Sell-Out Trends Will Accelerate Throughout the Next Six Months
According to the results of our survey, demand for passenger and light truck replacement tires declined in February. Indeed, from a volume standpoint, the dealers reported they sold 1.4% fewer tires in February relative to the previous year’s period. The decline marks the second straight month of weak results, as respondents reported a slight decrease in sell-out trends in January.
Needless to say, the warmer-than-normal winter weather seen in January persisted in February, creating an unfavorable operating backdrop. In fact, nearly every tire dealer and distributor whom 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. Our contacts also suggested they believe the delayed disbursement of tax refunds to upwards of 40 million individuals pushed sales out of January and February into March, which compounded the weather headwinds. In our opinion, the slow start to the tax season is 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 that cumulative tax refunds were down 7% year-over-year through the end of February despite disbursements being up over 80% since Feb. 10. The latter stat helps explain why many of the respondents noted traffic and sales picked up significantly in the second half of the month. Lastly, the loss of Leap Day also contributed to the shortfall. That said, these headwinds were partially offset by the benefit of a better economic backdrop for consumers including, higher employment levels, improving consumer sentiment and low fuel prices.
Despite the slow start to the year, we continue to believe 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 survey 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 dealer community will be able raise prices to offset the cost pressures. 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. That said, we are paying close attention to commentary regarding inventory levels given the slow sell-out trends in the first two months of the year. 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 in March and April. To this point, we were encouraged to hear dealers indicate the second half of February was much stronger than the first half of the month and strong demand has continued into March. Until next time, keep the tires rolling out the door.
A number of independent tire dealers were surveyed concerning current business trends. Except for tire prices and costs, the results of the February 2017 survey are compared with those of February 2016.
Dealers still expect gains in 1H17
According to the survey results, 67% of passenger and light truck tire dealers believe business will improve over the next six months, and none are worried that trends will worsen. The rest of the respondents, 33%, felt business trends will stay about flat with the previous year. 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 and 60% see business trends staying about the same. None of the participants believed commercial truck tire demand trends would worsen. The table highlights the outlook that the respondents have conveyed to us in recent months.
Volume trends contract due to transitory headwinds in February
According to dealer reports, consumer demand for passenger and light truck replacement tires declined in February compared to the prior year’s period. From a volume standpoint, the dealers reported they sold 1.4% fewer tires last month relative to the previous year’s period. The decline marks the second straight month of weak results, as respondents reported a slight decrease in sell-out trends in January. Not surprisingly, many installers blamed transitory headwinds for the poor results, including unseasonably warm winter weather, delayed disbursement of tax returns to upwards of 40 million Americans, and the loss of Leap Day. 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 positive in the commercial truck category, but weaker results in the retread channel. In fact, the dealers who responded to the survey reported medium truck replacement tire volumes were up 0.9% in February after being down 0.4% in January, while retread units were down 5.7% after being up 1.8% in January and down 11% in December.
Dealer costs modestly increase versus the prior year’s period
The tire dealers who responded to the survey noted manufacturer pricing on value and branded products increased modestly in comparison to February 2016. Specifically, branded tire costs increased 2.8% and value tires were up 2% versus the same period a year ago. It is important to remember that the first pricing increases from manufactures would become effective in February 2017 with the majority to follow in March and April. As such, cost pressures will continue to build. Meanwhile, the dealers noted that like-for-like incentives were firmer (less discounting) in the period due to the industry’s successful rebalancing of inventory levels in 2H16.
Inventory levels rise slightly due to weak sell-out trends in early 2017
Of the dealers who responded to the survey, 50% of them noted that inventories at the end of the month were at an appropriate amount to satisfy demand (vs. 60% in January), while 50% noted that inventories were too high (vs. 20% in January), while none noted inventories were too low (vs. 20% in January). Dealers indicated the weak sell-out trends year-to-date are partially responsible for inventories being too high at the end of the period. As noted earlier, this build-up of inventory could threaten dealers’ ability to raise prices, however, many expressed a viewpoint that they were comfortable with their inventories heading into the busy spring season and expected demand trends to improve, especially given the strong results in the second half of February. We share the sentiment that the higher inventories reported in the latest period reflect transitory headwinds rather than a lasting imbalance between supply and demand. That said, we will keep a close eye on dealer’s commentary regarding inventory moving forward.
The responses regarding inventory levels among commercial truck tire dealers indicated more mixed results than we’ve seen over the previous few months, as 20% of those surveyed noted they had the appropriate amount of inventory, 40% of respondents indicated inventory was too high, and 40% thought inventory was too low during the period. The neutral net result shows inventories are balanced overall, but we believe the varying responses can be directly tied to the mid-February International Trade Commission (ITC) ruling, which determined that no anti-dumping/countervailing (AD/CV) duties will be levied against Chinese truck and bus tire (TBR) manufacturers. Prior to the ruling, dealers reported that they were still working off the product associated with all the pre-buy activity, but now some dealers feel they are under stocked given the prices of TBR tires are coming down significantly.
Repair sales were essentially the same year-over-year in February
Dealers indicated automotive repair sales trends were about the same as last February after four consecutive months of increasing service revenues and mixed results throughout the first half of 2016. Specifically, the dealers who responded to the survey indicated service sales, which accounted for a net 29% of total revenues, were flat on a year-over-year basis in February, which compared to increases of 7% in October, November and December and a 5% increase in January.
Nick Mitchell is a managing director, research analyst with Northcoast Research Holdings LLC based in Cleveland, Ohio. Mitchell covers a variety of subsectors of the automotive industry.
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