In today’s Finshots Markets, we explain how a substance that goes into tyres to give it the black colour is a proxy for the automotive growth story.

The Story

Have you ever looked at tyres and thought — if tyres are made out of rubber, shouldn’t they be white? After all, that sappy liquid which oozes from the rubber tree is white.

And you’d be right. When the first rubber tyres for cars were made in the 1890s, they were indeed white!

But in 1910, B.F. Goodrich, the founder of the eponymous tyre brand, changed the game forever. He picked up a substance called ‘carbon black’ — which was a byproduct of burning crude oil at a particular temperature. And slid it into the tyre manufacturing process.

The end result? The black tyre.

But the thing is, this little addition wasn’t made for any aesthetic purpose. Or just to make the tyres match the roads and look cool. Nope. Goodrich actually realised that the precious Carbon Black could be quite revolutionary. You see, it was quite brilliant at absorbing light and heat. That meant, it could prevent damage from UV rays. And it would even take away the heat from other parts of the car such as the tyre belt area. It could prevent wear and tear. And basically, tyres would be even more durable.

In fact, a tyre without carbon black runs for only around 8,000km. But, infuse a little of the miracle material into it and a tyre can easily survive for 50,000km.

And there’s probably nothing more vital for the tyre industry today. Except for rubber, of course. But an average tyre contains around 3 kg of carbon black. That means, tyre manufacturers consume the carbon black in bulk. And such is the demand that over 70% of carbon black’s demand comes from the tyre industry.

Now that seems like a great proxy to play the automobile story, doesn’t it?

I mean sure, you could pick an auto stock. But first, you’ll have to decide whether you want to invest in a company that sells passenger vehicles like Maruti Suzuki. Or maybe two-wheeler giants such as TVS Motors. Maybe even commercial vehicle makers such as Ashok Leyland. Once you do that, you need to dig in to compare every company in a segment against its peers.

Or you could pick a tyre stock itself. After all, everything needs tyres — cars, two-wheelers, even cycles. That way you don’t need to break your head over the auto category. You don’t even need to bet on auto sales rising exponentially. Because only 30–40% of the demand for tyres comes from auto manufacturers. The rest of the demand is generated by the replacement market. So you just need people to continue the habit of replacing their tyres at higher frequency than they change cars.

But…you probably still have to decide between a tyre manufacturer who focuses on two-wheelers such as Ceat. Or maybe an MRF that sells primarily to carmakers. The dilemma isn’t over.

Enter, Carbon Black. The proxy idea that’s pretty much at the bottom of this chain.

Now there are a few carbon black manufacturers out there. Not too many but a fair number. And there’s one in particular that stands out — PCBL (earlier known as Phillips Carbon Black). Part of the RP-Sanjiv Goenka Group, this 60-year-old company commands nearly a 50% market share in India. It’s even the seventh largest carbon black player in the world.

It pretty much dominates the industry.

And PCBL has some tailwinds that could work in its favour.

For starters, carmakers are seeing strong sales as disposable incomes rise and loans become even more easily accessible. That means tyre companies are also turning bullish and on track to spend more than ₹24,000 crores over the next 3 years to set up new manufacturing.

But the big picture is that two key exporters of carbon black — Russia and China are facing their own challenges.

Russia, for instance, is facing sanctions from most of the world. And since over half of Europe’s carbon black supply comes from Russia, it’s a great time for PCBL to step up and fill the void. Also, China is seeing a supply constraint. Their wage costs are rising, the government is keeping a tab on pollution and carbon black manfacturers are consolidating. It may not be able to easily offer the low prices it once did.

It seems like it’s the perfect storm for PCBL.

And it’s not sitting idly. It’s gearing up to expand its capacity too. It’s building out a new manufacturing plant in Chennai. It’s also expanding its current capacity in anticipation of rising demand. Both domestically and globally.

But at the end of the day, there’s a big risk — its fate is deeply intertwined with the tyre industry. So, if people decide to tighten their purses, they won’t buy cars, bikes, trucks and tractors. They may even postpone replacing their tyres. All this could hurt the demand for carbon black.

And while its on course to diversify a bit, it could still take a bit of time. Its speciality grade carbon which is used in plastic pipes, food trays etc still only makes up 7% of its sales. And that’s where the money actually lies — and you can see that slowly playing out in PCBL’s EBITDA (earnings before interest, tax, depreciation and amortisation) per ton which has risen from ₹5,300 in FY16 to ₹14,400 in FY22.

Then there’s the matter of price fluctuations for its raw materials — Carbon Black Feedstock (CBFS), that’s derived from oil and natural gas. High crude prices can stay elevated for extended periods and hurt the margins of the company. Sure, PCBL has deals with tyre makers that incorporates a raw material based pricing formula. But, it may not be able to pass on the full extent of its input cost inflation all the time.

And not to forget — PCBL imports nearly 80% of its raw materials, but, despite being a major global player, its exports are still only 30% of its sales. That means, currency fluctuations can also hurt the prospects of the company.

Put all this together and you could see why the stock has only risen by 3% over the past year. Investors still seem to be on the fence when it comes to dealing with its cyclicality.

But anyway, that’s the story about Carbon Black. We just thought it would be interesting to look at something that permeates our everyday life — whether it’s a car tyre or even our banknotes. While we see carbon black every day, we don’t really see it. It’s invisible but it’s a damn interesting thing, don’t you think?

Until then…

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