Our recent discussions with dealers leave us with a view that sell-out trends improved in May versus the prior year’s period, re-accelerating from year-over-year contractions early in the year. While always somewhat subjective, we note commentary from installers was at the highest level since October 2017. From a volume standpoint, surveyed dealers reported they saw unit sales volumes up nearly 2% relative to the previous year’s period.
We believe one external factor that could have had an outsized impact on consumer purchasing behavior in May could have been the vast disparity in weather conditions between April in May. Although historically April can begin to see positive volume trends as winter weather has abated and the freeze-thaw cycle peaks (especially in warmer climates), Mother Nature delivered the complete opposite this year.
Our analysis of April weather trends suggests that almost half the United States (22 states), recorded months that were in the top 10% of the coldest Aprils ever in their state’s history including Wisconsin and Iowa who registered their coldest April on record. We hypothesized this could have led to consumers keeping specialized tires (snow tires) on their vehicles through the duration of the month until the winter weather had completely passed along with the freeze-thaw cycle and could be partially attributed to April’s lackluster results.
Conversely, May’s weather conditions delivered the exact opposite. Nearly 90% of contiguous states (42 states) recorded months that were in the top 10% of the warmest Mays ever in their state’s history including eight states who registered their hottest May on record. This, in combination with the fact that precipitation levels were normalized throughout the country during this unseasonal heat wave, should not be underestimated on the impact this had on consumers given that just a month earlier much of the United States was experiencing weather conditions that are normally present in the middle of winter. The Goldilocks weather environment of warm spring weather and minimal precipitation present in May could have finally begun to unleash pent-up consumer demand that has been held back by a treacherous winter and delayed tax season. The sustained warm weather could have finally led consumers to unload their winter tires or at least transition to a new set of tires ahead of the summer driving season.
Given May’s results and the positive industry data points thus far in June, most of the headwinds may now be in the rearview, and we continue to expect mix trends to improve in the back half of the year. Accordingly, commentary from industry contacts in early June leaves us feeling incrementally more positive on a go-forward basis could signal a shift in sales trends that would bode positively for the remainder of the year. It appears most factors present that have been working against the industry to start the 2018 are beginning to abate.
In response to best and worst performers, Tier 1 brands curiously continue to remain out-of-favor with consumers. Tier 1 legacy nameplate brands have now been the worst performer for six consecutive months and have only been the top performer in three out of the last sixteen months. Meanwhile, Tier 2 brands regained the top spot among contacts and continued to be the standout performer over the past year as this is a segment value-conscious continually gravitate towards while Tier 3 brands continue to gain momentum at the expense of Tier 1.
While Tier 1 brands continue to underperform the market, we feel the mega-trend of the market shifting to HVA shipments remains a long-term opportunity. Our channel work suggests that channel inventories remain healthy after much of the excess was cleared from the channel in 4Q17 and positions remained lean through the first quarter. We continue to hear from contacts that manufacturers remain disciplined in their production schedules and are not chasing share with pricing. That said, some manufacturers are using promotions to move some of their lower quality/ low margin product, specifically, in the Tier 3 categories, which may help to explain why Tier 3 tires have displayed such strong performance among our contacts. We think the market needs to see a bigger uptick in sell-out trends before the promotional activity moderates.
We continue to view the market as one that is on the mend and hold a view that better things are to come for dealers and wholesalers. In fact, we note the majority of individuals in the dealer community we have spoken with this month continue to have an upbeat outlook for volume trends going forward, driven by the following factors: (1) renewed expansion of the car parc, including an uptick in the number of cars entering the first replacement cycle; (2) the ongoing belief that there is a modest amount of pent-up demand on the sidelines, especially given the lackluster results throughout 2017; and (3) the likely tailwind to consumer spending from tax reform. As such, we expect sell-out trends in 2018 will be more in tune with favorable macro conditions.
A number of independent tire dealers were surveyed concerning current business trends. The results of the Mayl 2018 survey are compared with those of May 2017. See the report on www.moderntiredealer.com.
Replacement tire sales volumes improve
Dealer commentary suggests consumer demand for passenger and light truck replacement ties was notably up in May compared to the prior year’s period. The number of respondents indicating they saw a net increase in demand year-over-year was 15% of contacts compared to May 2017’s 3% of contacts experiencing positive growth. Although too early to label as a trend, May could be an inflection point for 2018 as contacts reported the largest increase in volume in 2018 and we have seen the number of dealers reporting year-over-year increases in tire volumes increase sequentially for three straight months from 26% in March to 41% in May.
With most of the summer driving season still ahead, an accelerating economy, a historically tight labor market, and a confident consumer, pent-up demand could finally be showing through the cracks as consumers may finally be feeling the effects of the tax cuts flowing to their bottom line and this should help lead to increased purchase activity that will realign to levels typically seen during this level of GDP growth.
A look at mix trends in the market
Our May survey suggests that consumer demand has not shown much variance from a product category standpoint. Our survey work continues to illustrate that although consumers may desire a recognizable brand, the product’s price point is the main factor driving the purchasing behavior. This is especially true when customers arrive at the garage due to unexpected technical difficulties.
The theory that an accelerating economy, confident consumer and tight labor market would allow opportunities for industry participants to upsell toward more recognizable (and expensive) nameplate brands has not played out in reality. We note that since December 2017, Tier 2 and 3 brands have been ranked as the top two choices by consumers while Tier 1 continued its six-month skid at the bottom of the rankings.
Last month, we called out rapidly rising oil prices as a factor that could put downward pressure on sell-out trends as that could limit the amount of consumer’s discretionary income available for tire purchases and could lead to trading down to lower tiered products or delaying purchase decisions altogether. However, oil prices have stabilized, for the time being, and OPEC and non-OPEC producers have been hinting at increasing oil output to cool down the overheated market and replace supply that will be lost from Iran and Venezuela.
Although the stabilization is encouraging despite gas prices remaining at a multi-year high, there seems to be a new factor present that could impact consumer purchase behavior. When assessing raw material spot market costs, prices are up 4% y/y QTD and 6% when comparing May 2018 to a year-ago. We note that if raw material prices were to hold steady, the cost of producing a tire would be up 8.2% over the average price during 2H17.
There is a lag time of 4-6 months for many of these input costs increases to truly impact the producers, but if this trend continues, manufacturers may no longer be able to keep absorbing the increased production costs and may have to pass them downstream to consumers, which could ultimately hurt sales volumes down the road. This, in turn, would push prices higher for tire SKU’s, and as such, the trend of consumers shopping frugally may be exacerbated in the back-half of the year.
John Healy is a managing director and research analyst with Northcoast Research Holdings LLC based in Cleveland, Ohio. Healy covers a variety of subsectors of the automotive industry.