Higher-Than-Planned Inventory Levels are Hampering Dealer Channel
According to the results of our survey, demand for passenger and light truck replacement tires improved slightly in July. The latest results mark the third consecutive month of healthier, albeit far from strong, trends after a very challenging start to the year.
Anecdotal commentary from the dealers suggested that demand was steady throughout the month, but many contacts in the Great Lakes, northeast and southeastern regions of the country noted elevated precipitation levels and cooler-than-normal temperatures limited traffic in the period.
While we are encouraged by the healthier results in recent months, sales trends have not been significant enough to definitively change the narrative that demand trends have not met expectations for 2017.
Notwithstanding the healthier results in recent months, our contacts have offered little explanation as to why sell-out trends across the PLT replacement tire market were so soft during the first six months of 2017. In fact, most of the dealers noted that the weak results run opposite to the favorable trends in many of the key drivers of intermediate-term demand, including a stronger consumer due to low energy costs and a solid labor market; favorable miles driven trends over the past 24 months (despite softer trends over the past 6 months); and an expanding car parc.
While the sluggish sell-out trends in the first half of 2017 created a difficult operating environment in the short-run, the inability of any of our contacts to point to any structural factors that might be creating secular pressures on demand trends, in addition to the positive results in June and July, lead us to believe that the odds are still high that the weak trends will prove to be transitory. As such, we are cautiously optimistic that sell-out volumes in the second half of the year will closely resemble the results from June and July in light of the fact that the key drivers of intermediate-term replacement demand remain favorable.
From a pricing perspective, our recent channel work suggests that the broader pricing environment continued to firm in July, largely reflecting a stabilization in promotional activity that followed some minor progress working down channel inventories. Recall that earlier in the second quarter of 2017 dealers noted that many manufacturers ratcheted up promotional activity -- volume-based promos upstream and rebate investments downstream -- in response to weak sell-out trends and elevated channel inventory coming out of the first quarter of the year. Despite the stabilization in the pricing environment at retail during June and July, as well as heathier sell-out trends over the past three months, we believe the channel is still dealing with higher-than-planned inventory levels.
A number of independent tire dealers were surveyed concerning current business trends. Except for tire prices and costs, the results of the July 2017 survey are compared with those of July 2016.
Despite challenging 2Q17, dealers still expect gains in 3Q17
According to the survey results, 33% of passenger and light truck tire dealers believe that business will improve over the next six months, and none are worried that trends will worsen. The rest of the respondents, 67%, felt business trends will stay about level. While the outlook of the dealers has fluctuated slightly over the past six months, we remain encouraged by the fact that none of the respondents expect trends to decline.
The outlook for commercial truck tire demand was also positive, as 40% of the dealers we spoke with see the business improving in the coming months while 60% of the participants see business trends staying about the same and none see trends worsening.
Replacement tire sales volume trends are healthier, albeit far from strong, in July
According to dealer reports, consumer demand for passenger and light truck replacement tires increased in July compared to the prior year’s period. From a volume standpoint, the dealers reported they sold slightly more tires in July relative to the previous year’s period.
July’s results are encouraging, and given dealer commentary that sales were steady throughout the month, which many expect to continue over the next few months, we are cautiously optimistic that sell-out volumes in 2H17 will closely resemble the healthier results from June and July rather than the lackluster volumes through the first five months of the year. The improving results likely benefitted from the dissipation of headwinds associated with abnormal weather patterns in the spring and the delayed disbursement of tax refunds, in addition to the benefits of lower unemployment, low fuel prices, and an expanding car parc.
Dealers reported disappointing demand trends across the other tire categories in the period, with negative trends appearing in the commercial truck and retread categories. The latter having been negative for most of the first half of 2017. Specifically, the dealers who responded to the survey reported medium truck replacement tire volumes declined 2% versus July 2016 following modest increases in the previous two months. Retread units were down over 7% versus the prior year’s period, which marks a decline in every month of 2017 so far, except for flattish trends in June.
Dealer costs increase as volume discounts are slowly reeled in
The tire dealers survey noted manufacturer pricing on value products was modestly higher (2%) than it was in the previous year’s period while branded product costs, on a net basis, increased 1.4%. It is important to remember the first price increase in the channel (Goodyear’s) became effective in February 2017, with the majority of manufacturers following suit in March and April. However, efforts to work down inventories included increased promotional activity downstream and upstream, with the latter largely, albeit not entirely, concentrated in the Tier Two and Tier Three segments of the market. That said, we believe that the promotional activity has stabilized in recent weeks, and we will continue to monitor moving forward.Inventory levels still a little high but on the verge of being right sized
Eighty-three percent of the responding dealers noted inventories at the end of the month were at an appropriate amount to satisfy demand (vs. 67% in June), while 17% noted inventories were too high (vs. 33% in June), while none noted that inventories were too low (same as in June). Some dealers indicated the weak sell-out trends year-to-date are partially responsible for inventories being too high at the end of the period, but manufacturers are doing a diligent job of managing the supply.
The responses regarding inventory levels among commercial truck tire dealers indicated imbalanced inventories similar to what we’ve seen over the previous 12 months, as only 20% of those surveyed noted they had the appropriate amount of inventory, while 40% of respondents indicated inventory was too high, and 40% thought inventory was too low during the period.
The net neutral results show inventories are balanced overall, but we believe the varying responses of the past few months can be directly tied to the mid-February ITC ruling, which determined that no anti-dumping/countervailing duties will be levied against Chinese TBR manufacturers. Keep in mind this ruling is being appealed by the USW and Pirelli.
To this point, some dealers noted that they are going to take advantage of the changing supply/demand dynamics and build up a safety stock in the event that the appeal is successful. That said, uncertainty about future demand remains the prevailing sentiment.
Repair sales increase year-over-year in July
The dealers indicated automotive repair sales trends increased in July, which is in-line with the increases in service revenues in five of the previous eight months (February was flat, May was down 2%, June was down 1%). Specifically, these dealers indicated service sales, which accounted for a net 31% of total revenues, were up 2% on a year-over-year basis in July. This compares to increases of 5% or more from October through January, flat trends in February, and a 1.8% and 2% gain in March April, respectively.
Nick Mitchell is managing director, research analyst, for Northcoast Research Holdings LLC based in Cleveland, Ohio. Mitchell covers a variety of subsectors of the automotive industry.
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