Retail

Our Contacts Record 11th Straight Month of Positive Volume Growth

John Healy
Posted on August 6, 2019

Our recent discussions with dealers leave us with a view that retail sell-out expanded in May and remains on the positive side of the ledger.

From a volume standpoint, surveyed dealers reported they saw unit sales volumes improve marginally compared to the prior year’s period after improving in the low single-digit range in 1Q19. Two-thirds of the way through 2Q, we largely see the environment as expected with fairly positive industry demand dynamics and raw material costs that are showing relative stabilization.

We believe climate conditions may have had an outsized impact on consumer purchasing behavior in May and acted as a tailwind to sell-out trends during the month as our analysis of weather trends gave us a bit of déjà vu. As a reminder, May 2018 was a historically warm month as nearly 90% of contiguous states (42 states) recorded months that were in the top 10% of the warmest Mays ever in their state’s history including eight states that registered their hottest May on record. Despite these extremely tough comparisons, May 2019 was also an unusually warm month as 11 states recorded months that were in the top 10% of the warmest Mays ever while Florida registered its hottest May on record.

However, unlike May 2018, last month saw significantly elevated precipitation levels amid historic flooding in the mid-western region and only 12 states saw lower precipitation levels on a year-over-year basis (mainly the Mid-Atlantic which coincided with the historically warm temperatures). More specifically, 16 states recorded a month that was in their top 10% wettest Mays on record with three states (Kansas, Missouri and Nebraska) delivering their wettest May on record.

Furthermore, nearly one-third of U.S. states saw precipitation levels increase over 100% versus last May while entire regions like the Midwest and West collectively saw the entire regions precipitation level rise 79% and 66% year-over-year, respectively.

We hypothesize that slicker road conditions and flooding in many regions helped aid overall demand levels as problems encountered by elevated water levels caused an above average number of consumers to visit dealers that may have led to the discovery of further problems with the vehicle, including the ability to upsell new tires. At a minimum, the warmer weather could have finally led consumers to unload their winter tires or at least transition to a new set of tires ahead of the summer driving season.

Looking closer at the recent trajectory of raw material costs, the basket of raw materials to make a common replacement vehicle tire rose 1.6% on a year-over-year basis in May while increasing 1% from April. From a quarterly perspective, holding current spot prices flat would yield a 1.5% year-over-year increase in input costs in 2Q19 to “build a tire” (+3.8% from 1Q to 2Q) while the quarter-to-date time frame (April/May) is up 1.6% versus the same time period in 2018.

It is worth monitoring raw material cost inflation closely through the back-half of the year to gauge whether manufacturers will have to exercise pricing actions to offset higher costs like the industry experienced in 2H18; we note this has already been taking place in the commercial truck tire market. In assessing raw material price movements, carbon black continues to experience significant cost pressures and is still increasing at a double-digit rate on a year-over-year basis (mainly since the beginning of 2018), natural rubber prices continue to display a solid rebound and have remained positive on a year-over-year basis for two consecutive months for the first time since August 2017 while crude oil prices experienced notable pressure in May amidst downward financial market pressure (down HSD/LDD year-over-year). Meanwhile, synthetic rubber costs remained negative for two straight months and price pressures on reinforcement items (cord, fabric, etc.) continue to track negative year-over-year at a low-to-mid single digit rate.

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. As such, we expect sell-out trends in 2H19 to become more aligned with this level of GDP growth.

Monthly survey

A number of independent tire dealers were surveyed concerning current business trends. The results of the May 2019 survey are compared with those of May 2018.

Replacement Tire Sales – Selling Environment Suggests Dealers Pleased with Recent Trends

Dealer commentary suggests consumer demand for PLT replacement rose in May compared to the prior year’s period. The net number of respondents indicating they saw an increase in demand year-over-year was 14.3% of contacts compared to May 2018’s 14.7% of contacts experiencing positive growth.

We note that our tire demand index was roughly flat on a year-over-year and we continue to believe that volumes are becoming more closely aligned with the current level of GDP growth as our dealer contacts have seen eleven straight months of positive volume growth.

Further, conversations with dealers indicated that business conditions thus far through 2Q reside in positive territory and our research suggests that demand levels remain above a year ago for most dealers (at a low single-digit rate) with growth rates in terms of industry sell-out marginally better than those experienced by dealers at the end of 1Q.

A Look at Mix Trends in the Market

In response to the best and worst performers, our recent survey revealed that Tier I brands were the segment of most significant growth among our surveyed contacts for the third straight month. On the other hand, Tier III escaped the basement of our rankings in May while Tier II curiously returned to the bottom of our mix rankings for the first time since February and we note it has not been atop our rankings since November 2018 (see chart below).

Despite the transitory weakness, the combination of price and performance that Tier II tires provides continues to make it 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 seventeen months). We believe the recent strength seen in Tier III since the end of 2018 is transitory in nature and we expect consumers to opt for higher quality and performance given customers are more comfortable with recent pricing actions and recent tariff movements.

We point out that on a longer-term basis, Tier III brands have been ranked or tied for last place by our respondents in 26 of the past 57 months. We surmise the recent strength seen in the Tier I category over the past few months is no coincidence and could continue in the near term. The reason for this can mainly be attributed to recent tariff actions on Chinese imports as this puts domestic manufacturers (like Goodyear) in a net positive position.

Higher quality brands could see some benefit in the US replacement market as imported products become more expensive and could result in consumers purchasing quality products and brands as the playing field levels out and the price gap closes.

When examining the landscape from a longer-term view, we continue to believe that the pricing environment in North America will remain rational and in-line with raw material costs. We expect Tier I and Tier II producers to continue remaining 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 remain relatively lean. Moreover, dealers and wholesalers are being tactical with their approach to inventory allocation given legislative moves (tariffs), recent 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 john.healy@northcoastresearch.com.

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.

Related Topics: John Healy, retail, wholesale, Your Marketplace

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