Automotive component and parts manufacturers are all set to face the storm that the downstream automobile industry is experiencing on account of shrinking demand. This decline has come in faster for commercial vehicles and only materialized in the passenger segments, both cars and motorcycles, toward the end of FY19. It is perhaps for this reason that General Tyre (PSX: GTYR) still made a profit in FY19.

The tyre manufacturer sells nearly 45 percent of its tyres to passenger cars while the next big segment for the company is motorcycle tyres. The revenue shortfall from last year of 10 percent is not a lot, and is in line with expectations. The company has raised prices as costs of production rose but, bare necessities as it faces tough competition from local legal and illegal contenders.

The macroeconomic climate has changed over the past year. The economy is wrought with inflation—pressures are rising on fuel and power prices, as well as input prices. In order to curb inflationary pressures, the central bank has tightened monetary policy which translated to much higher interest rates offered by bank. The economy has also been hit with a series of rupee devaluations which has pushed costs of imports up as well. Import of inputs like synthetic and natural rubber which are used to make General's tyres will have cost more. Since raw material takes up most of the costs of production, the decline in margins is testament to these changing cost factors.

The company faces competition from a myriad of undocumented tyre makers and smuggling traders who sell tyres for cheap as they don't pay taxes or duties on imported goods. This illegal machinery affects General's and many other formal tyre manufacturers' market share in the replacement market ultimately leading to subdued revenues. The company has been expanding over the past few years and as it raises capacity and gets bigger, it has to be ever more careful about cash flows. Evidently, higher borrowing by the company on account of its ongoing expansion has led to higher finance costs (rose to 6% in FY19 from 2% of revenues), only exacerbated by the higher cost of financing by commercial banks.

The company has kept a tight fist on administrative and distribution expenses which remained 7 percent of revenues for FY19. This could be further trimmed but lean business for a tyre manufacturer seems to be an unlikely scenario.  Moving forward, as it expands, the company should think about reducing its concentration risk by venturing into markets overseas. If sales mix can be adjusted between local and foreign sales as domestic demand recedes and comes back up again, it would greatly help General in growing its top-line.

Copyright Business Recorder, 2019