’m still concerned about the timing, especially given the big moves we’ve seen recently.

Look at auto parts stocks by all means – Toyota group suppliers like Denso, for example – so that you can ride the surge in production over the next 12 months, but also look at tyre stocks. Natural rubber prices are substantially lower than in 2011 and that could turbo-charge profits. I summarise the likely positive impact on Bridgestone here.

Why tyres are like handbags

When you look at tyre stocks, you don’t have to focus only on Japan, although I would argue that you have some ignored value opportunities here. Korean tyre supplier Nexen has been the big story of the past couple of years and the share price performance relative to its global peers shows that clearly. As I understand it (and please note that I have not visited the company) Nexen has added or is adding enough capacity to be able to take advantage and to grow into this robust expansion of demand.

Personally – and I’m not allowed to say this officially because my Korean analyst colleagues would get upset – I think we should keep in mind that Nexen and Hankook are selling low-end tyres. Those two companies may argue that their product is as good as those of Michelin, Bridgestone or Goodyear, but what management thinks is irrelevant: your product is only as good as customers’ perception of your brand. To take an extreme case, there are plenty of handbags in the world, so how can Louis Vuitton get away with charging 5 or 10 times the price of some other brands? Is there really that much difference in objectively verifiable levels of quality? No, of course not, this is a brand issue. That doesn’t make Vuitton’s perceived quality any less important though.

Tyres are rather less sexy than designer handbags and I suspect that female consumers don’t brag about their tyres the way they might brag about their latest Birkin but make no mistake, brand is still very much involved. Consumers who buy a BMW 5-series with Continental tyres do not willingly replace them with Hankook or Giti tyres. They just don’t. And what this means is that if you think the economy is going to improve, you should in my view assume that there will be a shift away from the lower end towards higher end brands of tyre.

Such a shift would likely be rather modest, given that mobility between different levels of brand (as opposed to lateral mobility between brands at the same level) is limited. But more importantly, be aware that if and when tyre supply catches up fully with demand and if and when price wars return to the industry, it is the low-end suppliers that will be most affected, because they do not have the brand power to insulate themselves from price competition. Their main selling point is value, and value-conscious consumers are going to switch to whoever offers the lowest price at certain a purported level of quality. Those who live by the sword, die by the sword…

Finally, auto production

For auto parts suppliers, auto production (not sales) is the short-term driver of revenue, so you should keep an eye on vehicle output. Production for a specific month is reported several weeks after sales data, in both the US and Japan. As sales of OEM tyres track auto production very closely (as one would expect – you don’t ship cars without tyres) you can get a heads-up on production in Japan by checking the tyre shipments. OEM tyre sales rose 14.2% MoM. If we assume that auto production also rose by 14.2%, would that be good or bad? That would be a little bit better than the median from 2004 to 2011 of +12,1%, but there’s not much in it. (From 2004 to 2011, the month-on-month change in auto production in Japan for the month of February was +10.5%; +12.1%; +14.6%; +12.1%; +12.4%; -16.5% (that’s 2009); +11.7%; +12.7%.) Call it a mild positive for auto parts stocks, but confirmation of the trend rather than “new news”.

Previous post:

Next post: