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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: Michelins 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 markets scepticism and managements 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 Bridgestones 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

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 worlds 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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Tuesday 24 May 2011

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Global Markets: Influences from Asia

...competing in all product segments.

The company competes in all tyre segments globally: passenger cars, commercial vehicles (trucks and buses) and OTR (off-the-road) tires, which are categorised, under speciality tires and mainly represent sales to mining and agricultural customers. The margins on such specialty tires are significantly above truck and car tires; nearly 15% at Bridgestone against 5.8% overall for FY10. When sales are strong, 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). Chart 2: Regional sales and operating profit breakdown for Bridgestone

Though European exposure is relatively light.

45 40 35 30 25 36

42

31

27

27

20
15 10 5 0 Japan US Europe 13 4.5

18

% total sales % total operating profit

Other (Asia and Latin America)

US market: strong demand and tight supply


US sales are rising.

Trends within the tire market remain very encouraging across the US. In Q1, Bridgestone reported US sales up 7%, in line with volume growth witnessed at Goodyear however strength in high margin segments enabled the company to improve product mix. In mid-February, Bridgestones management noted the strength of commercial truck tire sales. In late April, Goodyear echoed these comments, 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 12.5% YoY. Although car tire demand also remains strong (OE car tire sales are now forecast to rise 12% YoY in 2011), such sales are relatively low margin. 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, such as high performance tires or replacement car tires, where demand is also reportedly robust. The capacity issue is becoming increasingly important. Our report on 23rd March (Rising demand and passing costs on) addresses the subject in more detail however Bridgestone, Michelin, Goodyear and Yokohama are all reportedly operating at full capacity. Moreover Goodyear, as part of efforts to cut high cost capacity, will close its Union City, Tennessee plant in the autumn. Thus with inventory levels remaining low, tight supply is supporting price increases.

Particularly for commercial truck tires, up 80% YoY.

Capacity constraints now becoming a problem.

Tight supply is supporting price hikes.

Asia: mixed reports but broadly encouraging


Asia is a high priority region where company is achieving high sales growth.

Bridgestones management has already categorised the Asian market as top priority. 25% of its global production capacity is located in Asia ex-Japan (57% in Asia incl Japan) and its expanding capacity at 3 major plants in India (the priority market within Asia), Thailand (truck and bus tires) and Indonesia. Through Q1, the company saw other sales (predominantly Asia) climb 19% YoY. Although this represents the strongest growth among the companys regional portfolios, peers are experiencing mixed performances: Michelin (ML FP): Asian markets saw slowing trends in Q1 (just 12% of Michelins sales are in Asia). Although replacement demand in China rose 26% YoY, the OE market softened (alongside new car sales) to just 9% YoY growth. Continental (CON GY): Saw replacement tire demand climb 12% YoY across Asia though India and China experienced higher growth rates. Goodyear (GT US): Sales in both Asian and Latin American markets declined YoY in Q1 however management conceded that this resulted from internal, 1-off issues and didnt represent any major change in trend across those markets. Cooper Tire and Rubber (CTB US): Approximately 30% of companys sales are in China where the company focuses on the passenger tire segment. Asian sales volume fell 2% YoY in Q1.
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Michelin see slowdown...

Continental see high growth in India & China...

Cooper expects growth to pick up through Q2.

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Global Markets: Influences from Asia

Management admitted that YoY comparisons were high but also emphasised they had phased out low margin products, implying that improved product mix drove the overall strength in revenues (up 28% YoY). They also expected growth rates to recover through Q2 and beyond.
Hankook enjoying strong growth in Asia.

Hankook Tire (000240 KS): Approximately 50% of the companys sales are in Asia and results offered a more encouraging perspective: Q1 sales rose 16% YoY, 3% QoQ and China sales climbed 19% YoY to a record quarterly high. Moreover volumes and price hikes drove an improvement both in overall operating margins (up 2.4ppts QoQ to 12.4%) and specifically at the companys Chinese production facilities (up 1.1ppts QoQ to 2.3%).

Japan: Weak OE demand but tracking sideways, not downwards


Overall sales are sluggish...

Japanese demand remains relatively sluggish: Bridgestone reported Q1 sales in Japan up 4% YoY while Sumitomo Rubber, with 53% total sales in their home market, noted that strong demand in Asia allowed them to off-set muted demand in Japan to achieve 8% YoY sales growth in Q1. Toyo Rubber also witnessed a sharp drop in OE demand, 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, high performance tires and solid replacement demand to achieve positive revenue growth. 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, 15% on OTRs and 10% on farm tires) while Sumitomo Rubbers management reiterated their determination at the Q1 results meeting to pass higher costs through to customers; something theyve successfully achieved so far.
st

...though not negative.

And margins are secure.

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, aircraft, motorbike and mining tires. In the ultra-large mining tire segment (i.e. 53 or larger), where advanced technology specifications mean barriers to entry are relatively high, the company holds a 40% market share creating an effective duopoly with Michelin (which also holds 40% share). The companys entire production of OTR tires is located at 2 facilities on the southern island of Japan (Kyushu), from where the tires are shipped to their global customers. In Q1, Bridgestone acknowledged that OTR tire sales were significantly higher YoY. Michelin agreed, describing growth as substantially higher YoY but offered more colour: total OTR tire demand has already exceeded the 2008 peak and its continuing to grow with replacement demand strong for both mining and agricultural tires and agricultural OE demand firm in all global markets, especially for highpowered tractors. Goodyear, Titan and Yokohama Rubber, who supply tires for farm equipment and smaller mining equipment, painted a more dramatic picture. Titan, whose sales are focused on the North American market, saw mining tire demand just exploding and farm equipment dealers throwing orders in like youve never seen before. Titans Q1 sales rose 40% YoY with earthmoving tire sales up 59% YoY. Both Goodyear and Yokohama are starting to alert customers of potential shortages by end-2011. Goodyears order book is full through to mid-2012, their fill rates are already deteriorating and theyre starting to receive orders for 2013. Yokohama believe that demand will continue to exceed supply for the next few years.

Both Michelin and Bridgestone see strong demand.

Titan sees explosive demand in the US.

And many are reporting full order books and capacity shortages.

Europe: Strong growth though less impact for Bridgestone


Europe has less impact on Bridgestones results.

Just 13% of Bridgestones global output is manufactured in Europe and the European subsidiary has been persistently dogged by low margins, hence 13% of total sales generate just 4.5% total operating profits. Nonetheless, the region may provide small upside to FY11 results. OE demand from truck makers is reportedly strong and rising, though the overall market is still 17% below the peak demand achieved in 2007. 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.

Pricing: Bridgestones caution contrasts with global trend


Will strong Q1 margins be temporary?

Both managements guidance and analysts forecasts imply that Q1s margin growth is transitory and will fall sharply in Q2: by 5.8ppts to 2.1% according to management, and by 4.1ppts to 3.8% according to sell-side consensus. Evidence from Bridgestones global peers suggest this is excessively pessimistic:

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Tuesday 24 May 2011

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Global Markets: Influences from Asia

Michelin doesnt think so...

Michelin assume euro1.8bn negative impact from rising raw material costs in 2011. Price hikes announced thus far are apparently sufficient to off-set almost 80% of this impact meaning the company needs to lift prices by 2.5% on car tires and 5% on truck tires within the next 3 months to cover the remaining 20% of costs. Management are very confident of achieving this. Goodyear achieved a record-ever improvement in their pricing and product mix through Q1 to counter the 26% rise in raw material costs. Indeed the companys operating margin climbed 1.9ppts QoQ to 5.1% in Q1, an 18-month high. Across Asia, margins also appear secure. Nexens margins in China improved to 3.7% in Q1, against 1.7% in Q1 2010 after the ASP increased 7% QoQ. Hankook also achieved higher margins at its Chinese production base. Although raw material costs climbed 15.7% QoQ through Q1, improved price and product mix ensured overall operating margins remained stable. Further price hikes are also planned across Asia in Q2.

...nor does Goodyear.

And Asian companies are supporting margins as well.

Negligible impact from the earthquake


Early fears for heavy impact proved unfounded.

The company recognised Y2.3bn ($28mn) in extraordinary losses in Q1 results stemming from the earthquake and tsunami. 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. Management have also warned of the impact from power restrictions through the summer. However the overall impact is likely to be marginal and the Modern Tire Dealer magazine quoted a US-based distributor in early May saying weve seen very little impact on the supply of tires that we import from Japan. Although 31% of Bridgestones global production capacity is domestically based, the majority of those facilities are located either on the southern tip of Honshu or the north coast of Kyushu, where power supply will not be an issue. Only 3 plants (of 14 in total) face the risk of power restrictions: a) b) c) A large 598 metre squared plant in Tochigi, 150km north of Tokyo manufacturing both commercial and passenger vehicle tires. The smaller 191 metre squared Nasu plant, also in Tochigi producing car, light truck, motorcycle and farm equipment tires. The large Tokyo plant covering 601 metres squared supplying tires for cars, light trucks and aircraft.

And export volumes have seen minimal impact.

Power restrictions may be a risk to some plants through the summer.

Conclusion
After consolidating at crucial chart support, Bridgestones stock will now rally.

Bridgestones stock price has consolidated after an important break through technical resistance. We believe that the strength in fundamental trends across the global tire industry will drive Bridgestones profits higher, taking the share price with them. US demand is robust, particularly on trucks and replacement tires on cars. With capacity constraints becoming an issue, the company is now able to maximise margins in the US by allocating production to high-end products. OTR tires are also experiencing significant growth rates. Competitors are reporting full order books for the next 18 months and alerting customers to the risk of shortages by late-2011. Chart 3: Bridgestones stock price consolidates above key support

Recently confirmed break through 2-year resistance.

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Tuesday 24 May 2011

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Global Markets: Influences from Asia

Asian demand counters sluggish Japanese demand.

In the areas of greater contention, commentary from industry participants also encourages a positive stance. In contrast to Bridgestones cautious guidance, tire manufacturers are passing higher raw material costs through to customers in all global regions. And while growth rates in Asia have slowed from the mid-20s pace witnessed in 2010, they are still climbing 15-20% YoY. For Bridgestone, this as an important new market thats off-setting the sluggish trends evident in Japan. Even after that huge over-shoot to targets that the company achieved in Q1, we expect another large upward revision before H2 results in early August. This will also surprise the sell-side consensus, which still expects a QoQ plunge in margins similar to that witnessed at the height of the financial crisis. Thus with the stock on 5.2x FY11 and 4.4x FY12 cashflow forecasts, we believe the current level offers an excellent entry point.

An upward revision ahead and valuations cheap.

Disclaimer
This report is issued by Global Market Perspective Limited which is authorised and regulated by the Financial Services Authority. 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 Firms professional clients and eligible counterparties to whom it is distributed. The report is not, and should not be construed as, a recommendation, solicitation or offer to buy or sell any securities or related financial products. The information contained in the report is believed to be reliable but has not been independently verified, and the Firm makes no guarantee, representation or warranty and accepts no responsibility or liability as to the accuracy, completeness or appropriateness of the information. The information contained herein may not be current due to, among other things, changes in the financial markets or economic environment. Opinions reflected in this report are subject to change without notice. The report does not constitute, and should not be used as a substitute for, tax, legal or investment advice. The report has been prepared without regard to the individual financial circumstances, needs or objectives of clients who receive it. The securities and investments referred to in this report may not be suitable for all investors. Readers should independently evaluate particular investments and strategies, 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. The Firm accepts no legal responsibility from any investor who directly or indirectly receives this report. The final investment decision must be made by the investor and responsibility for the investment rests with the investor.

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Copyright 2011 Global Market Perspective Ltd

Tuesday 24 May 2011

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Global Markets: Influences from Asia

Global Market Perspective Ltd

See disclosures at the end of this document

Copyright 2011 Global Market Perspective Ltd