Dealers continue to benefit from lower tire costs

Jan. 24, 2013

We think that weak consumer demand and the lower prices of Chinese tires in the post-Tariff 421 world continue to be the big stories in the tire industry right now.

After experiencing a pick-up in sales during October, dealers reported that year-over-year unit sales dropped again in November. Whether the weak replacement sales are symptomatic of macroeconomic pressure on the consumer; an unfavorable vehicle replacement cycle (i.e., the country’s light vehicle population is so old that some consumers are planning on getting rid of their vehicles), which in turn is causing consumers to defer replacement unless absolutely necessary; or the lack of inclement winter weather, one thing appears certain: People aren’t buying tires. In fact, the lack of demand is causing growing concern among dealers, which is evident by the gloomiest outlook we have seen from our respondents in years.

On the cost side of the equation, dealers continue to benefit from lower tire costs — especially in the value segment — which reflects the expiration of Tariff 421 and favorable raw material costs. Thus far, the pricing environment at retail has remained rational as dealers are pocketing these savings to recover some of the profitability they lost during the run-up of raw materials. However, we have to ask ourselves: How long will this last when unit demand is as weak as it is? In our view, it is only a matter of time until someone in the marketplace invests these savings into price in an attempt to spur demand. From a bigger perspective, matters were complicated further by the looming prospect of a longshoremen’s strike on the East Coast and the possibility that we could go over the fiscal cliff — neither of which would have helped the industry. It continues to be a fascinating time to follow the industry.

Happy New Year!

Monthly survey

A number of independent tire dealers were surveyed concerning current business trends. Except for tire prices and costs, the results of the November 2012 survey are compared with those of November 2011.

Pessimism emerged in dealer survey

According to our dealer survey, only 9% of passenger tire dealers believed business will improve over the next six months while another 55% believed it will stay about the same. The other 36% believed it will worsen. Meanwhile, none of the truck tire dealers we spoke with saw business improving; 64% believed that business trends will stay about the same and 36% believed it will get worse. November was noteworthy as it was the first time in two years that the percentage of dealers expecting business conditions to worsen outnumbered the proportion of dealers that saw business conditions improving over the next six months. Indeed, some of the feedback we got from survey respondents was downright bleak as dealers noted that consumers are simply strapped for cash and remain unwilling to commit their money to new tires. Moreover, the whispers of needing help from Mother Nature were becoming louder — especially as winter weather has been muted thus far in many parts of the country.

No holiday spending on tires

The modest improvement in tire demand that we saw in October proved to be fleeting, as dealer reports suggest that tire unit sales were soft again in November. In fact, passenger replacement tire sales fell 1.2% versus November 2011 after being slightly positive in October, according to our survey. As we pointed out in our last report, the improvement in October was likely exaggerated by the calendar, which moved a Sunday out of October and into September relative to the prior year. In other words, the optical improvement overstated the true demand underpinning the industry. The weakness was not limited to passenger tires as truck tire sales fell 1.1% while retreads dropped 0.8% — both figures represent deterioration from results in October.


Market continues to pocket value segment savings

Falling raw material prices and the expiration of Tariff 421 have reduced the cost of tires to dealers, which has allowed manufacturers to become a little more aggressive with price — though not as much as some in the industry speculated. Specifically, 63% of passenger tire dealers saw pricing as aggressive, while 18% characterized it as firm and the balance (19%) felt it was normal, which is in-line with responses in October. When it comes to truck tire dealers, 55% of respondents saw pricing as aggressive while 27% noted that pricing was normal. The remaining dealers (18%) saw pricing as firm. As expected, the most aggressive manufacturer pricing was seen in the value arena, as our survey indicated that tire costs fell approximately 2% (after dropping almost 10% in October). Manufacturer price declines were less prevalent on branded tires, as tire costs in this segment fell less than 1% during November 2012. Despite the fact that dealers have seen price relief on tire costs in the value arena, the market is opting to pocket the savings in lieu of passing it along to the consumer.

This is evidenced by the fact that tire prices at retail were virtually unchanged on value tires. Likewise, branded tire prices fell less than 1%.

Soft demand caused inventories to rise

Dealers were reluctant to purchase tires ahead of Tariff 421’s expiration due to their belief that the combination of falling raw material costs and the effect that an influx of inexpensive Chinese tires would translate into manufacturer price concessions. However, they increased their purchases after the tariff expired, which is reflected in the fact that, for the second consecutive month, not a single dealer reported an under-stocked assortment. In fact, the pendulum now appears to have swung the other way, as dealers generally noted that they had more inventory than they needed. Specifically, 70% of passenger tire dealers believed inventories were too high (vs. 47% in October), while the rest believed inventory levels were just right (53% in October). Truck tire dealers fared a little better as only 27% indicated that inventories were too high (vs. 31% in October), while 73% thought inventories were in line with current business levels (vs. 69% in October).

Service continues to be bright spot

In a theme that we have seen for months, dealers who provide service indicated that, during November, it was tailwind to sales trends. Service work, which generated 31% of the total revenues of the dealers in our study, rose almost 5%, which is consistent with results in October. The fact that service work has been a bright spot for dealers this year is even more encouraging given that much of the automotive aftermarket has been challenged this year.    ■

John Healy and Nick Mitchell are research analysts with Northcoast Research Holdings LLC based in Cleveland, Ohio. Healy and Mitchell cover a variety of subsectors of the automotive industry.