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Analyze this!

Tire industry analysts are not infallible. Oil and raw material prices can fluctuate following even the slightest change in the global economic climate. On the whim of a cartel such as OPEC (the Organization of Petroleum Exporting Countries), the price of oil can rise or fall quickly. Last October, the price passed the $55-a-barrel mark; in December, it had dropped more than 20%, to $40 a barrel.

Six years earlier, it was selling for $10 a barrel.

When those changes can be predicted, analysts come off as geniuses; when they can't, the guessing -- and second guessing -- begins. When extraordinary events like the war in Iraq and the 9/11 terrorist attacks occur, all bets are off, and the job becomes nearly impossible.

Still, analysts are paid to examine industry events in detail, determine tendencies and trends, and share their findings come what may. Saul Ludwig, the pre-eminent tire industry analyst in the United States, takes his job as seriously as anyone in the field.

As a managing director with KeyBanc Capital Markets (a division of McDonald Investments Inc.), Ludwig concentrates on the tire and chemical industries. He has been writing about the tire marketplace for Modern Tire Dealer on a monthly basis since 1975. But he began his annual review of the tire industry in our 1973 Facts Issue.

His 2005 forecast is full of both optimism ("we will see a modest 2.3% growth in overall tire shipments") and doubt ("I think the consumer tire segment is going to have a tough year on the OE side"). It comes on the heels of a schizophrenic 2004, in which replacement consumer tire shipments were up close to 2.3% versus 2003, while comparable original equipment shipments were down 4%.

MTD: How would you compare your replacement tire shipment predictions for 2004 with actual shipments?

Ludwig: One of the things that greatly affected the tire industry in 2004 was the surge in gas prices. A year ago, analysts, including myself, didn't predict that. It looks like replacement passenger tire demand fell a little over one million units less than what I predicted. I think we can attribute that to a slowdown in consumer buying, in part because of high gasoline prices.

We also had the whole issue of the Iraq war, which took people's attention off, or maybe created some fear about, driving. Even the presidential election had an effect. People were more engaged in this election than I can ever recall, and I suspect that some purchases and trips were delayed as people were striving to get their particular candidate elected.

All of these things combined to make replacement passenger tire demand a little less than what industry analysts thought.

The first half of the year was very, very strong in terms of replacement shipments. But then in the third quarter, shipments were very weak. Retailers had loaded up inventories in the first half of the year, in part because business was good and in part because they wanted to buy more tires in advance of price hikes, which were announced.

When the retail demand slowed in the summer, their purchases from manufacturers dropped sharply in the third quarter. In the fourth quarter, demand was about equal to where it was in 2003, resulting in 2004 replacement passenger, light truck and medium truck tire shipments of close to 249 million units versus 244 million in 2003.

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MTD: What were the U.S. replacement shipment highlights in 2004 versus 2003 for both consumer and commercial tires?

Ludwig: Passenger tire shipments were up about 2%, while light truck tire shipments were up 4%. Light truck tire shipments came in almost exactly as I forecasted.

In the medium truck tire segment, shipments were down slightly, from 15.5 million in 2003 to 15.4 million last year, about 300,000 units less than I predicted.

MTD: How did 2004 OE shipments compare with 2003?

Ludwig: On the original equipment side, I had predicted a very, very strong original equipment truck market, and that did turn out to be the case. OE medium truck tire shipments in 2004 were up 1.4 million units, from 4.2 million to 5.6 million. I had predicted 5.7 million, so I was almost right on the money.

In regard to passenger tires, OE shipments were down 3.3% in 2004 versus 2003, from 54.5 million units to 52.7 million. I had predicted 53 million units.

My biggest miss was on the OE light truck tire side. Last year, OE light truck shipments totaled 7.3 million units, down from 8 million in 2003. I predicted an increase of 2.5%. Light truck tire shipments were directly impacted by higher gasoline prices.

MTD: What are your replacement and OE passenger, light truck and medium truck tire shipment predictions for 2005?

Ludwig: On the replacement side, I would say that in general, we will see a modest 2.3% growth in overall tire shipments. However, it's important to note that the halves in 2005 will be reversed compared to 2004. We may not see much of an increase at all in the first six months of the year. But conversely, shipments will greatly increase during the last six months of '05.

So for the full year, I'm looking for about a 2% increase in replacement passenger tire shipments, a 3% increase in light truck tire shipments and a 4% increase in medium truck tire shipments.

I think the consumer tire segment is going to have a tough year on the OE side. I would look for lower sales of automobiles and slower production -- almost all of the major vehicle manufacturers announced production cutbacks late last year -- and a 5% decline in passenger and light truck tire shipments.

But I see continued strength in the OE medium truck tire segment, with a 10% increase in shipments. Diesel engine emission regulations for 2005 model-year trucks will result in the accelerated purchase of trucks. That was true in 2004 and will continue in 2005.

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MTD: Who gained and lost domestic market share in 2004?

Ludwig: I think the winners were the tire importers, particularly the Chinese imports like Federal, Maxxis and Double Coin. There's a whole smorgasbord of Chinese companies that export tires to the U.S.

I think Toyo did very well in 2004. I think Pirelli did very well last year, too. But I don't think any of the domestic producers gained market share.

MTD: We estimated that the Goodyear brand was up in domestic consumer tire market share in 2004.

Ludwig: It depends on whether we are talking about the Goodyear brand or Goodyear company-wide. The Goodyear brand increased in U.S. market share, but that was more than offset by reduced share among the Dunlop, Kelly and custom brands. Overall, I would say the company had a slight loss in market share, as did Continental Tire North America.

I would estimate that Cooper, Bridgestone/Firestone and Michelin stayed about the same.

MTD: There were multiple waves of tire price increases last year, as there were the year before. Did any of the price increases stick in 2004?

Ludwig: I think about half stuck. The consumer price index is not up anywhere near as much as are the prices the manufacturers charge retailers. But the upcoming ones in early 2005 should stick fully.

MTD: How would you describe Goodyear's financial situation? With two years of its three-year turnaround strategy completed, is Goodyear on the right track?

Ludwig: Yes. I think the company has made good progress. It still has a lot of challenges ahead, like its balance sheet. Goodyear is $5 billion in debt and has a pension fund under-funded by $3 billion.

Also, there will be more low-cost tires coming into the U.S. and Europe, so Goodyear still has to eliminate some high-cost capacity over the next two years. But operationally, it is doing better. Its stock started the year selling for $7.86 a share and finished the year significantly higher. (Ludwig has Goodyear's stock rated at "Hold.")

I think when Goodyear's current team took over, they inherited a plate full of problems. I think internally they recognized that they couldn't chase every problem all at once. So they decided 2004 would be the year of the Goodyear brand. That involved tremendous work improving dealer relations and fortifying the management team serving the Goodyear brand. And, of course, we can't ignore the success of the Assurance tire line.

Goodyear did a lot of things to rekindle the dealers' enthusiasm for doing business with Goodyear. It intensified its advertising in Modern Tire Dealer and other trade magazines, where it had been absent for many years. And Goodyear dealers bought more Goodyear tires.

The company did not give the same attention to the Dunlop, Kelly and custom brand business. That is where they lost market share. As the year drew to an end, however, Goodyear fortified the management team on the Dunlop side, and introduced three new Dunlop lines at the SEMA (Specialty Equipment Market Association) Show. So 2005 is going to be the year Goodyear puts energy behind the Dunlop brand, while not compromising in any way the intensity of its efforts in regard to the Goodyear brand.

In the custom brand area, Goodyear decided to be more selective with the customers it serves. It also emphasized its relationship with retailers and reduced its emphasis on pure wholesalers. That meant looking for business in more places like Wal-Mart, Discount Tire and TBC retail, while de-emphasizing distributors such as Treadways and TBC wholesale.

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MTD: What are your thoughts on the status of the individual North American tire manufacturers, beginning with Bridgestone Firestone North American Tire LLC?

Ludwig: Bridgestone Firestone has very strong management, great dealer relations and good prospects. It is doing better all the time. The only place the company is losing money is on the original equipment business.

I think its replacement consumer business run by John Gamauf is slightly in the black. Its stores are very profitable. The company is doing very, very well in Latin America, which is part of Bridgestone Firestone's North American division. And I think its non-tire businesses are profitable. The only money loser is OE.

When Bridgestone Firestone executives say they are losing money in North America, they are referring in that statement only to the consumer business, both OE and replacement. They are not including their stores in that business. They are not including their truck business, their farm business, or their off-the-road business.

I know that Bridgestone Firestone North America is very profitable. The challenge and the intent are to get price increases at OE. But Bridgestone Firestone did recently put into effect a series of price increases for all tires, including OE. It has to recover some of the raw material cost increases.

MTD: Continental Tire North America Inc. appears headed for another year in the red.

Ludwig: While losses continue in the U.S., Continental AG is the star performer in the global tire arena. Management had vision to move production to low-cost areas sooner -- and in greater quantities -- than any of its competitors. Continental will still have a significant loss in North America in 2004, in large part due to the shutting down of passenger tire production in Mayfield, Ky. But the company's cost of making tires is too high, even excluding the Mayfield facility. Also, its OE/replacement mix is too heavy in favor of OE, more than any of its competitors.

I think Continental has strong relations with large distributors, but weak relations with independent retailers. Its goal is to get to be profitable by the fourth quarter of '05. To help do that, the company is increasing its production in Mexico, and has stopped making high-cost tires in Mayfield. It also has garnered more OE business, which it hopes will spur more replacement business.

I think the objective is a lofty one. Continental Tire North America CEO Martin de Louw is intensively focused on achieving the goal, and in his mind he has a plan. I believe the company will still have a loss for all of 2005, albeit less than the loss it incurred in 2004.

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MTD: Cooper Tire & Rubber Co. may have been more active in the tire industry than any other domestic manufacturer in 2004.

Ludwig: Cooper had a very interesting year. It booked a ton of new business, but didn't deliver on all of it because of some manufacturing snafus. It tried to transition out of truck tires and 14- and 15-inch tires and into more 17-, 18-, 19- and 20-inch tires.

As the year came to an end, Cooper seemed to get a better hold on manufacturing challenges, and then from a strategic standpoint made the decision to sell Cooper Standard. But what will it do with the proceeds? For sure, I think the company will use some of the money to pay down debt and buy back some stock. It also will look for opportunities to invest some of the money in China. But Cooper's goal of a billion dollars in tire sales in China in five years seems aggressive to me.

Certainly, Cooper really raised its brand profile on high performance tires, whether it was from its involvement in racing, the Zeon tires or its Mickey Thompson subsidiary. Its Super Bowl Challenge program was clearly oriented toward younger people. The company made a major move to raise the profile of the Cooper brand, from being a generic replacement product to a more performance-oriented product. It will take several years to fully accomplish that goal.

MTD: You've already singled out Pirelli Tire North America Inc. as a market share winner.

Ludwig: Pirelli is knocking them dead in North America. Huge increases in OE fitments have raised Pirelli's profile. Its problem is keeping up with replacement demand. And the dealers really like CEO Guy Mannino.

MTD: How would you sum up Michelin North America Inc.'s strategy in 2004?

Ludwig: Michelin's market share was flat last year. But it has really tried to push its customers to buy more flag brands and less custom brands. So while its overall share was flat, Michelin would say it has a better mix of business. I would say the BFGoodrich brand did very well, but that Michelin's custom brand business probably was down. The Michelin brand kept pace with the industry.

I think Michelin strained some relationships with wholesale customers because it not only put the push on to buy more flag brands, but also began to sell to more independent dealers directly. To that extent, it bypassed some wholesalers and distributors.

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MTD: Toyo Tire (U.S.A.) Corp. has broken ground on a new tire manufacturing facility in Georgia.

Ludwig: I was a little surprised by the company's decision to build a plant in the U.S. because we're certainly not the lowest cost place in the world to make tires. But neither is Japan. It could indicate a desire to develop an OE presence here. But as you know, Hankook has an OE presence at Ford without a U.S. plant. So I don't know how important having a U.S. plant is.

Dealers who deal with Toyo like the brand. It's the largest selling tire at Les Schwab, and other dealers like Kauffman Tire and Colony Tire rave about the product. They also like Toyo President Carlos Kibata a lot.

MTD: Any thoughts on Titan Tire Corp.?

Ludwig: After years of losses, Chairman and President Morry Taylor's number finally came up. He surprised the industry with good results and improved relations with his workers. And his (Titan International) stock was the star performer in the industry last year.

MTD: Are there any other brands that you think are having an impact on the marketplace?

Ludwig: I hear more and more about Federal. Kenda is about to enter the U.S. market with Cooper as its distribution agent. Kumho and Hankook have carved out meaningful niches in the market, and Indonesia's GT has also developed more distribution.

In my opinion, there are way too many brands competing for a limited market, and that is one of the reasons it is difficult to get pricing improvement.

MTD: How would you describe the state of the wholesale tire segment? It seems to be going through some major changes.

Ludwig: It's in a big consolidation mode and has been for years. You look at American Tire Distributors buying both Target Tire and Big State Tire Supply this year. Among wholesalers this trend is going to continue in 2005 and beyond. We're going to get fewer players. The survivors will see their profitability increase, but there also will be some casualties as the market for tires sold by distributors continues to contract.

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MTD: What influences and trends do you feel may impact the tire industry in the near future?

Ludwig: Well, we have a number of uncertainties we have to take notice of. The price of oil is one. Another is Amerityre, which has made constant claims about its success with polyurethane tires. For the last 30 years, companies have been trying to develop a polyurethane tire. Thus far, they appear to have met with certain challenges, but are not yet ready to produce polyurethane tires for commercial use. Amerityre bears close watching, however. Aspect ratios -- the height to width ratio -- have been declining by about 1% a year, while rim sizes have increased 1% to 2% a year. I also think that because of high performance tires, average tire life has peaked.

There also will be huge increases in the supply of imports from low-cost countries, which will flood Europe and the U.S. and affect manufacturing plants here and in Europe.

Globally, there are too many tire producers, and they will be some more consolidation. We have too many tire producers chasing a finite market.

MTD: What kind of effect will the Kmart-Sears merger have on the tire manufacturers supplying Sears?

Ludwig: I don't know how that's going to play out. My guess is they will eventually get out of the tire and automotive service business. Kmart didn't have success with it.

I don't know how important tire and auto service is in the mind of the CEO running Kmart, Edward Lampert. I think he's more of a merchant than a service provider. So I wouldn't be surprised to see the new company sell all free-standing auto centers and place the emphasis on general merchandising.

MTD: Thanks again for your insight, Saul.

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