'Return to Normal?' Analyst John Healy Discusses Why The Tire Industry Will Move Forward - Not Backward - in 2021
As an analyst at Northcoast Research Holdings LLC, John Healy has a bird’s-eye view of the domestic tire industry. Healy, who also writes MTD’s monthly Your Marketplace column, calls 2020 “the most unpredictable and at the same time, the most surprising” year in recent memory.
“It was not a terrible year to be in the retail tire business,” he says. Healy explains why - and looks ahead to 2021 - in this exclusive MTD interview. “From our perspective, 2021 will be all about managing a ‘return to normal.’ However, defining ‘normal’ is the difficult part.”
MTD: Many consumer tire dealers have told MTD that their business has rebounded much more quickly than anticipated. From your perspective, what drove this? And did the rebound surprise you, as well?
Healy: Being in the prediction business is not something that was easy in 2020 and expecting the tire industry - on the replacement side - to hold up as well as it has was unexpected. We view tire replacement demand as something that contains a high degree of variability due to weather, economic and miles driven-related factors.
We estimate that the United States replacement market was down high single digits this year, with summer activity levels for many dealers above year-ago levels, while not quite recovering from the demand destruction caused by the pandemic.
That said, there are probably a number of reasons in hindsight that could be described as contributors, including changes in miles driven as consumers moved away from flying to more controlled environments, such as their own vehicles; increased money in the pockets of some consumers due to stimulus activity this summer; and some pent-up demand that was released, associated with deferred maintenance.
Additionally, we note that Walmart idled its automotive car centers for much of the year, roughly mid-March through September, with the retail giant using this part of the store for health screenings, while also experiencing tight labor dynamics.
Given this, we think this business needed to go elsewhere and likely created some demand lift for those who remained open to serve customers. Being open with the right tires is a big part of the battle for business. And independents largely were able to do that in 2020.
MTD: During COVID-19, dealers have reported that many customers have flocked to lower-priced brands, which also has been validated by your own research. How long will this trend last?
Healy: The movement to tier two and tier three manufacturers from a replacement market standpoint is not new and is something that probably is driven solely by one factor: price. We believe this value part of the market experienced above-market growth trends in 2020.
We think consumers at times are reluctant to pay up for tires when replacement activity is needed. We also think the move towards SUV and pick-up trucks brings with it some additional surprises, as some customers are stunned at the bigger price for bigger tires compared to previous models of vehicles owned.
As we look to 2021, there is potential for growth in the value category to see some abatement. We are of the view that if tariffs/duties are imposed on import units, we will see the price point of these units move higher as distributors and retailers will pass along these increases to the consumer.
This, by default, will narrow the pricing gap between value and tier-one brands and thus will potentially allow tier-one operators to recoup some share or pass along their own form of price hikes. From where we sit today, we think tier-one brands will look to push pricing higher and not aggressively play the share game.
MTD: How long will it take for the North American tire market to return to 2019 levels?
Healy: We see the tire market in North America as the summation of four parts: original equipment, replacement, consumer and commercial. In any given year, each of these end markets may be benefiting or hurting from a number of factors. That said, as we look to 2021, it’s hard for us to see how each of these markets are not in growth mode.
Given this, we do not think it is unachievable for the industry to climb back to 2019 levels in 2021. We look for more consistent auto production and auto sales to be items that happen on both the consumer and commercial side of the market in 2021, which will help aid the tire industry.
Additionally, the pending tariff situation could allow for share gains for U.S.-manufactured units, as well. We think industry inventories are on the skinny side these days. But there could be a situation where if winter weather is severe enough, the first part of 2021 could see some further lift than the recovery/rebound we have seen in recent months.
"Being open with the right tires is a big part of the battle for business," says Healy. "And independents largely were able to do that in 2020."
MTD: During 2021, the U.S. Department of Commerce is expected to announce its final ruling on whether tariffs should be imposed on consumer tire imports from South Korea, Taiwan, Thailand and Vietnam. If punitive tariffs are enacted, what will be the short-term and long-term impact on the U.S. market, including the impact on those companies that either manufacture or bring in tires from those four countries? Will this force an eventual shift in manufacturing to other countries or zones? And how will tariffs impact tire dealers?
Healy: The impact of tariffs and the ultimate beneficiaries is always complicated. That said, we see domestic manufacturers that produce in this region as winners. Given this, we think tariffs likely increase the cost of imported passenger/light truck tires and as such, give a level of cover for domestic manufactures to pursue share gains or to push along price. We think the lean is towards price.
Roughly 30% of the U.S. replacement market is sourced from Southeast Asia and we believe that there are limited paths for these tires to go elsewhere, which we believe creates a favorable window for domestic, in-region manufacturers.
MTD: Despite the impact of COVID-19, it appears that merger and acquisition activities did not slow down during 2020. The biggest acquisition last year, of course, was Meritage's purchase of Les Schwab Tire Centers. Do you expect Meritage to make any substantive changes to Les Schwab's operations? What are some of the complexities of an outside-the-industry entity purchasing and running such a large, well-established property?
Healy: We have long been admirers of the Les Schwab operation. It is hard to say that there have been many in the industry more successful than those who have worn that name badge. While the motivations of an acquirer are never fully known to us as outsiders, we would say major changes to the Les Schwab operation would be unwise. ‘Why change what is working?’ is what we would ask Meritage.
Additionally, (Schwab’s) go-to-market strategy from a branding/service standpoint has unique attributes that if altered, may have a long-term impact on the business. That said, all acquisitions bring about change and we - like everyone else - will watch with bated breath to see what unfolds for this great operator.
MTD: Greenbriar Equity Group continues to acquire dealerships and auto store chains. Leeds West Groupscontinues to expand its footprint, primarily by buying Big O and Midas franchise locations. What should we expect to see from both companies in 2021? In addition, Monro has returned to the M&A game after a brief time-out. Do you expect Monro to make more acquisitions, and if so, when?
Healy: If 2020 couldn’t derail the M&A train, we are not sure what will. As we look at 2021, the pace of M&A was somewhat slower, but with some very high-profile deals occurring.
We think private equity-backed outfits - as well as strategics, like Monro - still remain committed to getting bigger via acquisitions. With the durability of the business demonstrated last year, we see this as likely, causing some to believe that the time is right to make more deals in the space.
As we look at the situation at Monro, we are of the view that the company remains committed to pursuing strategic M&A - especially on the west coast - to complement the company’s initial inroads into that market.
That said, we do think that the splashy, larger-type deals are likely off the table until a long-term answer for Monro’s CEO position is defined. Once this occurs, we imagine that there will be an incubation period for new leadership and the board to get on the same page for the long-term approach to M&A and growing the business.
"When the transaction occurs, we think many - if not most - customers want the approval and viewpoint of a trained tire professional," says Healy. "We have a long-term view that tires are sold and not bought."
MTD: 2020 was an interesting year for e-commerce. Michelin North America Inc. discontinued its e-commerce platform. Other platforms, like SimpleTire LLC, have continued to invest in enhanced capabilities. More consumers, as a whole, are turning to online sellers, as many tiremakers have noted. What's your take on the e-commerce channel as 2021 begins?
Healy: It is hard to read into moves that companies made to de-emphasize investments in 2020. The pandemic made spending on many initiatives subjective for nearly all companies and we would not read into the curtailment of e-commerce offerings by any outfit as a long-term indicator of lack of fit or viability.
We think the e-commerce situation for the tire industry is one that is somewhat of a work in progress. We think tire research - for example, how much to pay and consumer reviews - is an area that continues to garner traction and grow.
That said, when the transaction occurs, we think many - if not most - customers want the approval and viewpoint of a trained tire professional. We have a long-term view that tires are sold and not bought. This nuance centers around our view that consumers ultimately want to make sure (they consult with) someone who knows how those tires will fit, how they respond and most importantly, their quality, prior to making the purchase decision.
Outside of the actual purchase and research side of the tire buying process, we think scheduling service online and via apps is an area where national and regional outfits are gaining traction. We think having an e-commerce service solution is of more importance than having an e-commerce tire buying offering. And we expect that this will be the case for some time.
MTD: Several manufacturers implemented price hikes in 2019, followed by more increases as 2020 drew to a close. A number of tire manufacturers also implemented price increases on Jan. 1 and more are on the way in February. Will we see another wave of price increases in 2021? Is so, what will drive this?
Healy: Tire pricing is and always will be something that is driven by input costs, just as much as the motivations of manufacturers and supply/demand. Will this change in 2021? Unlikely.
We see an industry that had to idle production in the spring (of 2020), which has brought about a depletion of industry inventories. We continue to hear from dealers that fill rates and supply are sub-optimal. Given this, along with the potential for tariffs, the industry is well-positioned for some pricing lift.
Additionally, we think as demand goes, so will raw material prices. Given more steady production, it is likely that some key input costs will lift higher in 2021 and tire manufacturers will see input cost inflation.
MTD: Tire company executives are placing greater emphasis on “future mobility” (autonomous vehicles, electric vehicles, etc.) But many of these vehicles aren’t due to hit the market for several more years. How should tire dealers approach this shift, considering the fact that EVs currently make up a relatively small part of the market?
Healy: I see the move towards EVs as having larger ramifications on dealers who provide more traditional auto care service outside of tires. Changes to engineering and functionality of the vehicle will bring about changes in traditional repair cycles, as well as what drives store traffic. (Gone, in some cases, will be oil changes as a traffic driver).
For many traditional tire dealers, we do not see EVs as having medium-term implications. That said, one could argue that with changes to EVs, there could be a level of awareness towards the maintenance of the vehicle that is different due to the vehicle being seen as more fragile or unpredictable to the customer, especially in the case of first-time EV owners.
Given this, we could see higher attachment rates of OE fitments on vehicles as they enter the replacement cycle, thus causing dealers to stock up on higher-priced inventory, rather than value offerings, which have become popular in recent years.
MTD: What will the incoming Biden administration mean for the domestic tire industry and tire dealers?
Healy: With any change in administration, there will be significant changes to global trade, as well as how Americans feel about their financial future. Over the last four years, the Trump administration provided a good level of economic cover for the industry and brought about some protection from a trade standpoint. Going forward, we are not of the view that some of these benefits to the industry will change.
During the Obama administration, there were policies that were pro-U.S. tire industry, from a duty standpoint on Chinese imports. And at this point, reading the economic tea levels does not yet make us conclude that the backing the industry has received will dissipate.
Regarding the impact of changes in the administration on underlying demand, we think that more cash in the consumer’s pocket helps tire demand. So if Biden’s efforts can be accretive to the economic outlook, then we would expect positive things for the replacement and OE market. If not, things might not be as bright as they have been the last few years.
As we look to 2021, we think the normalization of economic activity and the re-emergence of the American consumer after the availability of COVID-19 vaccine will be a bigger impact than what either administration could have on the industry.
MTD What are the most critical things that independent tire dealers should prepare for as 2021 begins? What should they keep an eye on?
Healy: From our perspective, 2021 will be all about managing a ‘return to normal.’ However, defining ‘normal’ is the difficult part. We do not expect a rebound in travel activity until the second half of 2021. Some in the forecasting business believe it may take two to three years for travel levels to return to pre-Covid-19 levels.
Additionally, the recent de-urbanization of some cities brings unknowns. Will people return to some major metro markets or will working from home/remotely be with us for a longer period? That’s still anyone’s guess. Given this, we think finding out what the new normal is should be the place where we start the planning process.
Beyond this, reducing friction in terms of serving the customer is also key. A focus on a better in- store experience and e-commerce are areas of increased attention and focus by many large automotive players and we think tire dealers should not be excluded from this group.
We see it as very unlikely that anything that took place in 2020 will cause the industry to go backwards in terms of progress. This means more appointments booked online, customers shopping for the best price and even in some cases, tires being delivered to the customer with dealers serving as installation partners.
Customers and the industry are changing and this change will only continue in 2021. While some may wonder if tires will be bought online in a major way, we remain reluctant to support that view. That said, we believe dealers need to have a strong online presence to book appointments and also give customers the ability to find them when they are in need of support.