Pricing Environment Is Seen as Stable and In-Line With Raw Material Costs

Aug. 12, 2019

Our recent conversations with dealers provide us with a view that retail sell-out trends remained healthy in June and continue to trend on the positive side of the ledger. From a volume standpoint, surveyed dealers reported they saw unit sales improve in the low single-digit range compared to the prior year’s period while rising at a similar cadence for Q2 after improving in the low single-digit range in 1Q19. As we enter the third quarter, we largely see a fairly stable industry backdrop with an environment of stabilizing raw material trends.

For the second quarter as a whole, our survey work suggests a mixed bag in terms of tire retailing trends in Q2. More specifically, volume trends rebounded at the beginning of the quarter after showing a deceleration at the end of 1Q19 before experiencing a slowdown midway through Q2 (especially in the Midwest) while finally rebounding and experiencing an improved level of sell-out the last few weeks of the quarter. 

While we believe trends were still slightly higher year-over-year for the quarter (up low single-digits), we note trends of our index on a three-month moving average basis moved lower sequentially to an index reading of 62.1 from 62.8. All in all, we would describe Q2 as one of growth but ever so slightly as it relates to units sold at retail. From a pricing standpoint, the environment was one where pricing gains were held but additional increases, while seemingly achievable, have yet to be made.

With that being said, our recent channel work has led us to believe Goodyear instituted a price increase of 1% to 1.5% in early July 2019 on certain popular SKUs. We believe that manufacturers have been contemplating implementing price increases but have been gun-shy given the moderation in demand compared to Q1, however, given that one of the industry leaders appears to have made the first move, we would not be surprised to see other manufacturers follow suit in the coming months.    

Looking closer at the recent trajectory of raw material costs, the basket of raw materials to make a common replacement vehicle tire rose 1.3% on a year-over-year basis in June while decreasing 1.3% from May. From a quarterly perspective, raw material costs rose approximately 1.7% versus 2Q18 while registering an increase of 3.9% from 1Q19’s levels. Furthermore, holding current spot prices flat would yield a 1% year-over-year increase in input costs in 3Q19 to “build a tire” (-0.1% from 2Q to 3Q).

It is worth monitoring raw material cost inflation closely through the rest of the year to gauge whether more manufacturers will have to exercise pricing actions to offset higher costs like the industry experienced in 2H18; we note this has already been taking place in the commercial truck tire market. 

In assessing raw material price movements, we note carbon black continues to experience significant cost pressures and is still increasing at a double-digit rate on a year-over-year basis (mainly since the beginning of 2018), natural rubber prices continue to display a notable rebound and have remained positive on a year-over-year basis for three consecutive months for the first time since July 2017 while crude oil prices have experienced notable pressure since peaking in April (down LDD year-over-year). Meanwhile, synthetic rubber costs have remained negative for three straight months year-over-year and price pressures on reinforcement items (cord, fabric, etc.) continue to track negative year-over-year at a low-to-mid single-digit rate.

Although tire industry trends profit levels are often held hostage to raw material cost inflation, weather patterns, and competitive dynamics (supply/demand, capacity additions, etc.), we reinforce our view that the market continues to strengthen and that the outlook remains healthy for dealers and wholesalers. In fact, we note the majority of individuals in the dealer community we have spoken with this month have an upbeat outlook for volume trends going forward, driven by the following factors: (1) continued 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 from deferred maintenance, especially given the lackluster results throughout 2017 and most of 2018; (3) continued upward trajectory of miles driven and (4) a solid economic backdrop that has created a healthy, confident consumer. As such, we expect sell-out trends in 2H19 to become more aligned with this level of GDP growth.

Until next time, keep the tires rolling out the door.

Monthly survey

A number of independent tire dealers were surveyed concerning current business trends. The results of the June 2019 survey are compared with those of June 2018. 

Replacement Tire Sales – Selling Environment Suggests Accelerating Trends at the End of the Second Quarter

Dealer commentary suggests consumer demand for PLT replacement tires rose in June compared to the prior year’s period. The net number of respondents indicating they saw an increase in demand year-over-year was 33.3% of contacts compared to June 2018’s 2.7% of contacts experiencing positive growth. We note that our tire demand index was up nearly 30% year-over-year (up 16.7% from May) and we continue to hold a view that volumes are becoming more closely aligned with the current level of GDP growth as our dealer contacts have seen 12 straight months of positive volume growth.

As we enter the third quarter, most of the headwinds may now be in the rearview given a fairly stable industry backdrop with an environment of stabilizing raw material trends and we continue to expect mix trends to improve in the back half of the year. 

A Look at Mix Trends in the Market

In response to the best and worst performers, our recent survey revealed that Tier 2 brands were the segment of most significant growth among our surveyed contacts for the first time since November 2018. On the other hand, Tier 1 returned to the bottom of our rankings in June (first time since January 2019) while Tier 3 held steady in the middle for the second consecutive month. Tier 2 returning to the top was only a matter of time as we have long conveyed that the combination of price and performance that Tier 2 tires provide continues to make it the segment of the most significant growth among our contact base over one, two, and three-year time frames (as well as 10 of the last 19 months).

We are not surprised to see Tier 3 fading in strength as we have hypothesized that any strength seen in Tier 3 is transitory in nature and we expect consumers to opt for higher quality and performance given customers are more comfortable with recent pricing actions and recent tariff movements. We point out that on a longer-term basis, Tier 3 brands have been ranked or tied for last place by our respondents in 26 of the past 58 months (have only been atop our rankings foue times in the last 21 months).

We surmise the recent strength seen in the Tier 1 category over the past few months is no coincidence and could continue in the near term as long as consumers remain confident and spending healthy. The reason for this can mainly be attributed to recent tariff actions on Chinese imports as this puts domestic manufacturers (like Goodyear) in a net positive position. Higher quality brands could see some benefit in the U.S. replacement market as imported products become more expensive and could result in consumers purchasing quality products and brands as the playing field levels out and the price gap closes.   When examining the landscape from a longer-term view, we continue to believe that the pricing environment in North America will remain rational and in-line with raw material costs. We expect Tier 1 and Tier II producers to continue remaining disciplined in their efforts to manage the price/volume trade-off to maximize operating profit rather than market share, as well as capture the mix benefit from the shift to HVA tires. We are pleased with the disciplined approach to production schedules that we have seen at the manufacturing level and global inventory levels remain relatively lean.

Moreover, dealers and wholesalers are being tactical with their approach to inventory allocation given legislative moves (tariffs), recent pricing actions, and volatile raw material prices; essentially, downstream players have been directing orders in a way to capitalize on pricing spreads in the market.

P.S. – If you would like to be included in our monthly discussions with dealers, please do not hesitate to reach out to me directly at [email protected].

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.

About the Author

John Healy

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 and writes MTD's monthly Your Marketplace column. If you would like to be included in the monthly dealer discussions, contact him at [email protected].