R&I Rating Methodology by Sector

July 16, 2024

Tires

R&I applies this rating methodology to companies that supply tires for transport vehicles such
as passenger cars, trucks and motorcycles.

I. Evaluation of Business Risk

1. View of industry risk
The tire market has grown against the backdrop of rising global automobile demand. There is
room for expansion in the future as well in conjunction with worldwide economic growth. The
commercial tire market accounts for a large percentage of total demand, and production and sales
are influenced more by the total number of vehicles owned than by the volume of new vehicles sold.
Consequently, market volatility is less than that of automobiles and general automobile parts.
Tires are the only part of an automobile in contact with the road. Product quality therefore has
a major impact on the overall driving performance and fuel efficiency of an automobile. Although the
probability of significant technical innovations being introduced is low, every production process,
from blending of raw materials to tire construction, demands a high level of technical capability.
Furthermore, a tire manufacturer must have enough investment capacity to create a supply chain
that can meet demand from the overseas growth of automobile manufacturers and expand its sales
network for the commercial tire market.
The tire market is bifurcated into high-performance products and general-purpose products,
and competition with emerging country manufacturers is intense in the market for low to middle-
end products. On the other hand, global manufacturers maintain a technological advantage in high-
end products. Based on these considerations, R&I judges the tire industry to have a medium degree
of industry risk.

(1) Market size, market growth potential and market volatility

The global tire market is comparatively large, with sales presumed to be in excess of 20 trillion
yen.
The tire market has so far expanded mainly in advanced countries, and in recent years, demand

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has grown in China, India, Southeast Asia and elsewhere. In emerging countries, low to middle-end
products represent a large proportion of sales, and therefore demand growth could be more moderate
than in the past in value terms. Demand for high-end products such as large-diameter tires and
high-performance tires is rising, however. When viewed globally, the market would likely achieve a
certain amount of growth along with expansion of the world economy.
The commercial tire market accounts for about 70% of the total demand for passenger car tires
and roughly 80% of the total demand for truck tires. While demand for new passenger cars and
trucks is influenced by economic conditions through personal consumption and capital investment,
the demand fluctuation in the commercial tire market is small compared with tires for new vehicles.
Even if electric vehicles without internal combustion engines proliferate in the future, tires will
remain necessary and demand will unlikely diminish. As the automobile industry undergoes
structural changes owing to autonomous driving and connected cars, new demand and higher added
value are expected to contribute to market expansion for tires and their peripheral fields.

(2) Industry structure (competitive environment)

The top five companies constitute about half of all market share in value terms. The tire market
is divided into high-performance and general-purpose products. Tires are the only part of an
automobile in contact with the road. Because they have a significant impact on efforts to meet fuel
efficiency and environmental regulations, as well as on driving performance and design,
sophisticated technology is required for product development and each process of manufacturing.
Large-diameter tires are enjoying rising demand, benefitting from a global shift in demand to
large vehicles such as SUVs (sports utility vehicles) and pickup trucks. For better fuel efficiency,
light weight and low rolling resistance are also important parameters. Furthermore, tires for electric
vehicles require greater driving performance and quietness as well as measures against uneven wear.
The global manufacturers that excel in technical capabilities are superior in these high-performance
product categories.
For general-purpose products, where price competitiveness is considered a key factor, Asian
manufacturers such as in South Korea, China and Taiwan that use low-cost rubber materials are
increasing their market share. In high-volume markets, competition is global and ferocious.

(3) Customer continuity and stability

Tires have many roles to play, including ensuring safety. The tires finished vehicle

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manufacturers in advanced countries select for their new automobiles are mostly products from the
top-ranked manufacturers that have high technical capabilities. For specialized tires used on
construction machinery, mining vehicles and aircraft, the number of manufacturers handling these
products is even more limited, and customers tend to place greater value on considerations such as
product performance, reliability and after-sales services.
As regards commercial tires, manufacturers' advertising activities and retailers'
recommendations and services greatly influence customer continuity, because consumers purchase
their tires directly. For high-performance tires, a certain amount of brand loyalty exists as a result
of product durability, driving performance, and trust based on purchasing experience. To the extent
a product is recognized to be a high-quality product, the tendency is for customers to prefer tires
made by the same manufacturer who produced the tires for their new car. On the other hand, for
general-purpose products there is a high probability of customers switching to inexpensive tires
because the focus is on price rather than performance. The tendencies are similar for tires for
production vehicles such as trucks. Customer continuity and stability are lower for general-purpose
products.

(4) Capital and inventory investment cycles

Tire production is equipment-intensive, requiring large-scale machines for processes such as
mixing of raw materials and molding through curing. The amount of capital investment therefore
tends to be quite heavy. Tire development and production processes do not change significantly,
however, even as vehicles are restyled, and the probability of a major technical breakthrough also is
low. Product life cycles are comparatively long, and production facilities can be kept in operation for
many years as well. Because the size of the commercial tire market is so large, the inventory burden
is greater than that for general automobile components.

(5) Protection, regulations and public aspects

Subsidies and tax breaks for automobiles indirectly benefit tire manufacturers. Fuel efficiency
and emissions regulations are expected to become even more rigorous in an effort to reduce
greenhouse gas emissions and control air pollution. In Europe, there are moves to regulate particle
emissions arising from tire and road wear. Tire manufacturers would face a need to meet high
technological requirements for environmental performance in addition to driving performance.

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(6) Cost structure
Natural rubber and synthetic rubber account for roughly half of the raw material inputs for
tires and are commodity products. The bulk of natural rubber is produced in Southeast Asia and
represents a geographic concentration risk, including fluctuations in the quantity supplied because
of natural disasters or seasonal factors. Like natural rubber, prices for synthetic rubber also
fluctuate easily, because they are linked with the cost of naphtha, which is derived from crude oil.
Selling prices for tires for new vehicles are set through negotiations with finished vehicle
manufacturers. The leading tire manufacturers, however, have introduced contracts for setting
prices based on the volatility of materials prices, and this arrangement enables them to pass on
higher prices to customers, albeit with a timing gap. For commercial tires, shipping prices are set
according to supply and demand conditions and the competitive environment in each region. While
high-performance products are less susceptible to price competition, it is often difficult to raise prices
of general purpose products because their sales are largely dependent on prices.

2. View of individual firm risk

In contrast to industry risk, which highlights the standard risks of the industry of which the
subject firms are a part, the business risk of each company will differ depending on the individual
firm risk as explained below.

(1) Customer base for new car tires

Sales of new car tires are affected significantly by demand trends for passenger cars, trucks
and other transport vehicles. Consequently, the strength of the customer base assessed from
standpoints such as the relationship with and sales to the leading vehicle manufacturers is an
important input.
Tire manufacturers can increase consumer recognition of their products and capture demand
for commercial tires more easily if their products are adopted for new vehicles. In particular,
consumers who purchase a passenger car of a certain class or higher tend to prefer products made
by the same company that manufactured the tires installed on their new car. Provided a tire
manufacturer has built a strong business relationship with finished vehicle manufacturers through,
for example, joint development and supplies new car tires for globally strategic vehicles, luxury
marques and so forth, this will help to ensure its share of the commercial tire market. A tire
manufacturer can mitigate the impact from weak sales of some customers or car models, when it has

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well-diversified earnings sources with several leading vehicle manufacturers among its customers.

(2) Earnings from commercial tires and after-sales services

Compared with tires for new vehicles, commercial tire sales represent a larger market and are
less susceptible to a decline in new car sales. With higher margins, in general, than those on tires
for new vehicles, the commercial tire market is a source of profits. Market share, the extent to which
a company has established its sales network, and a company's development of various services, are
key points for evaluating earnings from commercial tires.
To maintain and increase their share in the commercial tire market, manufacturers must
publicize their brands extensively and make them the first choice of consumers. This means it is
vital to build a powerful sales network, including dealers and auto parts stores as well as direct sales
outlets, and work to gain more shelf space for the manufacturer's products. Provided a company can
offer product suggestions and tire maintenance advice through such retailers, consumers' preference
level for its products can be expected to increase.
For truck tires that suffer substantial wear and tear because of high vehicle utilization rates,
the retread business of recycling tires by recapping the surface with new tread is widespread in
North America and other regions. With respect to general-purpose tires, provision of after-sales
services is critical for ensuring profitability. Moreover, inventory control for very large products,
including tires for mining vehicles, substantially influences customers' convenience. For the major
tire manufacturers in particular, services to monitor aspects such as tire air pressure and usage
conditions and provide the appropriate maintenance have also emerged as a means to achieve
differentiation.

(3) Product competitiveness and technological flexibility

To absorb customers' demands for lower prices on tires for new vehicles and improve market
share and profitability in the commercial tire market, manufacturers must address technological
requirements for product safety, durability, fuel efficiency, driving performance and design, among
other aspects. For R&I's evaluation, key points include whether a company has a top-class market
share in high value-added areas, and whether it possesses cost competitiveness that will allow it to
maintain profitability.
R&I also takes into consideration a company's ability to address next-generation technologies.
Even if electric vehicles and self-driving cars proliferate, demand for tires will not decrease, and

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there is a possibility that new needs will arise in various aspects, including comfort. Provided it can
respond to next-generation technologies, a company's opportunities to generate earnings will
increase.

(4) Supply structure

The major finished vehicle manufacturers have built their supply systems globally, and to
receive orders for tires for globally strategic vehicles, a tire manufacturer is required to provide
efficient, stable supply in each region. In addition to mitigating the risks associated with trade
friction and exchange rate fluctuations and lowering logistics costs, this helps to reduce labor costs
and materials procurement expenses in emerging countries.
Key points in R&I's evaluation are whether a tire manufacturer has established its supply
system globally, and whether it can generate sufficient profits in the regions where it operates. The
evaluation will be constrained if a company's profitability is under pressure because it has too many
bases or it is unprofitable in some regions.

(5) Diversification of product uses

Provided a tire manufacturer enjoys earnings contributions from diversified businesses that
use rubber technologies, as well as from tires for industries other than automobiles, such as
construction machinery, mining vehicles, farm machinery, aircraft and industrial machinery, this
leads to a stable earnings base and earning capacity.
The number of manufacturers that handle the large and super-large tires used on construction
machinery, mining vehicles and industrial machinery is limited. Because unit prices and profitability
are higher than for ordinary tires for passenger cars owing to greater fabrication difficulty, these
products can pull total earnings higher. Compared with products such as passenger car tires,
however, they are more susceptible to economic fluctuations.
If a company has created a certain level of earnings base in sectors such as chemical products
or industrial materials by taking advantage of its technological superiority in rubber products, this
can mitigate the risk of fluctuations in tire demand.

II. Evaluation of Financial Risk

In its evaluation of financial risk, R&I quantitatively examines financial indicators that are
important for analyzing the tire industry, and also evaluates qualitative factors such as a company's

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financial management policy and liquidity risk.

(1) Earning capacity

ROA (return on assets), EBITDA (earnings before interest, taxes, depreciation and amortization)/average
total assets, EBITDA margin, operating margin
R&I evaluates whether a company is able to efficiently generate profits and cash flow from its
assets and net sales. In addition to ROA, an indicator of asset efficiency, it emphasizes the ratio of
EBITDA to average total assets, which excludes the effect of depreciation and amortization expense.
The EBITDA margin and operating margin are examined as well.

(2) Scale and investment capacity

EBITDA, equity capital
Tire manufacturing requires facilities corresponding to each process, from raw materials
mixing to tire building, curing under heat and pressure to finish the product, and quality inspection.
Certain levels of scale and investment capacity are requisite for creating a supply system including
sales channels and executing strategic investments for the future.
Making investments in development and production regardless of economic ups and downs is
necessary in order to maintain and enhance competitiveness. Boosting investment for the
development of advanced technologies is also critical for responding to changes in the industry
structure. To look at such investment capacity, R&I focuses on the amount of EBITDA. R&I examines
the amount of equity capital as well, as a measure of financial resilience for absorbing losses.

(3) Debt redemption period

Net debt to EBITDA ratio, net debt to operating cash flow ratio, (net debt – working capital) to FFO
(operating cash flow after deducting changes in working capital) ratio
The balance between net debt and cash flow is important when examining the debt redemption
capacity of an investment recovery-type manufacturing industry. R&I focuses on the net debt to
EBITDA ratio and also confirms the net debt to operating cash flow ratio. Note that the life cycle of
tires is longer than that of general automobile components and production facilities can also be used
over an extended period. Therefore, a comparatively long period can be allowed for the recovery of
invested capital.
Because the commercial tire market accounts for a large proportion of total demand, tire

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manufacturers need to have inventories globally, which makes their working capital burden
comparatively large. Accordingly, R&I also emphasizes the ratio of (net debt – working capital) to
FFO, which excludes working capital factors.

(4) Financial profile

Equity ratio, net D/E ratio (ratio of net debt to equity capital)
A company needs to maintain a certain level of debt-equity structure in order to smoothly raise
funds from financial institutions even during economic slowdowns. This is important as well from
the standpoint of a risk buffer against deteriorating profits, impaired assets or other similar
circumstances. R&I places emphasis on the equity ratio, while also verifying the net D/E ratio, which
highlights the balance between net debt and equity capital.

III. Rating for Tire Industry

Issuer Rating

Individual Firm Risk Financial Risk

Importance Indicator Importance
Customer base for new car tires ◎ Earning capacity ROA ◎
Earnings from commercial tires and after-sales services ◎ EBITDA/average total assets ◎
Product competitiveness and technological flexibility ◎ EBITDA margin ○
Supply structure ◎ Operating margin ○
Diversification of product uses ○ Scale and EBITDA ◎
investment capacity Equity capital ○
Debt redemption Net debt to EBITDA ratio ◎
period Net debt to operating cash flow ratio ○
(Net debt – working capital) to FFO ratio ◎
Financial profile Equity ratio ◎
Net D/E ratio ○

Industry Risk: Medium

Note) Importance is indicated by ◎: extremely important, ○: important, or △: relatively important.

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 * This report replaces all previous versions that have been released to date.

The Rating Determination Policy and the Rating Methodologies R&I uses in connection with evaluation of creditworthiness (collectively, the
"Rating Determination Policy and Methodologies") are R&I's opinions prepared based on R&I's own analysis and research, and R&I makes no
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Japanese is the official language of this material and if there are any inconsistencies or discrepancies between the information written in Japanese
and the information written in languages other than Japanese, the information written in Japanese will take precedence.

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