Cost Pressures Will Likely Continue to Build
According to the results of our survey, demand for passenger and light truck replacement tires declined in March. Indeed, from a volume standpoint, the dealers reported they sold 0.8% fewer tires in March relative to the previous year’s period. The decline marks the third straight month of poor results versus the prior year’s period. However, on more a positive note, trends improved sequentially.
Needless to say, it appears that the lingering effects of warmer-than-normal winter weather seen in the first two months of the year continued to weigh on demand for passenger and light truck tires in March, especially in the Northeast, Midwest and Upper Mid-Atlantic regions of the country. In fact, nearly every tire dealer and distributor we spoke with in these markets cited the balmy weather as a notable headwind to sell-out trends of replacement tires versus the prior year’s period. The slow start to the tax season was also a sizeable hurdle for the industry given the fact that many households earmark these funds for big ticket purchases, such as new tires.
The Internal Revenue Service’s data indicates cumulative tax refunds were still down 1% year-over-year through the end of March; however, disbursements were up 17% in March versus the prior year’s period. The latter stat helps explain why many of the respondents noted traffic and sales improved from the prior month albeit at a less than expected degree. In regards to the whole quarter, it is worth mentioning that some respondents speculated the late tax season resulted in consumers allocating more of their tax refunds to other items rather than car repairs and tires, which could have weighed on demand trends throughout the first quarter.
Despite the slow start to the year, we continue to believe that a favorable backdrop, including low fuel prices, solid job growth, an expanding car parc and healthy miles driven trends, combined with more normalized weather patterns going forward, should lead to decent volume growth in 2017. It is worth noting that most dealers shared this sentiment, as a large percentage of the respondents indicated they too anticipate sell-out trends will accelerate throughout the next six months.
The sharp move in raw material prices since 3Q16 combined with nearly every notable tire manufacturer already announcing or enacting sharp price hikes almost guarantees that tire costs are going to be meaningfully higher in 2017. At this point, we think the initial price hikes will stick; however, we are monitoring inventory levels closely as sell-out trends lagged sell-in trends in 1Q17.
At this point, we have not heard anything too alarming on this front; however, we will start to worry more about this risk if retail demand remains weak through the end of spring. If channel inventories become a bigger issue, the recent price hikes could be partially negated by increased promo activity or manufacturers may need to delay further price hikes, especially in the Tier Two and Tier Three segments of the market.
Regardless what the future holds, we believe the dealer community will be able to offset any net cost pressures through their own price adjustments. In our opinion, operators who lead with a model that includes high quality of service at fair prices will be able to maintain their margin structure in this category, while those who sell on price alone will only opt to pass along the higher costs and neutralize the impact on gross profit.
A number of independent tire dealers were surveyed concerning current business trends. Except for tire prices and costs, the results of the March 2017 survey are compared with those of March 2016.
Dealers still expect gains in 2Q17
According to the survey results, 33% of passenger and light truck tire dealers believe business will improve over the next six months, and none are worried 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 67% of the dealers we spoke with see business improving in the coming months and 33% see business trends staying about the same. None of the participants believed commercial truck tire demand trends will worsen.
Replacement tire sales volume trends decline
According to dealer reports, consumer demand for passenger and light truck replacement tires declined in March compared to the prior year’s period. From a volume standpoint, the dealers reported they sold 0.8% fewer tires last month relative to the previous year’s period. The decline marks the third straight month of weaker results versus the prior year’s period; however, on a more positive note, trends did improve sequentially. Not surprisingly, many installers blamed the transitory headwinds for the poor results, including the lingering effects of unseasonably warm winter weather and delayed disbursement of tax returns to upwards of 40 million Americans. Partially offsetting these headwinds were the benefits of lower unemployment, low fuel prices, and an expanding car parc. Despite the lackluster results, we were encouraged that dealers still speculated volumes would increase going forward, as nearly all of them believe that there is some pent-up demand on the sidelines after a mixed 2016 and slow start to 2017.
Dealers reported mixed demand trends across the other tire categories in the period, with trends turning flat in the commercial truck category, and weaker results persisting in the retread channel. In fact, the dealers who responded to the survey reported medium truck replacement tire volumes were about the same as the prior year in March after being up 0.9% in February, while retread units were down 3.1%, marking a stretch of declines, including three of the past four months.
Dealer costs were slightly higher versus the prior year’s period
The tire dealers noted manufacturer pricing on value and branded products, on a net basis, slightly increased in comparison with March 2016. It is important to remember that 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. As such, cost pressures will likely continue to build.
Inventory levels are just about right despite weak sell-out trends, but dealers see risk
Of the dealers who responded to the survey, 83% of them noted inventories at the end of the month were at an appropriate amount to satisfy demand (vs. 50% in February), while 17% noted inventories were too high (vs. 50% in February), while none noted inventories were too low (vs. none in February). 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 on managing the supply. However, dealers clearly recognize the risk is to the downside should sell-out trends continue to lag sell-in trends. The responses regarding inventory levels among commercial truck tire dealers indicated more mixed results than we’ve seen over the previous few months, as 67% of those surveyed noted they had the appropriate amount of inventory, 16% of respondents indicated inventory was too high, and 16% thought inventory was too low during the period. The net neutral results show inventories are balanced overall, but we believe the varying responses 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 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.
Repair sales increase year-over-year in March
The dealers who responded to the MTD survey indicated automotive repair sales trends improved in March after flat trends in February interrupted four consecutive months of increasing service revenues. Specifically, these dealers indicated service sales, which accounted for a net 18% of total revenues, were up 1.8% on a year-over-year basis in March, which compared to increases of 5% or more from October through January and flat trends in February.Nick Mitchell is senior vice president, research, for Northcoast Research Holdings LLC based in Cleveland, Ohio. Mitchell covers a variety of subsectors of the automotive industry.
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