‘Will We See a Recession?’
Raw material prices dropped so significantly in 2015 that the one thing everyone expected to happen during the year never materialized. Tire prices didn’t go up.
In June when the U.S. Department of Commerce finalized tariffs on consumer tires manufactured in China, tire dealers and industry watchers considered it “a matter of time” until all passenger and light truck tire prices increased. But the price hikes never materialized, and industry analyst Nick Mitchell doesn’t expect raw material prices to rebound in 2016. Look for them to drop even lower, Mitchell says.
Modern Tire Dealer asked Mitchell, senior vice president and research analyst at Northcoast Research Holdings LLC, to talk about the highs and lows of 2015, as well as what’s ahead in the new year. He names the tire manufacturer to watch, addresses whether the 2016 presidential election will have any effect on the tire industry, and covers which segment is the most likely subject of the next tariff investigation.
MTD also asked Mitchell to pick five words to describe 2015: “perpetually falling raw material prices.”
MTD: What are tire dealers saying about the state of their businesses? What are they expecting in 2016?
Mitchell: Dealers are saying business is solid, but not exceptional. Volume growth moderated in November and December due to unseasonably warm temperatures in the Great Lakes, Mid-Atlantic, and Northeast. Sentiment among the dealers is definitely upbeat, albeit not quite as optimistic as the tone at this time last year, as the participants are more divided over the likely strength in 2016. Specifically, one cohort is expressing optimism that an expanding car parc, including an uptick in the number of cars entering the first replacement cycle, low gasoline prices, and an improving economy will buoy volumes next year. This group expects to see a 2% to 3% increase in sell-out volumes, with some benefit accruing from the release of pent-up demand. Meanwhile, the rest of the dealers we speak with anticipate that sell-out trends will track in the range of flat to up 2%, as they expect less of a windfall from deferred tire purchases arriving in 2016, as well as a more modest tailwind from lower gas prices, especially amidst growing signs that the consumers in markets dependent on the oil and gas industry are starting to retrench in the wake of ongoing weakness in the price of oil.
Tying these views together, we think it is prudent to project that domestic volumes will increase in the low-single digit range next year, which is consistent with the assumptions in our models.
MTD: How would you sum up the tire industry in 2015? Where is the industry headed in 2016?
Mitchell: This year can be summarized as a fairly solid year for the industry, with replacement passenger and light truck sell-out volumes running up 1% to 2% through the middle of November. The higher prices that many expected to see in the wake of the new tariffs on light vehicle tires imported from China never showed up; however, a precipitous drop in raw material prices relative to the prior year more than made up for the lack of pricing power, and helped improve profit trends.
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 2016?
Mitchell: Overall inventory seems fairly well controlled. Dealers were able to work down the pre-buy product from 2014 without any problem despite the “pricing power story” never really getting off the ground. That said, given the warm temperatures and the lack of snowfall across the Great Lakes, Northeast, and Mid-Atlantic regions in the fourth quarter of 2015, we expect channel inventory of snow tires will be higher than ideal coming out of the first quarter of the year, which could present a minor obstacle to sell-in volumes in the first half of 2016.
MTD: After the tariffs on passenger tires made in China were approved, most expectations were for prices to increase like they did in 2009 after the previous tariffs were imposed. What happened?
Mitchell: Despite the fact the U.S. Department of Commerce finalized its anti-dumping and countervailing duties covering passenger and light truck tires produced in China in the middle of 2015, most players in the North American tire industry we spoke with noted they never saw a lasting benefit from the trade measures. In our opinion, the weakness in raw material prices was the primary culprit for the fact the initial increases to base prices on Tier 2 and Tier 3 products were rolled back or offset with promotions, including more aggressive volume incentives.
That said, we are surprised the pricing terms for product coming from Thailand, Indonesia and Vietnam are very aggressive. It sounds as if this phenomenon is being driven by Chinese suppliers still quoting prices that are on par with those seen prior to the implementation of the tariff.
MTD: How much are tire dealers depending on tire sales for their bottom line? Has there been a shift during 2015? Do you expect this to change in 2016?
Mitchell: Tire sales are as relevant today to the bottom line as they ever were. The category remains a key traffic and profit driver and is still the best category to forge relationships with customers. Service has become more important over the years, but the profit difference between a well-run dealer and an average dealer lies in how well the tire portion of the sales mix and inventory portfolio are managed.
MTD: What’s happening with tire production in China?
Mitchell: Tire production continues to expand in China despite the new protective trade measures in the U.S. However, we have heard some chatter about banks foreclosing on small manufacturers as credit tightened. We expect overall tire production in the country will expand by 5% plus in 2016.
MTD: Raw material prices have been low in 2015. When should dealers expect those prices to rise again?
Mitchell: Predicating raw material prices is tough, to say the least. That said, we think the basket of key raw material prices will be flat to down low-single digits in 2016, driven by the weakness in oil and natural rubber prices.
MTD: Oil prices have decreased throughout the year, and that affects raw material costs as well as consumer habits. Who’s benefiting more, tire manufacturers or consumers?
Mitchell: The lower oil prices are a win-win for all parties; however, consumers are reaping the bulk of the benefits at the pumps as tire prices have been fairly sticky.
MTD: What’s the forecast for tire wholesalers?
Mitchell: Tire wholesalers expect the market to grow 1% to 3% in 2016, and that we will see more consolidation in this segment of the industry.
MTD: Do you foresee any shifts among the Tier 2 and Tier 3 manufacturers?
Mitchell: We expect the mix to shift up to Tier 1 and Tier 2 brands at the expense of the Tier 3 players. We anticipate there will be some consolidation in the Tier 3 bucket, especially in China and other parts of southeast Asia. We expect the mix at retail to shift up to Tier 1 and Tier 2 brands at the expense of the Tier 3 players, as the combination of the improving labor market, low gas prices, and product innovation should cause some consumers to trade up. We anticipate there will be some consolidation in the Tier 3 bucket, especially in China and other parts of southeast Asia as margins in these regions are pressured from supply outpacing demand in the wake of new tariffs on passenger and light truck tires in the U.S.
MTD: Who would you label a “manufacturer to watch” in 2016?
Mitchell: Falken Tire Corp. is definitely the manufacturer to watch in 2016 and 2017. With the Goodyear/Sumitomo Rubber global business alliance dissolved, we anticipate Falken will be much more aggressive in the market, especially as it relates to product innovation and dealer relationships.
MTD: Goodyear started off 2015 with a bang with its announcement it would start selling tires on goodyear.com. Other manufacturers are following their lead. How much of a game changer is this, and what can independent tire dealers do?
Mitchell: Honestly, more noise has been made on this topic than it deserves. At the end of the day, less than 5% of all tire transactions are completely made online without the consumer calling or visiting a store while researching the available options. More importantly, the manufacturers will always need channel partners to mount and balance the tires, and those are very important elements of the value proposition that dealers should be able to monetize.
MTD: What’s the biggest story of the year in the commercial tire side?
Mitchell: The biggest story on this front has to be the fact that Pirelli & Cie SpA was acquired by China National Chemical Corp. (ChemChina). The deal creates the fourth largest commercial tire business in the world with roughly 12 million units of capacity. Integration is the hardest part of any merger, and this seems like it will be a tricky one to pull off without a hiccup in light of the fact it requires bringing together two very different cultures.
MTD: How much are tire dealers depending on fleet work to maintain, or grow their businesses?
Mitchell: Fleet work is a very important segment of the market. It is typically a lower margin business but the size and predictability of the volume trends make it attractive. It should continue to be an area of focus going forward.
MTD: With so many tire plants under construction in the U.S., in addition to extra production and faster fill rates, what are the other benefits?
Mitchell: The greatest benefits besides the ones listed are: supply chain optimization via greater use of a near-sourcing production strategy (i.e. shorter lead times), and improved product mix (new plants only support high-value-added machinery).
MTD: Which segment of the tire industry will see the most growth in 2016?
Mitchell: We expect to see the best volumes in the OE light truck category, as the relentless drop in retail gasoline prices should boost demand for pickups. Meanwhile, we expect the worst trends to be seen in the OTR and agricultural categories.
MTD: How’s the auto service repair business? How will the economy affect those profits?
Mitchell: The service business is good, and we expect this to remain the case in 2016, assuming a slowdown in China and falling oil prices do not pull the U.S. into a recession.
MTD: What are your predictions for the do-it-for-me (DIFM) and do-it-yourself channels for 2016? How have those channels performed in 2015?
Mitchell: The DIFM market was red hot through the first three quarters of 2015 on the heels of a very strong performance in 2014. We expect the data will ultimately show trends moderated in the fourth quarter in light of the unseasonably warm weather across the Great Lakes, Northeast and Mid-Atlantic regions. I think this segment of the market will grow 3% to 5% in 2016, assuming the U.S. economy does not slip into a recession.
MTD: Are consumers more confident in the economy? How is that relating to their tire purchases and auto repairs?
Mitchell: Notwithstanding the recent weakness in the stock market and retail sales, consumers seem to be fairly upbeat and healthy from an economic standpoint, and this is helping fundamentals across the tire and auto service in the form of stronger volumes, less deferral activity, more proactive maintenance, and a richer sales mix (i.e. consumers are trading up).
MTD: With the tariffs on passenger tires now in place until at least 2020, what are the chances tariffs will be leveraged against truck tires?
Mitchell: It is tough to say, and speculating on such matters is never fun. That said, the International Trade Commission voted unanimously in early 2014 to retain the antidumping and countervailing duties that were levied against Chinese off-the-road tires in response to a 2008 judgment; and similar measures were finalized against passenger and light truck tires imported from China. As such, I would not be surprised if the next area of focus is on the TBR market. China has the ability to produce over 120 million radial truck tires, so it is clearly a force that needs to be monitored.
MTD: Thanks for your insights, Nick. ■
To read MTD's 2016 Facts Section, click here.