How Far Will Tyre Companies Increase Prices in 2010?

There are price increases and there are price increases. Anyone who has observed the tyre market for long enough will be aware that what it says in the book and what customers pay are often two different things. Firstly when someone like a bank says “price increases” they are referring to the proportion the price the vendor receives for their tyres increases relative to its prior level. And secondly due to the volatility of raw material commodity markets and other associated input costs any predictions are libel to change and even cancel each other out. Sound like teaching grandma to suck eggs? Perhaps, but the latest round of price increases issued by swathes of tyre producers highlight these principles in spades. Higher prices do not necessarily mean higher costs to buyers on the one hand and, if they do, this does not automatically mean more profitability for those issuing the prices increases.

Here’s how Morgan Stanley analysts summarised the situation with reference to the leading global tyre makers in March: “We believe the increase in list price will not automatically translate into higher transaction prices…wholesalers and dealers buy [at] a discount to list price at all times.” Therefore recent increases in list prices do not imply a “tailwind” to pre-tax profits and in fact, the analysts characterised the European pricing environment “especially challenging, given fierce competition from Asian companies (e.g. Hankook)” and depressed truck tyre volumes.

‘Extraordinary opportunity’ for non-premium tyre companies

Furthermore, Morgan Stanley reported stated that the bank believes 2010 will afford an “extraordinary opportunity” to non-premium tyre companies to increase their market share in Europe. Commenting specifically on Pirelli (the subject of the investors report quoted here), the analysts singled out the Italian tyremaker as being in a “slightly more advantageous position given the higher relative weight of less price-competitive regions (Latin America, MEA) and the high skew towards the premium niche.” But the point remains that the same so-called non-premium tyremakers that gained a significant market share foothold in 2009, according to some market observers, now have an “extraordinary” chance to extend this.

Ask a premium tyre manufacturer about this and they will – correctly – point out that while companies like the South Korean majors or others may have sold significant amounts in unit terms, the values they are able to achieve per unit are less impressive. Again we come back to pricing and this, arguably, is where the rubber hits the road. Few people dispute that the “price/perceived quality = value” equation worked well for these companies during 2009. But the premium tyre manufacturer representatives (in both the car and truck segments) Tyres & Accessories spoke to point out that this was at a pre-increase price point and that certain manufacturers delayed or limited price increase implementation last year in order to make their products comparatively attractive. As a result these companies will have to implement relatively steep increases in order to cover raw material price increases.

The management of Hankook Tire for example are reportedly targeting an 11 per cent increase during the course of 2010. Financial analysts reported that the company is “confident in their ability to increase their products’ global average selling price by between seven and eight per cent in 2010” but Deutsche Bank additional price hikes are possible in order to hit the 11 per cent total during the year. According to the analysts, Hankook’s confidence of being able to successfully implement the prices increases is based on the fact that “demand in key markets remains supportive.”

To continue the example, Hankook reportedly raised the average selling price in its profitable domestic market by 3 per cent in January. There are said to be plans to raise domestic prices another 5 per cent in the first quarter of this year, followed by another 5 – 6 per cent in second half. The company is said to be confident about raising prices in the Korean, US and Chinese markets (in that order) in the second half of 2010.

However, it is interesting to note that the analysts left Europe off of this list. In Europe Hankook reportedly plans to improve its distribution network by focusing on the expansion of retail outlets. Hankook is believed to be targeting a 14 per cent year-on-year increase in global tyre sales in 2010 (80 million units).
Looking forward, Deutsche Bank points out that new capacity in Hungary and China should be a key earnings driver from 2011. In the Chinese market, Hankook reportedly plans to reduce exports to take advantage of strong pricing.

Natural rubber breaks US$3.5/kg barrier

The key justification for the tyre manufacturers’ price increases has been the cost of raw materials, specifically natural rubber, supplies of which have been hampered by droughts in Thailand and Southern China. On 1 April prices broke through the US$3.5/kg level for the first time in 60 years, which according to the Rubber Research Institute of Thailand, represents an increase of around 75 per cent during the past year. Other sources said they have more than doubled during the course of this year.

The news that already high prices were still on the up is likely to cause two further prices increases from tyremakers this year, which are expected to take “four to six” to have an effect on the tyre companies’ profit and loss accounts. To put this into context, analysts at Deutsche Bank used three premium manufacturers’ natural rubber purchasing bills as examples. According to them, last year Continental spent approximately 500 million euros (7 per cent of tyre sales); Pirelli 340 million euros (8 per cent tyre sales) and Michelin 950 million euros (6 per cent of sales) on natural rubber.

Therefore, say the analysts, a two-times natural rubber price surge means the tyre industry will have to increase selling price by 7-8 per cent to fully offset this “headwind,” taking a constant dollar rate into account. Deutsche Banks view is that, as only 35 to 50 per cent price increases stick, the industry will have to pass on at least another 5 per cent price increase later to fully offset the latest increase.

However, price increases (and we are talking about the part that is actually implemented in transactions here) don’t always simply cover the costs and no more.  Reporting on Michelin’s full-year 2009 results, Morgan Stanely analysts said that the raw material price cuts gave Michelin 318 million euros tailwind in the second half of the year. Now at this stage rubber prices, for example, remained high despite being than they had been. The point is that the benefit did not just come from the lower raw material cost, but also the lag effect of the earlier price increase implemented by the manufacturer.

And here is where the unpredictability effect comes in. Prognostication is a notoriously difficult business, something that is exemplified by the fact that in this case some key sources decided against giving forward-looking outlook advice for the rest of the year, citing fluctuating raw material costs (specifically natural rubber) as their reasoning.