Long-term CAGR projection at 10-12%
Domestic automotive demand came under pressure during Q3 of FY17 post the cash crunch created by demonetization related measures. Some segments like two-wheelers (2W) and light commercial vehicles (LCV) were severely impacted due to their dependence on the rural economy where cash transactions are high, whereas the performance of other segments like passenger vehicle which already has high levels of financing penetration were less impacted. With the impact of demonetization easing substantially in January, industry experts are expecting full recovery by March.
The silver lining in Q3 was automotive exports which supported the overall production volume. During Q3 FY17, PV and M&HCV production grew by 11.8 per cent and 4.2 per cent respectively despite much weaker domestic wholesale volume. Consequently, despite the weak domestic demand, the overall volumetric demand from the OE segment remains positive for the auto component industry.
Exports account for 28 per cent of demand for auto components in India. The auto component export has a high exposure in the US and EU markets, which together account for around 60 per cent of the total export of components from India. Slowdown in the US as well as the European markets will have a bearing on Indian exports though higher order share and market share expansion could counter it to an extent. The aftermarket segment which accounts for nearly 17 per cent of the domestic auto component market was however impacted during Q3 (post-demonetization). With the segment having a high level of cash transactions especially at the end customer (garage/spare parts outlets) level, the market saw challenges as customers deferred discretionary spending owing to cash crunch.
The sample of 48 auto ancillaries, which constitutes around 25 per cent of the industry’s turnover, grew by 6 per cent (revenue) during Q3 FY17 as against the 4 per cent growth in the previous quarter. Revenue growth was primarily driven by higher realization in the backdrop of steady increase in commodity prices, whereas volumetric growth remained in a low single digit. During Q4 FY17, pre-buying ahead of nationwide BS-IV emission norm implementation is likely to propel M&HCV demand. The proposed mandatory heating, ventilation and air-conditioning (HVAC) system in M&HCVs from April is another positive for domestic auto ancillaries, especially for HVAC suppliers, though automotive OEMs are expecting deferment in the deadline for its implementation.
Rising commodity price
In FY16, the operating margin of auto ancillaries benefitted from soft commodity prices; however, these benefits were eventually passed on to the OEMs with a lag of a quarter or two. The benefits of commodity prices had peaked out in Q3 FY16 and RM expense, as a percentage of sales have started increasing sequentially since then.
Certain commodities like steel, rubber and copper have witnessed sharp jump in prices over the last 12 months. Auto ancillaries have to absorb these increased costs in the immediate term, though it will be gradually passed on to the OEMs with a lag of quarter or two. During Q3 FY17, tyre companies were amongst the worst impacted due to a sharp increase in rubber prices (over last 12 months) which resulted in a steep 300+bps correction in contribution margin for major tyre companies. Battery manufacturers like Exide and Amara Raja also witnessed sharp increase in RM cost on account of higher lead prices.
Our sample of 48 auto ancillaries witnessed a steep 166 bps YoY decline in operating margin to 13.8 per cent, mainly on account of RM cost pressure as well as higher sticky costs (employee and SG&A expenses). With likely improvement in volume off-take during Q4, operating margins are likely to expand sequentially (QoQ) during Q4; however, given that RM benefit have peaked out, operating margins are expected to witness YoY moderation over the next few quarters.
Stable credit profile
Given surplus capacities, the industry has been on a consolidation mode over the last two years, taking steps towards deleveraging their balance sheet. However, select OEMs are exploring inorganic growth entailing fund-raising. Ancillaries continue to focus towards moving up the value chain to mitigate profitability and competitive pressures in an increasingly competitive industry environment. Incremental investments by auto ancillaries are primarily towards new order/platform related requirement or debottlenecking of existing capacity. Supported by healthy cash accruals, gearing as well as coverage indicators for the industry have improved considerably over the past two years; ICRA expects industry-wide credit trends to remain stable, supported by robust demand from the OEM segment in the near term.
Market outlook
Considering the increasing content per vehicle due to various technological advancement as well as regulatory measures (emission, safety regulations), the growth in the auto component industry will be relatively higher than the underlying growth in the automotive industry in the medium- to long-term. ICRA maintains its projection of 10-12 per cent long-term CAGR expectation for the Indian auto component industry.
Over the medium- to long-term, growth in the auto component industry will be higher than the underlying automotive industry growth, given the increasing localisation by OEMs, higher component content per vehicle and rising exports from India. Operating margin in FY17 are likely to ease around 14.9-15 per cent level from 16 per cent in FY16. We maintain our medium-term margin outlook of around 13.5 per cent as compared to earlier 12 per cent witnessed prior FY12 owing to a richer product mix, and rising revenues from the profitable aftermarket segment.
Short-term growth drivers
* Sustained growth in the PV and 2W industry
* Stable aftermarket
Long-term growth drivers
* Domestic automotive demand given low vehicle penetration in India
* Increasing localisation by OEs in structural components
* Increasing content per vehicle
* ‘Make in India’ initiative – Developing India as export hub for auto components and small cars/UVs
Key challenges
* Regulatory & infrastructure bottleneck
* Low R&D spending and dependence on global suppliers for technology knowhow
* Rising imports from China; Chinese competition in the global market
* Fragmented industry, with only one player in the global top 50 auto ancillary list