Recent conversations with dealers leave us with a view that retail sell-out continues to trend positively as retail conditions remain healthy and volumes improved over the prior year’s period (8th straight month). From a volume standpoint, surveyed dealers relayed they saw unit sales volumes improve modestly (~1.1%) compared to the same period last year.
We would be remiss to ever underestimate the impact that weather conditions can have on the tire retailing industry. Accordingly, we saw the direct result of this last month as the majority of the United States encountered harsher winter weather conditions than we have seen in recent Februarys. Precipitation levels were elevated for most of the country with 19 states recording a month that was in their top 10% wettest Februarys on record with Tennessee experiencing its wettest February ever. The Western region may have had an outsized impact on results as year-over-year comparisons show a triple-digit increase in precipitation levels with California alone showing a nearly 1,500% increase compared to the same month last year, which is notable because of its size and overall impact on the economy (over 14% of total GDP).
It seems that the weather environment helped aid our contact base of dealers in delivering their 8th consecutive month of positive volume growth and offset the headwinds that were presented by the continuance of a disrupted tax return season among American consumers. As of the end of February, the total individual income tax returns received by the IRS was down by 3.2% compared to the same time period in 2018.
Furthermore, the total number of refunds issued was down 4.2% year-over-year while the average refund was down 3.5% comparatively. Although these percentage comparisons may not seem significant at first glance, we note that there has been 1.92 million fewer refunds filed and $5.18 billion less in refunds issued (roughly $2,700 per return filed) at the end of February 2019 versus the end of February 2018. Despite a noteworthy improvement in tax return activity since the middle of February when we pointed out that individual returns and refunds were down 4.8% and 26.5%, respectively, we still believe that these reduced levels of cash flow that consumers are normally accustomed to receiving in the first few months of the year could be inhibiting bigger ticket purchases like a new set of tires.
Looking closer at the recent trajectory of raw material costs, the basket of raw materials to make a common replacement vehicle tire was up 2.2% on a year-over-year basis in February while increasing 2.0% from January. From a quarterly perspective, it appears that we may have witnessed a temporary top in price pressures near the end of 2018 (1Q18 to 2Q18: +3.4%, 2Q18 to 3Q18: +0.6%, 3Q18 to 4Q18: -2.7%, 4Q18 to 1Q19: +0.2%) although it is worth monitoring price movements closely through 1H19 to gauge the trajectory of raw material prices as that could foreshadow if manufacturers have to implement price increases to offset higher costs much like we saw in 2H18.
Index readings for Q4 indicate rawmat prices are projected to increase 5.3% year-over-year versus 4Q17 following a 10% increase year-over-year in 3Q18 and early estimates for 1Q19 are indicating prices will show a 1.3% year-over-year increase. In assessing raw material price movements, we note materials such as carbon black and synthetic rubber have been seeing meaningful multi-period increases on a y/y basis (since early 2018) while natural rubber and crude oil have been experiencing a resurgence from their depressed price levels in 2018.
We reinforce our view that the market continues to strengthen and that the outlook remains healthy for dealers and wholesalers. In fact, we note the majority of individuals in the dealer community we have spoken with this month have an upbeat outlook for volume trends going forward, driven by the following factors: (1) continued expansion of the car parc, including an uptick in the number of cars entering the first replacement cycle; (2) the ongoing belief that there is a modest amount of pent-up demand on the sidelines from deferred maintenance, especially given the lackluster results throughout 2017 and most of 2018; (3) continued upward trajectory of miles driven and (4) a solid economic backdrop that has created a healthy, confident consumer.
Until next time, keep the tires rolling out the door.
A number of independent tire dealers were surveyed concerning current business trends. The results of the February 2019 survey are compared with those of February 2018.
Replacement Tire Sales – Climate Conditions Aid Consumer Demand for Tires
Dealer commentary suggests consumer demand for PLT replacement rose in February compared to the same period last year. The net number of respondents indicating they saw an increase in demand year-over-year was 34.8% of contacts. We note that our tire demand index increased 35% year-over-year and reached the second highest level seen since December 2016 indicating that demand trends remain not only healthy but are accelerating.
We have long predicted that transient factors were affecting the level of demand in the industry over the past couple years and that volumes would become more closely aligned with this level of GDP growth. We believe we are more closely following this trajectory as our dealer contacts have seen eight straight months of positive volume growth.
A Look at Mix Trends in the Market
In response to best and worst performers, our recent survey revealed that Tier 3 brands showed the strongest relative performance among surveyed contacts for the third consecutive month. Commentary from our dealer contacts indicates that delayed/smaller tax refunds this year and higher tire prices year-over-year have induced a change in consumer buying behavior as they seem to be trading down to cheaper products. The combination of price and performance that Tier 2 tires provide has been a significant tailwind to sell-out trends for these products over the past couple years; given this, we were surprised to see Tier 2 fall to the bottom of our rankings last month. We note this is the first time since November 2017 that Tier 2 fell to the bottom of our rankings and only the second time since September 2016.
However, Tier 2 continues to be the segment of the most significant growth among our contact base over one, two, and three-year time frames (as well as nine of the last 15 months). We believe the recent strength in Tier 3 is more transitory in nature as we expect consumers to opt for higher quality and performance over the long-term especially in an environment of low unemployment, rising wages, and healthy GDP growth. We point out that on a longer-term basis, Tier 3 brands have been ranked or tied for last place by our respondents in 24 of the past 54 months. We are slightly perplexed as to the lackluster performance of Tier 1 tires among our contact base but believe that the mega-trend of the market shifting to HVA shipments continues to remain a long-term opportunity.
When examining the landscape from a longer-term view, we continue to hold a view that the pricing environment in North America will remain rational and in-line with raw material costs. We continue to expect Tier 1 and Tier 2 producers to remain disciplined in their efforts to manage the price/volume trade-off to maximize operating profit rather than market share, as well as capture the mix benefit from the shift to HVA tires.
We are pleased with the disciplined approach to production schedules that we have seen at the manufacturing level and global inventory levels are relatively lean. Moreover, dealers and wholesalers are being tactical with their approach to inventory allocation given the promotional environment, timing of various pricing actions, and volatile raw material prices; essentially, downstream players have been directing orders in a way to capitalize on pricing spreads in the market.
P.S. – If you would like to be included in our monthly discussions with dealers, please do not hesitate to reach out to me directly at firstname.lastname@example.org.
John Healy is a Managing Director and Research Analyst with Northcoast Research Holdings, LLC based in Cleveland, Ohio; Healy covers a variety of subsectors of the automotive industry.
Average Tire Tier Rankings
Tier ... Dec’17 ... Jan ’18 ... Feb ’18 ... Dec ’18 ... Jan ’19 ... Feb ’19
Tier 1 ....... 3 ............. 3 ................. 3 ................. 3 ............... 3 ............... 2
Tier 2 ........ 1 ............. 1 ................. 1 .................. 2 ................ 2 ............... 3
Tier 3 ........ 2 ............. 2 ................ 2 .................. 1 ................ 1 ............... 1
Source: Northcoast Research estimates