The Average Customer Continues to Look More Toward Quality Than Value

Dec. 13, 2019
Feedback from dealers leaves us with a view that retail sell-out trends showed strength in October with a notable pickup in momentum from September. From a volume standpoint, surveyed dealers reported they saw unit sales improve roughly 1% to 2% compared to the prior year’s period and came in as the third highest observed growth rate in our tire demand index for the year.

As Mother Nature can single-handedly dictate the ebbs and flows of sellout trends in the tire industry, climate conditions were a noteworthy topic last month as temperature across the country were largely below the levels seen in October 2018 and experienced extremes on both ends when compared to 20th-century averages. We point out that the comparisons from the prior year’s period come off an average October, while the preceding months were typically much hotter than observed averages.

More specifically, October 2018 only saw 5 states report a month that was in the top 10% warmest October’s on record with two states reporting the month was in the top 10% coldest October’s on record. Fast forward to October 2019 and our data indicates that 11 states experienced an October that was in the top 10% warmest October’s on record with temperatures markedly elevated in the Southern part of the United States. Such hot temperatures can place a notable strain on vehicles which could cause any number of problems that will lead consumers to bring their vehicles into repair shops which could reveal additional problems and allow dealers to upsell customers on other items like tires.

It should also be noted that these relatively warm areas of the country were offset nationally by colder than usual temperatures in the Midwest and Western part of the United States, with 14 states in these regions experiencing their top 10 coldest October’s on record.

Additionally, while temperatures were slightly below last year’s levels, precipitation was notably elevated, particularly in the South and Midwest where 13 states had their top 10% wettest October’s ever while Mississippi experienced their wettest October on record. These rainfall records led to a 15% increase overall compared to October of 2018 which will likely lend an additional sellout tailwind into November and December.

Looking closer at the recent trajectory of raw material costs, the basket of raw materials to make a common replacement vehicle tire fell 8.2% on a year-over-year basis in October while decreasing 0.8% from September; this is rather notable as this marks the fourth consecutive month that our raw material index has declined on a year-over-year basis, which last occurred in April 2018. From a quarterly perspective, raw material costs fell approximately 5.6% year-over-year in 3Q19 while holding current spot prices flat would yield a 4.4% year-over-year decrease in input costs in 4Q19 to “build a tire” (-1.5% from 3Q to 4Q).

We note that notable movements lower in raw material cost pressures have begun to subside as last month raw material prices were projected to fall 4.5% year-over-year in 4Q19 while sequentially decreasing 1.6% from 3Q to 4Q. In assessing raw material price movements, we note carbon black has begun to see its cost pressures subside on a year-over-year basis, at the beginning of the third quarter costs were up 10.5% y/y and by October costs have reversed trends to decreasing by 1.5% y/y.

This decreased pricing has been a massive turnaround for carbon black, as pricing had been in double digit y/y growth mode for each month going back to the beginning of 2018. Natural rubber prices rose 8% y/y in October, while showing moderate gains on a monthly basis from September (1% increase). Crude oil prices have experienced notable cost pressures since peaking back in April for the year, with double digit decreases y/y, and October falling by more than 20% y/y. Lastly, synthetic rubber costs have remained negative for seven straight months year-over-year and price pressures on reinforcement items (cord, fabric, etc.) continue to track negative year-over-year at a mid-single-digit rate.

Although tire industry trends profit levels are often dictated by 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 4Q19 and 2020 to become more aligned with this level of GDP growth.

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

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].

Results of Independent Tire Dealer Survey Which Compared Business Trends in October 2019 vs. October 2018

Replacement Tire Sales – Sellout Levels Continue to Remain Favorable

Dealer commentary suggests consumer demand for PLT replacement tires rose in October compared to the prior year’s period. The net number of respondents indicating they saw an increase in demand year-over-year was 30.0% of contacts compared to October 2018’s 7.3% of contacts experiencing growth. We note that our tire demand index was up 21.1% year-over-year (up 12.7% from September) and we continue to hold a perspective that volumes are becoming more closely aligned with the current level of GDP growth as our dealer contacts have seen sixteen straight months of positive volume growth.

This view is reinforced given a more stable industry backdrop with raw material cost pressures declining and we continue to expect mix trends to improve through the rest 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 fifth consecutive month. Conversely, Tier 3 remained at the bottom of our rankings for the fourth consecutive month while Tier 1 stood pat in the middle spot. The dynamic of Tier 2 retaining the top spot for months at a time was only a matter of time as we have long predicted 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 13 of the last 22 months).

We are not surprised to see Tier 3 weakness continue (has not been atop our rankings since February 2019) as we have long theorized that any strength seen in Tier 3 is transitory in nature as we expect consumers to opt for higher quality and performance given consumer spending/confidence remains healthy and labor market conditions remain historically tight. We point out that on a longer-term basis, Tier III brands have been ranked or tied for last place by our respondents in 28 of the past 60 months (has only been atop our rankings 4 times in the last 22 months).

It is clear that a strong shift has occurred in the consumer’s mindset when it comes to thinking about Tier I tires. While for a time they were the worst performer in the majority of 2018 and start of 2019, the segment is now consistently ranked in-between Tier 2 and Tier 3 brands, which we believe was brought on by the mega-trend of the market shifting to HVA shipments. What makes this even more impressive, is that this shift has been occurring while many Tier 1 brands have been instituting price increases (Michelin, BFGoodrich, Bridgestone), showing that customers are still willing to pay a premium for higher quality tires.

It should be noted that there has been progress in tariff/trade talks in the past few months, which might move some of the tire business back to international producers, who typically have cost advantages in comparison to their domestic counterparts. Overall, we believe that the general/average customer has continued to look more towards quality rather than value, essentially placing themselves in-between buying Tier 1 or Tier 2 type tires.

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 2 producers to continue remaining disciplined in their efforts to manage the price/volume trade-off in order 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.

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].