MUMBAI: The drop in crude oil prices could prove to be a margin tailwind for margins of tyre makers, said Nomura Financial Advisory and Securities (India), in a report.
At current levels, it would imply a benefit of 250 basis points in gross margins if current prices are sustained and no price cuts happen in the replacement segment by tyre companies, the research firm said.
Owing to existing raw material inventories, the research firm expects the margin benefit to start becoming visible for tyre companies from the January-March quarter onwards.
“We have factored in a 100 bps (basis points) improvement in gross margins for most companies in 4Q, and believe there is some scope of upside risk,” said Nomura.
There is a high correlation between crude oil prices and gross margins of tyre makers, given that crude derivatives, such as nylon tyre cord fabric and chemicals, make up around 30% of the total raw material basket of tyre companies in value terms.
According to Nomura, a decline of around 10% in prices of crude derivatives could lead to improvement of 110 basis points in gross margins, assuming it is not passed on in the replacement segment and price cuts in the original equipment manufacturers segment.
Benign natural rubber prices are also likely to aid margins of tyre companies, said Nomura.
Nomura prefers Apollo Tyres in the tyre sector with a buy rating and target price of ? 288, estimating a 26% compounded growth in earnings per share over the FY18-FY21 period.
Earlier this month, Nomura had said in a note that the Indian tyre industry is witnessing a phase of cyclical uptick in demand which should drive 8% compounded growth in volume over FY18-FY21 period.
The industry is likely to witness strong double-digit revenue growth over the next few years led by healthy original equipment demand and resilient replacement demand, Nomura had said. Pricing discipline, high utilisation and benign commodity prices augur well for EBITDA growth as well, it added.
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