Looking at the numbers in financial reports of such tire giants as Michelin (MGDDF.PK), Goodyear (GT), and Bridgestone (BRDCY.PK), one could argue that the business of making tires is at least as bad as aviation. No doubt it's good for consumers to have ever-safer and efficiently rolling tires, but it's just a horrible business for investors. Producing tires requires a lot of capital for maintaining and updating the factory lines and holding stock of the final product. Margins are thin as consumers don't really mind which tires they drive on, as long as the tires fulfill their basic quality standards. The prices of rubber and oil are also rising, further deteriorating margins.
But there is a bright exception among the miserable giants, Nokian Tyres (NKRKF.PK) -- a tire company that consistently produces results that might make even Buffett salivate. First, a few of this Finnish company's key ratios from its latest annual financial review, highlighting a consistently high profitability with very little debt:
- Return on equity (10 year avg.): 21.7%
- Operating margin (10 year avg.): 18.7%
- Equity ratio (2011): 63.20%
- Gearing (2011): -0.3%
So what is Nokian Tyres' secret sauce? What really sets it apart is its specialization and long history of developing high-end winter tires. It produces only replacement tires, so it doesn't compete with the big guys in the flooded market of new cars. Its profit comes overwhelmingly from passenger car winter tires that are sold under its main brand, "Hakkapeliitta." It also produces summer tires under the "Hakka" brand, as well as specialized tires for trucks, harvesters, and other vehicles. It also owns a tire chain franchise, Vianor, which operates more than 900 stores in 23 countries in areas where winters tend to be harsh and snowy. The stores are mostly located in the Nordic countries, Russia and Ukraine, but there are a few (16) in the U.S. too. Vianor works as the company's contact surface on its end-customers and a marketing channel for its products.
The name of the company might ring a bell. Nokian Tyres was spun off from the historic parent company of Nokia Aktiebolag, the same company that today is known for mobile phones. The city of Nokia in Finland is the birthplace of the historic Nokia company. Nokian Tyres still operates its headquarters and its original factory in the same small city, whereas the mobile phone company moved 200 kilometers south to the city of Espoo. Nokian Tyres is expanding its capacity at a fast pace, and it is not building its new factories in Finland, but rather in its most promising market, Russia. Designing, test driving, and prototyping still takes place in Finland, but increasingly production is shifting to countries with cheaper labor.
Nokian Tyres leads the market in Russia in terms of volume sold and revenue. Its brand ranks among the best in terms of perceived quality. Russians seem to like their SUVs equipped with the best Western tires for their notoriously rough roads.
No doubt Russia has the greatest potential for future growth for Nokian Tyres, both in terms of production and end-market. In terms of GDP per citizen, the Russian economy has been developing quite nicely during the Putin presidency. However, the economy is very much dependent on gas and oil. There are also huge problems still in Russian society in terms of civil rights, freedom of speech, income inequality, etc., and things don't seem to be improving. Russia has taken the important step to join the WTO, but it is just one small step in the right direction. There is still a lot to do for Russia to become a stable market economy.
The future of Russia is very much the acid test of Nokian Tyres, and if you think you're able to stomach that acid, then the company might be worth a deeper look for you. The company's stock trades on the Helsinki Stock Exchange (OMX Helsinki) with a P/E of 12.1 and with a market cap of 4.3 billion euros.
Disclosure: I am long NKRKF.PK. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.