Softening natural rubber prices, expected pick-up in replacement demand and improving sale of truck and bus radials promise good prospects for JK Tyre and Industries (JKT), a company with about 20 per cent market share in the Indian tyre industry.

Investors with a two-to-three year perspective can buy the stock. At Rs 89, it trades at a price to earnings ratio of about 5 times its estimated FY13 earnings. This is at a discount to bigger players such as Apollo Tyres and MRF.

Raw material prices ease

Raw material costs account for 70 per cent of the turnover for tyre companies. Of this, 45-50 per cent is natural rubber cost. Beginning December 2009, domestic rubber prices marched upwards.

By April 2011 prices of RSS 4 variety used by the tyre industry had peaked at around Rs 240 a kg.

While international prices at certain times during this period were relatively attractive, companies were not able to take advantage due to high import duties as well as rupee depreciation.

Price of crude oil from which raw materials such as synthetic rubber and nylon tyre cord fabric are derived too had moved up last year.

The tough times are now seen changing for the better. Rubber prices have fallen off its peak in the last few months and is hovering around Rs 190-200 a kg currently.

With the lag effect of previously high input prices beginning to fade away, operating margins, which had taken a hit so far, will expand.

Already, operating margins for JKT in the third quarter (October-December 2011) have improved to 5 per cent from 2 per cent in the second quarter.

Replacement demand

Considering that tyres are replaced every two years, robust auto sales in 2009-10 and 2010-11 will lead to replacement demand for those vehicles now. Higher margin-yielding replacement market sales bring in more than half the revenues for any tyre manufacturer.

Hence, the expected pick-up in replacement demand is a positive for JKT. Softening of interest rates is likely to spur new vehicle sales as well.

So, top-line growth will also be supported by higher volume growth in the current year .

The company has recently added Bharat Benz (Daimler India CVs) to its clientele. Daimler will launch its trucks in mid-2012.

JKT will benefit from the rapidly improving radialisation levels for CVs in addition. From about 14 per cent two years ago, radialisation in CVs stands at 20-25 per cent currently.

With fast improving highway infrastructure, ban on overloading of vehicles and the move towards a hub and spoke model that will encourage use of radial tyres, this is expected to go up further.

These tyres offer better fuel efficiency, have longer life and turn out to be cheaper in the long run. Its Chennai plant for radial tyres has gone on-stream in February 2012 and is expected to reach maximum capacity in six months time.

The additional volumes from this plant will help absorb costs better and will lower the impact of the high interest cost (on borrowings for setting up the same) on its profitability.

Financials

For the quarter ended December 2011, net sales grew by 21 per cent year-on-year to Rs 1418 crore. JKT recorded a loss of Rs 21 crore in the third quarter.

In addition to high input and interest costs, its profitability took a hit due to marked to market loss on foreign currency transactions. Adjusting for this, profits grew by 44 per cent to Rs 17 crore. Its debt/equity is about two times.

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