Saul Ludwig has a sixth sense of sorts, which comes in handy when you are the pre-eminent analyst in the tire industry. He can see not only what is happening inside and outside the marketplace, but also how that affects the future.
In essence, he combines an acute attention to detail with the ability to see the “big picture.”
He knows, for example, that because raw material prices rose dramatically this year, Cooper Tire & Rubber Co.’s profits were negatively affected because it follows the LIFO (last in, first out) accounting method. Goodyear Tire & Rubber Co., however, reaped benefits from managing its inventory using the FIFO (first in, first out) method.
That doesn’t mean he is always right. As he likes to say, an analyst “is often wrong, but never in doubt!”
Ludwig focuses on the tire and chemical industries as a managing director at Northcoast Research Holdings LLC. This is the 40th consecutive Facts Issue that has featured Ludwig’s in-depth analysis of the tire industry.
MTD: How do you explain the roller coaster — some might say schizophrenic — year we’ve had with consumer tire shipments quarter to quarter?
Ludwig: The year began with dealer consumer tire inventories very low, so they bought heavily in the first quarter of 2011. And because fill rates were a problem, they double-ordered tires. So shipments increased by 9% in the quarter compared to the first quarter of 2010.
In April, however, gasoline jumped to over $4 a gallon, and purchases fell. Dealers purchased 7% fewer tires in the second quarter than they did the previous year.
Shipments were flat at best during the summer through September, when publicity about a weakening economy and an increasing unemployment rate did nothing to jump-start tire sales. By the fourth quarter, as raw material costs began to subside, dealers pulled in purchases believing that tire prices would go down. They didn’t want inventory that was potentially devalued. That added to extreme volatility in the consumer tire business throughout the year. As a result, consumer tire shipments were down a couple of percentage points in the last three months. In contrast, demand for truck tires remained firm most of the year, but tailed off a bit in the fourth quarter.
MTD: We are in the third year of the tariffs enacted on Sept. 26, 2009. How much of an effect do Chinese consumer tire imports to the U.S. have on the marketplace at this time?
Ludwig: I don’t think the tariffs had much effect on the market. Through September, Chinese passenger tire imports fell 14%, but imports from elsewhere rose 11%. Overall, total imports actually increased 3%. Because domestic tire shipments were flat, imports gained a little market share.
As far as tire prices are concerned, the tariff alone possibly accounted for a small percentage of the increase, but the main influence on prices was the 26% increase in raw material costs. The tariffs had no effect on jobs, in my opinion, as other imports more than made up for a fall off in Chinese imports.
MTD: What do you think will happen on Sept. 26, 2012, when the 25% tariff is removed? Will the government try to keep some sort of tariff in place?
Ludwig: I do not expect the government to extend the tariff. It has bigger battles to fight than this one. What will happen then? Chinese tire manufacturers will resume shipping to the U.S., and imports from other countries will likely decline. Prices might come down a bit — assuming no change in raw material costs — but it won’t be dramatic. Chinese labor costs continue to rise, as does shipping costs, and the Chinese government will stop giving Chinese tire manufacturers subsidies. Overall, imports will probably continue to gain share versus domestically produced tires. I think having free trade without the tariff is appropriate.
MTD: Will there be any more plant closings in North America in the next few years?
Ludwig: I do not expect any more plants to be closed in the U.S. in 2012. But longer term, there are still some older, less efficient plants that may be closed. Multi-million dollar expansions in the U.S. by Continental, Bridgestone and Mitas, plus Titan’s purchase of a closed Goodyear plant, are a welcome reversal of what was a long-term decline in U.S. tire manufacturing. The Kumho plant is still on the back burner.
MTD: What were the defining moments in the industry in 2011?
Ludwig: I can think of three.
1. Goodyear’s much improved profitability. In 2010, Goodyear’s segment operating income, that is, income from its day-to-day operations before subtracting interest, taxes, corporate items and special expenses, was $917 million. In 2011, it could be close to $1.5 billion — a rather dramatic improvement.
2. Surging raw material costs were met with multiple increases in tire selling prices.
3. The major capacity expansions in the U.S. noted above were unexpected when 2011 began.
MTD: What were the U.S. replacement shipment highlights in 2011 vs. 2010 for passenger, light truck and medium truck tires?
Ludwig: In 2011, passenger tire shipments were flat, while light truck tire shipments were up about 3%, to 29.6 million units. Consumer shipments this year were less than I expected at the beginning of the year, although not by much, and that was because of high gasoline prices. I predict modest increases in 2012.
Medium truck tire shipments actually finished lower than I predicted, although at 16.5 million units, they were still more than 4% higher than in 2010. Truck tire shipments will be comparatively flat in 2012.
MTD: In the original equipment tire segment, how did the consumer and commercial numbers shake out in 2011?
Ludwig: I would say my 2011 OE predictions made last year were pretty close. Passenger tire shipments came in at 35 million, just as I estimated. Light truck and medium truck tire shipments finished a little higher: 4.1 million and 3.9 million units, respectively. Vehicle manufacturing will continue to rebound from 2009 levels, and OE shipments in all three categories will follow suit.
MTD: How will political uncertainty in Washington, D.C., entering an election year affect our industry?
Ludwig: One key will be whether or not the tariffs are allowed to expire and as stated herein I expect that they will. I would view an extension of the tariffs detrimental to the U.S. tire industry, and some of the capacity expansions recently announced could be at risk. The inability of Congress to work together and thus, leaving uncertainty about future taxes and legislation, is viewed negatively by most observers.
While it’s hard to make the connection definitively, manufacturers have been reluctant to recall previously laid-off workers, and the unemployment rate has remained high. Agencies who place temp workers have boomed as manufacturers have gone that direction versus rehiring permanent staff. On one hand, the auto industry has seen a surprising resurgence, yet consumer replacement tire sales have not recovered, even though as a general rule, if the OE segment is strong, that bodes positively for replacement shipments. Despite historically low interest rates, housing is still limping along. Certainly a more cooperative political climate would be a big plus.
MTD: How did raw material costs in 2011 compare to 2010? How will raw material costs in 2012 compare to 2011?
Ludwig: Tire raw material costs increased an average of 26.6% in 2011 compared to 2010. That’s on top of an average 25% increase in 2010 vs. 2009. In particular, butadiene and natural rubber pricing skyrocketed. However, we’re ending the year with prices lower than the average for the year — 12% lower. Will they remain at the year-end level? I don’t know.
MTD: Tire wholesalers seem to be jockeying for position. In addition to American Tire Distributors (ATD), Terry’s Tire Town has made major moves. And Michelin’s TCi wholesale division is adding distribution centers. How has this affected our industry? Do you think this regional/national trend will continue?
Ludwig: Yes, there was a major consolidation and expansion of wholesalers in 2011. ATD is the most aggressive in opening several new distribution centers, but Carroll Tire (owned by TBC Corp.), TCi (owned by Michelin North America Inc.), and TDW (owned by Hercules Tire & Rubber Co.) also have grown. Terry’s Tire Town acquired two competitors. Regional wholesalers such a Capital Tire in Toledo, Ohio, Sullivan Tire in Boston, Albert Tire in New Jersey and Kauffman Tire in Atlanta, just to name a few, also have expanded.
The proliferation of tire brands, names and sizes has made it impossible for the average retail dealer to carry every tire a customer might need. Many years ago when retailers were consolidating at a rapid pace, some wholesalers sold their businesses fearing that tire dealers would buy more of their tires directly from the manufacturer.
But the opposite has occurred and even the largest tire retailers in the country have to buy some tires from wholesalers because of the variety of products that have been introduced by the OE auto companies.
Wholesalers had to grow. The trend toward wholesalers’ gaining share of tire distribution is likely to continue, so manufacturers must be diligent with whom they align as this trend proliferates.
MTD: What are your thoughts on Pep Boys – Manny, Moe & Jack and its movement in the aftermarket?
Ludwig: Under the leadership of CEO Mike Odell, Pep Boys has made very good progress reshaping a company that was under-managed for several years. He inherited a mess. Turning around a large organization like Pep Boys takes time; it had some stores where they had no competitive advantage and other stores that were too large relative to the business being done.
They have made good progress turning the company around, yet more work remains to be done. Management and its board feels now is the time to leverage its business base. Pep Boys acquired about 100 stores in 2011 to augment its Dec. 2010 store count of 700, and opened about 20 new stores on its own. And more acquisitions are being aggressively pursued — Mike Odell told me that he is in negotiations with 10 retailers. All acquired stores will be renamed Pep Boys to leverage advertising and the broad consumer awareness of its name. Pep Boys also introduced major brand tires in addition to its historical private brand offerings of Futura, Cornell and Definity tires that are produced by Cooper and Hankook. It is too soon to claim victory, but it does appear that progress is being made.
MTD: As always, thanks for the insight, Saul!
4 on the floor in 2012: Ludwig says pay attention to these critical issues
When asked, “What are your top matters of concern or interest to watch out for in 2012?” tire industry analyst Saul Ludwig, a managing director at Northcoast Research Holdings LLC, answered as follows.
1. Price decreases. “With raw material costs having subsided, will there be much price give back by the tire manufacturers?”
2. Too much capacity? “There are currently 30 new consumer tire plants and 10 medium truck tire plants being constructed someplace in the world. About 45% of that new capacity will be in China, but expansions are actually underway in 15 countries, and this new capacity will come on stream beginning in 2012 and continue through 2017.
“Dealer inventories are close to normal right now. While I believe that new supply will closely match new demand, the possibility of having too much new capacity before it is needed is always a concern. I will be monitoring these developments very closely.”
3. Elimination of tariffs on Chinese imports. “Will my post tariff expectations play out as expected? Might the Chinese government give local manufacturers who export tires to the U.S. some early, but temporary, incentives so as to get the plants operating sooner than would otherwise be the case? And if so, might we see a surge of low priced tires enter our country soon?”
4. Campaign promises. “With the economy being the most important aspect of the coming election in 2012, comments and promises of the candidates could impact business decisions during the year. This is an uncertainty that could impact both business and consumer decisions on spending. I cannot predict how this will unfold, but it certainly bears close watching as we move through the year.”
(For charts on the domestic tire shipments, 2010-2012, and raw material cost chages, year-to-year click here.)