Consumers May be Experiencing Sticker Shock Following Price Increases
Recent conversations with dealers leave us with a view that retail sell-out remains healthy and trends continue to remain on the positive side of the ledger. From a volume standpoint, surveyed dealers relayed they saw unit sales volumes improve in the low-single-digit range compared to the same period last year and were up roughly 1% for the first quarter as a whole.
It seems that the only speed bump that dealers have encountered is slight pushback from consumers who initially experienced sticker shock on premium priced products resulting from recent price increases. This has been reinforced through our survey work over the last few months as consumers have traded down in favor of less expensive products and made Tier 1 and 2 tires the worst performers among our contact base of dealers from November to February.
What is encouraging for dealers and manufacturers, however, is that despite initial friction at retail, price increases appear to be sticking. Our survey of more than 10,000 consumer replacement tire SKUs suggests a nice acceleration as retail prices were up 3.5% in 1Q19 compared to 4Q18 and nearly every major brand we tracked displayed price appreciation during this period.
More specifically, prices across the most popular passenger tires showed notable strength in 1Q19, increasing 3.6% sequentially while the most popular light truck tires were mostly flat quarter-over-quarter. We view the recent growth in the SKUs we track as evidence that the price increases implemented across the manufacturers have stuck and are flowing through to wholesalers and retailers.
Contrary to recent trends, the weather environment during the month of March was quite normalized both on a year-over-year and historical basis. Despite unfavorable weather aiding demand trends during the winter months, we view the lack of aberration in climate patterns as an incremental positive for the industry last month as it may have encouraged consumers to leave their houses after being cooped up all winter and resulted in greater miles driven activity.
As the end of the tax season quickly approaches, we thought it would be worthwhile to again gauge the status of individual tax returns compared to last year in light of the disrupted tax return season among American consumers. As of the end of March, the total individual income tax returns received by the IRS was down by 1.4% compared to the same time period in 2018.
Furthermore, the total number of refunds issued was down 2.2% year-over-year while the average refund was down 2.9% comparatively. Although these percentage comparisons may not seem significant at first glance, we note that there has been 1.28 million fewer refunds filed and $6.17 billion less in refunds issued (roughly $4,800 per return filed) at the end of March 2019 versus the end of March 2018. Despite a notable 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 having an effect on tire sell-out trends.
Looking closer at the recent trajectory of raw material costs, the basket of raw materials to make a common replacement vehicle tire declined 0.9% on a year-over-year basis in March while increasing 0.7% from February. From a quarterly perspective, raw material costs increased nearly 1% versus 1Q18 but registered a decline of 0.2% from 4Q18’s levels; furthermore, holding current spot prices flat would yield a 2.3% year-over-year decrease in input costs in 2Q19 to “build a tire.” We note that it is worth monitoring raw material cost inflation closely through the next two quarters to gauge the trajectory of raw material prices as that could foreshadow if manufacturers have exercise pricing actions to offset higher costs like the industry experienced in 2H18.
In assessing raw material price movements, carbon black continues to see double-digit increases on a year-over-year basis (mainly since the beginning of 2018) while synthetic rubber cost pressures have moderated recently but are still growing at a mid-single-digit pace year-over-year. Meanwhile, price pressures on reinforcement items (cord, fabric, etc.) have turned negative year-over-year the past two months, crude oil prices have rebounded from their steep sell-off in 4Q18 but still remains negative year-over-year, and natural rubber has shown relative stabilization from 2018 but still remains in negative territory compared to last year.
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 1H19 to become more aligned with this level of GDP growth.
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 March 2019 survey are compared with those of March 2018.
Replacement Tire Sales – Demand Environment Suggests Favorable Sell-Out Trends in the First Quarter
Dealer commentary suggests consumer demand for PLT replacement rose in March compared to the same period last year. The net number of respondents indicating they saw an increase in demand year-over-year was 20.7% of contacts. We note that our tire demand index increased nearly 28% year-over-year and we believe volumes are becoming more closely aligned with the current level of GDP growth as our dealer contacts have seen nine straight months of positive volume growth.
Further, our research suggests a constructive backdrop occurring within the North American tire market as dealers seem pleased with Q1 sell-out activity. Dealers west of the Mississippi highlight a strong start to the year with trends cooling as the first quarter progressed, while dealers east of the Mississippi tell us the opposite with a slow start to the year and strong end to the quarter.
A Look at Mix Trends in the Market
In response to best and worst performers, our recent survey revealed that Tier I brands were the segment of most significant strength among our surveyed contacts for the first time since August 2018. Conversely, after spending three months atop our rankings, Tier III again fell to the bottom spot for the first time since November 2018. After a delayed tax refund season, many consumers have finally received their refunds and the additional influx of cash in consumers’ pockets may have impacted buying behavior causing them to trade up to higher-quality, legacy nameplates. Tier II was firmly planted second in our rankings last month and rebounded from a rough showing in April that saw it fall to the bottom of our rankings for only the second time since September 2016.
Due to the combination of price and performance that Tier II tires provides, it 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 sixteen months). We believe the recent strength in Tier III is more transitory in nature as we expect consumers to opt for higher quality and performance especially now that consumers have grown comfortable with the recently instituted price increases. We point out that on a longer-term basis, Tier III brands have been ranked or tied for last place by our respondents in 25 of the past 55 months.
We are slightly perplexed as to the lackluster performance of Tier I tires among our contact base of late 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 I and Tier II 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.
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 ... Jan '18 ... Feb ’18 ... Mar ’18 ...Jan ’19 ... Feb ’19 ... Mar ’19
Tier 1 ....... 3 ............. 3 ................. 3 ................. 3 ............... 2 ............... 1
Tier 2 ........ 1 ............. 1 ................. 1 .................. 2 ................ 3 ............... 2
Tier 3 ........ 2 ............. 2 ................ 2 .................. 1 ................ 1 ............... 3
Source: Northcoast Research estimates