Global Markets: Influences from Asia

Read-throughs for stocks in developed markets from industrial trends in Asia
Tuesday 24 May 2011
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David McCulloch dcm@global-market-perspective.co.uk

Tel: +44-207-352-3973

Bridgestone (5108 JP): Buy on strong fundamentals Powerful demand and rising prices with upward revision ahead suggest excellent prospects.
Issues discussed today  US tire demand: Commercial tire sales rising 80% YoY. Capacity constraints emerging allowing focus on high margin products.    Asian tire demand: Growth rates decelerate but still witnessing high-teens pace that off-sets sluggish Japanese demand. Price increases: Michelin’s already covered 80% of higher input costs. Goodyear also achieving record price/mix improvement and Hankook seeing margins stable. OTR tire demand: Order books now full for next 18 months with some makers alerting customers to risk of shortages by late-2011.

Background (1): Q1 FY11 was an encouraging prelude
Results defy cautious guidance.

In spite of both the market’s scepticism and management’s caution, Bridgestone has delivered consistently strong results through Q4 2010 and Q1 2011. October to December 2010 saw sales climb 10% QoQ and operating margins rise 1.9ppts QoQ to 6.9%. However any enthusiasm was quickly deflated when management released some bleak guidance for 2011. Rising raw material costs (rubber, carbon black and butadiene) would squeeze operating margins down to 3.1% in H1 and 4.4% for the full-year. Actual Q1 results contradicted this pessimism: price increases, product mix improvements and cost cuts meant margins actually climbed 1ppt QoQ to 7.9% enabling the company to achieve 124% of its H1 operating profit target in Q1. Nonetheless the caution continues. The resulting upward revision (to H1 and full-year targets) only reflected the overshoot achieved in Q1 i.e. Y17bn and made no adjustment to the implicit assumption that trends would rapidly deteriorate. As a result, current forecasts suggest margins will slump 5.8ppts QoQ in Q2 to 2.1% (see chart 1 below) and only recover to 5.5% in H2. Commentary from Bridgestone’s global peer group suggests this outlook is too pessimistic. Chart 1: Quarterly operating margins at Bridgestone since Q1 FY07

Higher raw material costs were passed through.

Guidance still cautious, even after upward revision.

Management expect the largest QoQ plunge in margins for 8 years in Q2.

10

9.4

8.8 7.9

8 6.7 6 5.97 4.1 3.7 2 1.7 4.8 5.46 4.96 7.1 6.6 5.83 6.9

4

2.1

0
FY07 Q2 Q1 Q3 Q4 FY08 Q2 Q1 Q3 Q4 FY09 Q2 -1.2 Q3 Q1 -2.2 -4 Q4 FY10 Q2 Q1 Q3 Q4 FY11 Q2 Q1 (e)

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Background (2): Company details
Bridgestone is a global company...

Bridgestone is the world’s largest tire manufacturer with 16.2% market share and $32.7bn sales in 2010. 83% of its sales are derived from tire sales and 17% from diversified products (golf balls, office equipment, clothing etc). Chart 2 on page 2 details the breakdown in regional sales and operating profits; the purchase of Firestone in 1988 explains the high sales exposure in the US while Asia accounts for the majority of sales categorised in “other” i.e. approx 12-14% total sales.

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peers are experiencing mixed performances:  Michelin (ML FP): Asian markets saw “slowing trends” in Q1 (just 12% of Michelin’s sales are in Asia). 45 40 35 30 25 36 42 31 27 27 20 15 10 5 0 Japan US Europe 13 4. the company saw “other” sales (predominantly Asia) climb 19% YoY. Continental (CON GY): Saw replacement tire demand climb 12% YoY across Asia though India and China experienced higher growth rates.  Global Market Perspective Ltd .5 18 % total sales % total operating profit Other (Asia and Latin America) US market: strong demand and tight supply US sales are rising. having seen original equipment (OE) truck tire sales climb 80% YoY through Q1 and overall truck tire sales rise 40% YoY (replacement truck tire sales rose 12% YoY in Q1 at Goodyear) with revenue per unit up 12. tight supply is supporting price increases. The margins on such specialty tires are significantly above truck and car tires. such as high performance tires or replacement car tires.. Goodyear echoed these comments. Cooper Tire and Rubber (CTB US): Approximately 30% of company’s sales are in China where the company focuses on the passenger tire segment. In late April.” 25% of its global production capacity is located in Asia ex-Japan (57% in Asia incl Japan) and it’s expanding capacity at 3 major plants in India (the priority market within Asia). See disclosures at the end of this document Copyright 2011 Global Market Perspective Ltd Michelin see slowdown.8% overall for FY10. When sales are strong.5% YoY.. Thus with inventory levels remaining low. Trends within the tire market remain very encouraging across the US. Our report on 23rd March (“Rising demand and passing costs on”) addresses the subject in more detail however Bridgestone. Although replacement demand in China rose 26% YoY. Particularly for commercial truck tires. under speciality tires and mainly represent sales to mining and agricultural customers. Asian sales volume fell 2% YoY in Q1.   Cooper expects growth to pick up through Q2. the OE market softened (alongside new car sales) to just 9% YoY growth. Chart 2: Regional sales and operating profit breakdown for Bridgestone Though European exposure is relatively light.. as part of efforts to cut high cost capacity. Tight supply is supporting price hikes.competing in all product segments. Bridgestone’s management noted the strength of commercial truck tire sales. The company competes in all tyre segments globally: passenger cars. Moreover Goodyear. Asia: mixed reports but broadly encouraging Asia is a high priority region where company is achieving high sales growth. Continental see high growth in India & China. Hence capacity constraints at all the major manufacturers are encouraging tire makers to allocate what spare capacity remains after contract obligations are met to higher margin products. Tennessee plant in the autumn. up 80% YoY. Thailand (truck and bus tires) and Indonesia. Although car tire demand also remains strong (OE car tire sales are now forecast to rise 12% YoY in 2011). Goodyear (GT US): Sales in both Asian and Latin American markets declined YoY in Q1 however management conceded that this resulted from internal. which are categorised.. nearly 15% at Bridgestone against 5. will close its Union City. such sales are relatively low margin. In Q1.. commercial vehicles (trucks and buses) and OTR (off-the-road) tires. In mid-February. in line with volume growth witnessed at Goodyear however strength in high margin segments enabled the company to improve product mix. Bridgestone’s management has already categorised the Asian market as “top priority. Through Q1. Although this represents the strongest growth among the company’s regional portfolios. th this segment represents 10% total revenue but approximately 25% total profits (see our report on 5 May: “OTR tires: Booming market set to grow further” for more details). Capacity constraints now becoming a problem. 1-off issues and didn’t represent any major change in trend across those markets.. The capacity issue is becoming increasingly important.Tuesday 24 May 2011 th Global Markets: Influences from Asia . Goodyear and Yokohama are all reportedly operating at full capacity. Bridgestone reported US sales up 7%. Michelin. where demand is also reportedly robust.

implying that improved product mix drove the overall strength in revenues (up 28% YoY). In the ultra-large mining tire segment (i. Hankook enjoying strong growth in Asia.” especially for highpowered tractors. In Q1. not downwards Overall sales are sluggish. whose sales are focused on the North American market.. The company’s entire production of OTR tires is located at 2 facilities on the southern island of Japan (Kyushu). st . though the overall market is still 17% below the peak demand achieved in 2007. Bridgestone acknowledged that OTR tire sales were “significantly” higher YoY. Titan.” Titan’s Q1 sales rose 40% YoY with earthmoving tire sales up 59% YoY. Car tire demand is also buoyant: Continental saw replacement tire sales grow 16% YoY in Q1 while Michelin reported that OE demand has climbed faster than expected amid rising new car production. Moreover volumes and price hikes drove an improvement both in overall operating margins (up 2. 53” or larger).. aircraft. hence 13% of total sales generate just 4. who supply tires for farm equipment and smaller mining equipment. Japanese demand remains relatively sluggish: Bridgestone reported Q1 sales in Japan up 4% YoY while Sumitomo Rubber. Titan sees explosive demand in the US. Toyo Rubber also witnessed a sharp drop in OE demand. OTR tires: witnessing real strength OTR tires are an important product for Bridgestone Bridgestone holds a dominant position in this segment offering the full range of agricultural.4ppts QoQ to 12. Both Michelin and Bridgestone see strong demand. Yokohama believe that demand will continue to exceed supply for the next few years. describing growth as “substantially higher” YoY but offered more colour: total OTR tire demand has already exceeded the 2008 peak and it’s continuing to grow with replacement demand strong for both mining and agricultural tires and agricultural OE demand firm in “all global markets. Europe: Strong growth though less impact for Bridgestone Europe has less impact on Bridgestone’s results. 15% on OTR’s and 10% on farm tires) while Sumitomo Rubber’s management reiterated their determination at the Q1 results meeting to pass higher costs through to customers.  Hankook Tire (000240 KS): Approximately 50% of the company’s sales are in Asia and results offered a more encouraging perspective: Q1 sales rose 16% YoY. Goodyear’s order book is full through to mid-2012. something they’ve successfully achieved so far. saw mining tire demand “just exploding” and farm equipment dealers “throwing orders in like you’ve never seen before. the company holds a 40% market share creating an effective duopoly with Michelin (which also holds 40% share). the region may provide small upside to FY11 results. Evidence from Bridgestone’s global peers suggest this is excessively pessimistic: Global Market Perspective Ltd See disclosures at the end of this document Copyright 2011 Global Market Perspective Ltd . stemming from production shutdowns at automakers following the earthquake and tsunami however managed to off-set weaker volume growth with strong sales of high-end. Goodyear. painted a more dramatic picture.Tuesday 24 May 2011 th Global Markets: Influences from Asia Management admitted that YoY comparisons were high but also emphasised they had phased out low margin products.. their fill rates are already deteriorating and they’re starting to receive orders for 2013. They also expected growth rates to recover through Q2 and beyond. Michelin agreed. And margins are secure. noted that strong demand in Asia allowed them to off-set muted demand in Japan to achieve 8% YoY sales growth in Q1. Both Goodyear and Yokohama are starting to alert customers of potential shortages by end-2011. from where the tires are shipped to their global customers. high performance tires and solid replacement demand to achieve positive revenue growth. and by 4. Nonetheless.1ppts to 3.4%) and specifically at the company’s Chinese production facilities (up 1.3%).though not negative. And many are reporting full order books and capacity shortages. OE demand from truck makers is reportedly strong and rising. 3% QoQ and China sales climbed 19% YoY to a record quarterly high. Titan and Yokohama Rubber.8% according to sell-side consensus.5% total operating profits. with 53% total sales in their home market. Pricing: Bridgestone’s caution contrasts with global trend Will strong Q1 margins be temporary? Both management’s guidance and analysts’ forecasts imply that Q1’s margin growth is transitory and will fall sharply in Q2: by 5.8ppts to 2. Margins appear to be broadly intact: Bridgestone has 3 separate price hikes due to be introduced on 1 June (8% on passenger/light truck tires. where advanced technology specifications mean barriers to entry are relatively high. Just 13% of Bridgestone’s global output is manufactured in Europe and the European subsidiary has been persistently dogged by low margins. Japan: Weak OE demand but tracking sideways.1ppts QoQ to 2. motorbike and mining tires.1% according to management.e..

Management are “very confident” of achieving this. With capacity constraints becoming an issue. the majority of those facilities are located either on the southern tip of Honshu or the north coast of Kyushu. Conclusion After consolidating at crucial chart support.. the company is now able to maximise margins in the US by allocating production to high-end products. taking the share price with them. margins also appear secure. where power supply will not be an issue. We believe that the strength in fundamental trends across the global tire industry will drive Bridgestone’s profits higher. . motorcycle and farm equipment tires. And export volumes have seen minimal impact. Hankook also achieved higher margins at its Chinese production base. The large Tokyo plant covering 601 metres squared supplying tires for cars. Power restrictions may be a risk to some plants through the summer.7% in Q1.1% in Q1. light truck.3bn ($28mn) in extraordinary losses in Q1 results stemming from the earthquake and tsunami. Price hikes announced thus far are apparently sufficient to off-set almost 80% of this impact meaning the company needs to lift prices by 2. However the overall impact is likely to be marginal and the Modern Tire Dealer magazine quoted a US-based distributor in early May saying “we’ve seen very little impact on the supply of tires that we import from Japan. particularly on trucks and replacement tires on cars. Global Market Perspective Ltd See disclosures at the end of this document Copyright 2011 Global Market Perspective Ltd .7% in Q1 2010 after the ASP increased 7% QoQ. Bridgestone’s stock will now rally..  And Asian companies are supporting margins as well. 150km north of Tokyo manufacturing both commercial and passenger vehicle tires. Across Asia.8bn negative impact from rising raw material costs in 2011. Goodyear achieved a record-ever improvement in their pricing and product mix through Q1 to counter the 26% rise in raw material costs. an 18-month high. Further price hikes are also planned across Asia in Q2. also in Tochigi producing car.  Negligible impact from the earthquake Early fears for heavy impact proved unfounded. The smaller 191 metre squared Nasu plant.9ppts QoQ to 5. Management have also warned of the impact from power restrictions through the summer. US demand is robust.” Although 31% of Bridgestone’s global production capacity is domestically based. Competitors are reporting full order books for the next 18 months and alerting customers to the risk of shortages by late-2011.. Only 3 plants (of 14 in total) face the risk of power restrictions: a) b) c) A large 598 metre squared plant in Tochigi.. improved price and product mix ensured overall operating margins remained stable.5% on car tires and 5% on truck tires within the next 3 months to cover the remaining 20% of costs. light trucks and aircraft.Tuesday 24 May 2011 th Global Markets: Influences from Asia Michelin doesn’t think so.  Michelin assume euro1.nor does Goodyear. Nexen’s margins in China improved to 3. Indeed the company’s operating margin climbed 1. The company recognised Y2. Management were also reportedly operating domestic facilities 24/7 through Golden Week (late April) to catch up on the lost production immediately after the disaster and competitors believe tire export volumes to America dipped marginally through April. Bridgestone’s stock price has consolidated after an important break through technical resistance. Although raw material costs climbed 15. OTR tires are also experiencing “significant” growth rates. Chart 3: Bridgestone’s stock price consolidates above key support Recently confirmed break through 2-year resistance.7% QoQ through Q1. against 1.

The information contained herein may not be current due to. The securities and investments referred to in this report may not be suitable for all investors. The report has been prepared without regard to the individual financial circumstances. and should not be construed as. commentary from industry participants also encourages a positive stance.“ Global Market Perspective Ltd See disclosures at the end of this document Copyright 2011 Global Market Perspective Ltd . Thus with the stock on 5. and should not be used as a substitute for. Opinions reflected in this report are subject to change without notice. this as an important new market that’s off-setting the sluggish trends evident in Japan.2x FY11 and 4. we expect another large upward revision before H2 results in early August. The information contained in the report is believed to be reliable but has not been independently verified. a recommendation. completeness or appropriateness of the information.Tuesday 24 May 2011 th Global Markets: Influences from Asia Asian demand counters sluggish Japanese demand. And while growth rates in Asia have slowed from the mid-20’s pace witnessed in 2010.4x FY12 cashflow forecasts. The final investment decision must be made by the investor and responsibility for the investment rests with the investor. legal or investment advice. This will also surprise the sell-side consensus. needs or objectives of clients who receive it. solicitation or offer to buy or sell any securities or related financial products. For Bridgestone. In the areas of greater contention. representation or warranty and accepts no responsibility or liability as to the accuracy. In contrast to Bridgestone’s cautious guidance. which still expects a QoQ plunge in margins similar to that witnessed at the height of the financial crisis. The report is not. among other things. The report has been prepared by Global Market Perspective Limited (the “Firm”) solely from publicly available information for the sole purpose of supplying information to the Firm’s professional clients and eligible counterparties to whom it is distributed. An upward revision ahead and valuations cheap. changes in the financial markets or economic environment. and the Firm makes no guarantee. The Firm accepts no legal responsibility from any investor who directly or indirectly receives this report. tax. Even after that huge over-shoot to targets that the company achieved in Q1. they are still climbing 15-20% YoY. Readers should independently evaluate particular investments and strategies. Disclaimer This report is issued by Global Market Perspective Limited which is authorised and regulated by the Financial Services Authority. The report does not constitute. and seek the advice of an investment adviser before making any investment decision or entering into any transaction in relation to the securities and investments referred to in the report. tire manufacturers are passing higher raw material costs through to customers in all global regions. we believe the current level offers an excellent entry point.

Tuesday 24 May 2011 th Global Markets: Influences from Asia Global Market Perspective Ltd See disclosures at the end of this document Copyright 2011 Global Market Perspective Ltd .