In countries with colder climates it is commonplace, and often compulsory, for vehicle owners to change their car tyres seasonally. Higher natural rubber content, wider tread blocks, deep grooves and studs are some of the characteristics of winter tyres that enable better performance in challenging conditions.
Since splitting from the Nokia Corporation in the 1980s, Nokian has grown into a diversified tyre manufacturer targeting many tyre segments and geographical markets. As the inventor of the winter tyre and in many respects pioneering innovation in this regard, Nokian has become the market leader in the Nordic region and, in our view, is poised for global growth.
Viking of the Nordics
In Finland, the 1920s brought about a transition from horse-drawn carriages to trucks and lorries that motorised road and goods transportation. Weather conditions often proved treacherous, with heavy rain and snow regularly endangering drivers, pedestrians and horses. Drivers resorted to attaching snow chains to their truck tyres to gain more traction on the slippery roads.
In 1934, Nokian manufactured the first winter tyre for trucks, which boasted a transverse groove type of tread, providing a tooth-like grip and greatly improved traction in the soft mud and snow – unique at the time. This period also saw a flood of passenger vehicles on the roads and Nokian quickly identified the need for similar technology to be applied to smaller car tyres. This gave rise to the first winter tyres for passenger vehicles in 1936 and, in the 50 years that followed, the company demonstrated a great deal of innovation in this area. Their well-honed experience paid off in 1978, when Finland passed a law deeming the use of winter tyres as mandatory. Germany and Russia, among others, later followed suit with this practice.
The demand for winter tyres is inherently seasonal, with the laws governing usage typically enforced for only a portion of the year. For Nokian, this translates to seasonality in inventory levels and a cost to financing the higher average working capital they require. The company uses the seasonal demand to their advantage by offering a storage service to their customers – winter tyres can be stored when not in use and refitted when required. This strengthens customer relations and boosts brand loyalty. Despite the seasonality element, Nokian has achieved strong margins through its specialisation, quality product and enduring client relationships, producing high returns over time.
Strength in diversity
Nokian’s geographic footprint has grown extensively over the years and now services tyre markets across the Nordics, the rest of Europe, the US, Canada, Russia and China. It develops and manufactures winter, summer, all-season and heavy tyres and, alongside wholesalers and distributors, services aftermarket tyre demand through the Vianor chain of car service and maintenance centres. Its product offering is manufactured across four large factories in Finland, Russia and the US, with an additional two tyre testing centres in Finland and another being built in Spain.
Nokian entered the Soviet Union market soon after Finland’s trade agreement with the USSR in the 1960s. Four decades on, in the early 2000s, Finland’s neighbouring country, Russia, was targeted as a growth market with Nokian building a large factory there. When the use of winter tyres in Russia became mandatory, the company again worked on developing customer relationships and brand loyalty, as well as further expanding local production capacity. Today, Russia is home to two of the four factories and serves as a low-cost base that exports to over 35 countries. This makes Nokian the single largest exporter of consumer goods in Russia.
Lower cost base means better margins
Innovation, coupled with a focus on product quality and service, has propelled Nokian to the top of the Nordic and Russian tyre markets, enabling them to command a price premium as evidenced in the chart below. Nokian’s resultant high margins and good returns on capital have helped maintain a strong balance sheet. The company’s profit margins are, however, influenced by cyclically priced raw materials (currently low), emerging market production currencies (currently weak) and relatively low Russian labour costs.
Growth carries a price
Over the last three years, Nokian has invested €661 million on capital expenditure for growth. It has completed its new US factory, acquired the Finnish heavy equipment wheel manufacturer, Levypyörä Oy (a pre-existing supplier) and, in Finland, made further factory upgrades and built a new research and development centre.
Located in Dayton, Tennessee, the new US factory is intended to directly supply the US – the world’s largest tyre market. While Nokian had established a presence in the winter tyre market in the US prior to the construction of the Dayton factory (charts below), the distribution network has proven fragmented. The company anticipates that tyres from the new factory, with a “Made in America” stamp, will enable it to gain US market share.
It is also expected that the US tyre distribution network will be consolidating in the medium term, which will see tyre manufacturers and wholesalers joining forces to the benefit of large players. The recent joint venture between Goodyear and Bridgestone, called TireHub, is evidence of this trend.
Local Nokian production in the US will reduce lead times and transportation costs, and improve the servicing of North American customers. However, a focus on the more competitive all-season tyre market and increased operating costs will result in lower margins. We anticipate that the margin pressure will ease over time as the factory ramps up to full capacity and greater economies of scale are achieved.
Due to a colder climate, Nokian’s two Finnish testing centres are limited in their ability to test all-season and summer tyre products. The new testing centre in Spain is therefore much needed – particularly as the US factory focuses on all-season tyres.
The new vehicle market has been very negatively impacted by the Covid-19 pandemic (charted below) due to declining incomes and low consumer confidence. Yet, distances driven are expected to return to pre-Covid levels quicker than new car sales (as the resumption of daily activity begins to normalise), which should result in the replacement tyre market being more resilient than the new car sales market. As Nokian has no exposure to original equipment manufacturers (OEM’s) for passenger vehicles, solely servicing aftermarket tyre demand, they are seemingly better placed than other tyre manufacturers.
Patience will be rewarded
Nokian’s current performance is depressed by low consumer spending and milder winters in many of their key markets. This, coupled with the margin-dilutionary expansion into the US and scepticism about recent capital expenditure, seems to have weakened investor sentiment towards the company – evidenced by the multi-year low share price now.
Nevertheless, Nokian has a well-established presence in their primary markets and the groundwork in place to enable further penetration into their growth markets. Despite this capex cycle placing the company in a net debt position for the first time in 10 years, Nokian’s strategy remains to carry as little debt on the balance sheet as possible. They are backed by a history of generating solid margins and high returns. Furthermore, the appointment of a new CEO with prior experience in the North American and European markets should stand them in good stead on the growth and development front. We believe their prospects are strong.