Investors may have inflated expectations from the tyre sector: Kotak Institutional Equities

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Kotak Institutional Equities believes investors may have "inflated expectations" from the sector which is highly competitive, and has cyclical nature of the business. The sector is capex-intensive and the profitability of the tyre manufacturers will also depend on commodity prices. Shares of a tyre company JK Tyre have surged over 106 per cent in the last one year.

Stocks such as Ceat and Apollo Tyres have jumped 67 per cent and 59 per cent, respectively, in the same period. Shares of MRF (up 28 per cent) and Balkrishna Industries (up 13 per cent) have also gained significantly. Equity benchmark Sensex has gained 11 per cent in the last one year.

Most gains in the tyre stocks have come after the fall in commodity prices and a pick-up in demand which caused a sharp improvement in the profitability of tyre companies in the last two-three quarters. But the road ahead for the tyre sector may not be smooth. "The Indian tire industry is a good example of inflated expectations among market participants.

The market is extrapolating current high profitability in perpetuity and according to high multiples to peak profitability despite the capex-intensive, commodity, competitive and cyclical nature of the business," said Kotak. The brokerage firm pointed out that current high multiples imply strong earnings growth, supported by a structural shift to higher industry profitability. However, there has been no material improvement in the market structure, which can lead to better pricing power in future.