Yes, the United States Department of Commerce’s preliminary decision on Chinese tire tariffs drove the market in 2014, and the forthcoming final decision will affect the market again in 2015. But there’s more to tires than tariffs, and Modern Tire Dealer turned to industry analyst Nick Mitchell to review the last 12 months, and to talk about what’s ahead.
Tire dealers are optimistic about 2015, and they’re expecting business in the new year to be better than it was in 2014, Mitchell says. At the same time, he thinks dealers need to be thinking about how to drive traffic to their businesses. Relying on regular oil changes, especially those of fleet vehicles, isn’t going to cut it.
Since April 2009, Mitchell has studied the industry as part of his work for Northcoast Research Holdings LLC in Cleveland. Mitchell, senior vice president and research analyst, has been honored by the Wall Street Journal and Financial Times for the performance of his investment recommendations. He writes a monthly column, “Your marketplace,” for Modern Tire Dealer.
MTD: How would you summarize the tire industry in 2014? Where is the industry headed in 2015?
Mitchell: All things considered, I think 2014 was a fairly good year for the tire industry, especially in the U.S. where fundamentals remained solid all year, even after adjusting for the impact of the forward-buying of Chinese tires. Demand for passenger and light truck replacement tires started the year strong in most of the major global markets, but growth trends started moderating in the late second quarter and early third quarter. The most pronounced slowdown was seen in emerging markets, including Eastern Europe and parts of Latin America, especially in the original equipment channel. Demand in China has moderated relative to recent years; however, the first nine months of the year turned out to be pretty solid. That said, demand visibly weakened in the country once it was clear the U.S. would likely implement antidumping and countervailing duties.
In the truck and bus radial market, demand has definitely been the most robust and resilient in North America, especially in the U.S. Shipments in the OE and replacement channel were stable to positive in the first quarter in most of the major regions across the globe. Trends started deteriorating in the second quarter of 2014, with the most pronounced weakness seen in Latin America and Europe, especially in the OE channel. Fundamentals remained lackluster in the off-the-road (OTR) tire segment all year; the headwind should moderate in 2015.
Overall, we expect 2015 will be another exciting ride in the global tire industry, with most markets expected to experience growth — albeit more heavily weighted to the back half of the year.
MTD: What are tire dealers saying about the state of their business? What are they expecting in 2015?
Mitchell: Most of the retail players I have spoken with since early November have noted they expect unit volumes to increase 2% to 3% in 2015, which would be a step up from the consensus opinion that volumes are running up 1.5% to 2% year-to-date. The first half of 2014 was stronger than the third quarter, and volumes were flat to up 2% in 2013. Interestingly enough, members from the dealer community who I spoke with at this time last year indicated retail volume growth would likely range from 0% to 2% in 2014, so it appears 2014 will finish in-line with expectations.
I believe most of the optimism regarding the outlook for 2015 can be traced back to two main factors: A favorable outlook for gasoline prices, which should provide a tailwind to driving trends and consumers’ discretionary incomes; and a renewed growth in the car parc, including an uptick in the number of cars entering the first replacement cycle.
MTD: What’s the biggest inventory-related story of the year? Who’s got it and who doesn’t? And what opportunity, or problem, does that present for 2015?
Mitchell: The most prominent discussion on the inventory front is clearly the debate of whether or not the strategic, forward buying of Chinese passenger and light truck tires ahead of the potential countervailing and antidumping duties is pressuring shipment trends among the branded manufacturers in the U.S. The topic is definitely complicated, with ample evidence supporting both sides of the argument.
There is little doubt that many of the large domestic dealers and wholesalers flexed their balance sheets and warehouse capacity to import extra tires from China in the wake of the United Steelworkers filing a petition with the U.S. International Trade Commission in June requesting antidumping and countervailing duty relief under Sections 701 and 731 of the Trade Act of 1930. That said, I believe most of these organizations ratcheted back orders with Chinese suppliers by late September with concerns the shipments would not clear U.S. Customs by Nov. 21, 2014, the date of the preliminary determination in the countervailing duty investigation.
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More importantly, most of these contacts noted their inventory strategies related to Chinese passenger and light truck tires were not impacting their buying behavior for non-Chinese tires. In other words, sell-in shipments were largely matching sell-out.
As such, I, along with others in the industry, had expected the forward buying of tires from China to moderate significantly in the fourth quarter of 2014, and any related headwind on shipments of non-Chinese tires to subside. Interestingly, our analysis of federal trade data suggests this is occurring. Specifically, our work suggests the number of passenger and light truck tires imported from China increased 23%, 18%, 19%, and 12% in July, August, September and October, respectively. The average monthly gain in the first half of 2014 was 18%. I expect trends will continue to decelerate into 2015. Still, Goodyear and Cooper both attributed weakening demand trends for their product in the U.S. during third and fourth quarters of 2014 to their customers stocking up on Chinese tires. The companies indicated the headwind could continue through the first half of 2015.
MTD: What’s happening with tire prices? What do you expect for 2015?
Mitchell: Tire prices continue to decline in the U.S. as relief on the raw materials front continues to get passed on to consumers. We estimate retail prices were down 4% to 5% on a year-over-year basis in October, and prices contracted 2% to 4% at the manufacturing level.
While the enactment of antidumping and countervailing duties could create some modest upward pressure on pricing in 2015, we expect this will be largely offset by the benefit associated with falling raw material prices.
MTD: How much are tire dealers depending on tire sales for their bottom line?
Mitchell: Notwithstanding the weak demand environment that has lingered on in the years following the Great Recession, tires are still a key element of a tire dealer’s operations, with the category typically contributing 55% to 60% and 13% to 15% of the revenue and gross profit mix, respectively. Additionally, the traffic generated from tire sales provides the installers an opportunity to capture rub-off service sales and build loyalty with the consumer.
MTD: Will companies move manufacturing out of China, or bump up production elsewhere in light of the additional tariffs levied against some Chinese tires?
Mitchell: The impact of Tariff 421 (which expired in September 2012) definitely forced many manufacturers to alter their capital allocation and production strategies in terms of where new investments were going to be made and the utilization rates of their existing plants. I would expect the same to occur this time around. In fact, it could be more pronounced since these protective measures would not be temporary, but rather semi-permanent with mandatory reviews occurring every five years. Either way, I continue to think that tariffs, including the mere threat of such protective measures, will accelerate the trend of manufacturers adopting near-source production strategies. Examples of this include Giti Tire’s, Hankook’s and Kumho’s decisions to build plants in South Carolina, Tennessee and Georgia, respectively.
MTD: Are “green” tires making any headway in the market? Do customers care when shopping for replacements? Do car manufacturers care when planning OE?
Mitchell: I think eco-friendly tires are gaining traction in the market, no pun intended, but I believe the attraction to “green” tires is rooted in the promise of improved gas mileage from reduced rolling resistance, which can definitely lower fuel expense, rather than an over-arching desire to purchase tires produced via environmentally friendly manufacturing processes.
The promise of better fuel economy appeals to drivers and OE manufacturers. It is also important to remember there are performance trade-offs when it comes to “green” tires, including the give and take between fuel efficiency and traction.
MTD: What’s happening with the raw materials in tires? Are there new components coming that might change the face, or the price, of tires?
Mitchell: The underlying trend in the basket of key raw materials remains favorable. But manufacturers are not resting on their laurels, as they are all looking for alternatives to some of the more volatile raw materials, including new sources of rubber and silica. As an example, many manufacturers and research groups are working to develop standard manufacturing processes to allow for the use of rubber extracted from plants, such as dandelions and guayule, and silica from rice husk ash. I am not sure if the more traditional sources of supply will ever be fully replaced. However, aggressive research and development investments will likely yield some promising advancements on this front in the coming years.
MTD: How will low oil prices affect the industry?
Mitchell: Lower oil prices will definitely provide a tailwind to raw material prices, especially synthetic rubber, carbon black, silica, and select plasticizers, but, I expect manufacturers will only be able to hold on to a portion of these savings. The bigger benefit should come from increased driving trends and the boost to consumers’ discretionary budgets, both of which should spur demand for replacement tires.
Keep in mind every one-cent drop in the price of gasoline leaves approximately $1 billion of income in the pockets of consumers.
MTD: What’s the forecast for tire wholesalers?
Mitchell: The tire wholesaling segment of the market continues to consolidate. There is plenty of liquidity available for the large players to finance the acquisitions, so as long as the buyers can locate willing sellers, the buying spree will continue for the foreseeable future. Needless to say, as the market becomes less fragmented, the smaller ones have a harder time competing effectively.
MTD: What are your predictions for the Big Three: Goodyear Tire and Rubber Co., Bridgestone Americas Inc. and Michelin North America Inc.?
Mitchell: I do not expect any significant surprises from the Big Three in 2015. These organizations will likely continue to focus on increasing the share of revenue that comes from high value added tires, and managing the price/mix-to-raw materials spread. This disciplined commitment to managing the businesses for profitability rather than market share gains has paid off handsomely in recent years, and I doubt any of the players will abandon their winning strategies in 2015.
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MTD: What about the smaller manufacturers?
Mitchell: I think the smaller manufacturers that focus on the Tier 3 segment of the market will try to leverage the opportunity created by the protective measures against Chinese passenger tires in the U.S. Meanwhile, the product rich producers should make inroads in the niches they serve.
MTD: What’s the next merger you anticipate in the industry?
Mitchell: I expect American Tire Distributors Inc. and Monro Muffler Brake Inc. to continue rolling up smaller wholesalers and installers, respectively. When it comes to the manufacturing side of the business, deal activity is much harder to predict. I am sure there will be some deals announced in Asia, especially in China, as producers look for opportunities to create synergies in the wake of what appears will be more restrictive trade with the U.S. I do not think the Big Three will make any acquisitions in 2015, but I would not be surprised to see consolidation or strategic alliances-platforms to share technology, gain purchasing capital and capital alliances-formed among some of the manufacturers in the Tier 2 or Tier 3 segments. I suppose a suitor could emerge at Cooper Tire & Rubber Co.’s doorstep in Findlay, Ohio, but I do not think it is a high probability scenario at this point in time.
MTD: How much do tire recalls affect the bottom line?
Mitchell: Unfortunately, recall, product liability and warranty costs are here to stay as they are clearly a cost of doing business. I would say these expenses typically equate to 2.5% to 3.5% of a manufacturer’s revenue.
MTD: What’s the biggest story of the year in commercial tires?
Mitchell: The biggest story of the year in the U.S. has undoubtedly been the consistent and robust growth the channel has witnessed all year. Shipments in the OE and replacement channels were up approximately 17% and 10% through November 2014, respectively. This growth has also been resilient as the market grew every month. On the flip side, the strong performance creates a string of difficult comparisons for 2015, which will likely restrict growth trends.
MTD: Is there something tire dealers are doing today they won’t be doing by the end of 2020?
Mitchell: I do not think there is any service or work being performed today that will completely go away by the end of the decade. I would imagine tire dealers will perform fewer and fewer oil changes in the coming years as a greater percentage of the nation’s light vehicle fleet will be comprised of electric vehicles, and more and more of the non-electric cars and light trucks will use synthetic oil, which allows for longer intervals between oil changes. As a result, installers will need to come up with new ways to drive traffic to their establishments.
MTD: Michelin North America Inc.’s Tweel plant is now open in South Carolina. How big is the Tweel today, and how big will it be five years from now?
Mitchell: The technology behind Michelin’s Tweel is really amazing. Despite speculation this non-pneumatic tire/wheel assembly could serve as a viable replacement for pneumatic tires in many applications, it appears the product will only serve a more limited end market for the foreseeable future, including skid-steers and other small industrial vehicles. I suppose one could envision a world where the Tweel could be on passenger cars and light trucks, however it would require more research and testing by Michelin, and consumers would have to buy into the aesthetics.
MTD: Which segment of the tire industry will see the most growth in 2015?
Mitchell: Domestically speaking, the commercial truck tire market was very strong in 2014, which inherently creates a string of difficult comparisons for 2015 that will probably restrict growth trends. I expect the fundamentals in the OTR market will improve slightly in 2015, but demand will likely remain fairly lackluster. Based on these projections and the relief consumers will get from falling prices at the pumps throughout 2015, I think the safest bet is to assume the strongest shipments will be in the passenger and light truck segments. The one wild card here is any pressure from destocking the strategic build in inventory of Chinese replacement tires could create more of a headwind than I currently estimate.
MTD: How’s the auto service repair business? What economic factors do you expect to affect those profits?
Mitchell: I think fundamentals are fairly healthy in the auto service repair business. Traffic and the average ticket expanded in 2014, and the growth should continue in 2015. Cost pressures are fairly benign, the average age of a passenger vehicle continues to increase, and the car parc is starting to expand at more normalized growth rates after a few years of stagnation following the Great Recession. The uptick in miles driven trends and the increased disposable income resulting from the ongoing slide in gasoline prices will also provide a modest tailwind to demand in 2015.
MTD: Thanks again for your insights, Nick. ■
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Incredible cold led hot year for auto parts stores: Low gas prices will fuel business in 2015
Record cold temperatures in early 2014 were a big boost to auto parts sales, and 2015 should be another strong year, says Nick Mitchell, senior vice president and research analyst for Northcoast Research Holdings LLC.
“The big chains had very robust same-store sales trends in 2014, partially driven by a huge tailwind from favorable weather conditions in the first half of the year,” Mitchell says. “Looking forward, I expect the group will perform very solidly well into 2015.”
Mitchell looks for the do-it-for-me channel to lead the way, with sales to grow 2% to 5% in 2015.
But low gas prices will provide another boost, Mitchell says.
“The sharp drop in fuel prices should help the do-it-yourself (DIY) consumer, and stimulate demand in this segment of the market,” Mitchell says. He expects DIY sales to increase up to 3% in 2015.
Manufacturers fail in marketing:Despite the money spent, customers don’t know anything about tires
Tire manufacturers all spend money marketing their brands. They advertise. They promote every major sport and sponsor events from college football bowl games to professional hockey. Plus, there’s racing, a world that spins on the companies’ products.
But this doesn’t mean sports fans, or customers in general, are knowledgeable about tires, says Nick Mitchell, senior vice president and research analyst at Northcoast Research Holdings LLC.
“Consumers are usually forced to fork over a pretty decent chunk of change when they purchase four new tires,” Mitchell says.
“Unfortunately, most buyers have no idea what type of tires they want when they begin the buying process, which, in my opinion, is a sign the tire marketing campaigns are not very effective.”
So what does work? Mitchell says safety campaigns are often the most productive.
“I think the most successful marketing and advertising strategies focus on highlighting the safety benefits that can be harvested from investing in a mid-tier to premium tire, and educating the consumer on the pros and cons of each type of passenger and light truck tire available in the market,” Mitchell says.
“Unfortunately, I do not think the manufacturers have done a good job on this front.”
Cue the tire dealers to step in to bridge the gap. Mitchell says they “play a pivotal role” in the selection process.
