Founded in 1898 as Finnish Rubber Works, and later renamed Nokian Renkaat Oyj (“Nokian”), this Finnish gem rose to prominence in 1934 after developing the world’s first winter tire. This legendary tire was later branded as Hakkapeliitta, after the Finnish light infantry of The Thirty Years’ War. While that branding has been a constant, the tire itself has evolved immensely through 80 years of dedicated research and development. In 2013, its modern incarnation helped set the world record for the fastest car on ice when Nokian test driver Janne “Ice Man” Laitinen reached speeds of 335 km/hr (208 mph) on the icy Gulf of Bothnia in Oulu, Finland. These extreme speeds emphasise the traction of Nokian’s winter tires, a feature that has won the trust of drivers in almost every icy corner of the world. Today, Nokian’s range of high-end winter tires boast strong market positions.
Nokian is unique in that it does not sell to OEM car manufacturers which is a competitive and lower margin business. Instead, Nokian leverages its exceptional brand reputation in high-quality winter tires (70% of sales volume) to sell directly to drivers. Whereas most tire companies depend on high volumes to drive profitability, Nokian depends on brand reputation, niche focus and premium pricing. This strategy has helped to deliver 20%+ operating margins for over a decade leading into 2020, making Nokian’s record of profitability the envy of the tire industry.
Supporting the company’s unique approach is its extensive network of retail tire outlets, called Vianor. 50-70% of inventory at Vianor outlets tend to be Nokian’s brands. With leading positions in the Nordic Region and Russia, Vianor enables Nokian to protect its share of high-end winter tires (>40% in these regions) and sell them at a healthy premium. Vianor also has a sizeable presence in Central Europe, which continues to grow. Beyond its passenger tires, Nokian has strong positions in forestry, agriculture, truck, and off-the-road tires, which account for 14% of sales. In these heavy tire businesses, strong relationships with the manufacturers of specialty vehicles are its source of advantage.
From a current risk perspective, Nokian’s exposure to Russia stands out given the company produces 80% of its passenger tires (17 million) in a factory just outside of St. Petersburg. About 6.5 million of those tires are sold within Russia, which along with the Vianor network in the country accounts for 20% of the company’s revenues. The remaining 10.5mn tires are exported across Europe and constitute about 35% of the company’s revenues. In total, roughly 55% of Nokian’s revenues are tied to Russian production and distribution. On April 9, Nokian announced that the European Union has banned the import of tires from Russia. This development is going to take a toll on profitability over the short term but there are certain mitigating factors. Firstly, the 3+ million tires produced in the Finland and U.S. facilities, the heavy tires business (also in Finland) and the Vianor network outside of Russia continue to operate normally. Together, these businesses constitute 45% of revenues. Secondly, the business has additional capacity of 5 million tires in its U.S. and Finland facilities. Production in these facilities is being ramped up through the addition of shifts and equipment to supplement as much as half of Russian exports. Third, operations within Russia are ongoing and the business has been a share taker in this environment given their advantage of local production against others who are importers in the country. Finally, the business has EUR280 million in net cash to reinvest in capacity outside of Russia, which highlights the prudence of management in maintaining a strong balance sheet.
We believe the North Star in understanding Nokian’s investment case is the fact that its success comes from its brand, the quality of its tires and its niche focus. Profitability will be negatively impacted in the wake of disruption in Russia, but we believe these core advantages are sustainable and production can be supplemented in the long term. As a leading winter tire specialist with a strong record of profitability and a net cash balance sheet, we believe this unique tire company is positioned for long-term success.
Following our initial research, Sprucegrove established a position in Nokian in June 2013. We saw an opportunity to add to the position in 2014, when Nokian’s share price declined as the Russian annexation of Crimea unfolded. We see current geopolitical tensions as another buy opportunity and have continued to add to our position at an NP/E of 8.8x.