Tepid sales on account of economy downturn and new regulations will continue to impact both the automotive and ancillary industries with patience now being the key factor among manufacturers
India Ratings and Research, a Fitch Group company, has revised its outlook on the automotive sector for FY21 from stable to negative on the expectation of weak sales amid macroeconomic headwinds, leading to weak consumer sentiments. Furthermore, sector-specific factors such as an uncertain regulatory environment, limited credit availability and increased cost of ownership after Bharat Stage (BS) – VI implementation will add to negative consumer sentiments. India Ratings and Research expects flat-to-low single digit growth in the total domestic sales volumes in FY21.
The research agency expects passenger vehicle (PV) sales to grow 2%-4% year-on-year, while commercial vehicle (CV) to fall at 5%-7% year-on-year and the two-wheeler (2W) to decline 0%-5% year-on-year in FY21. During April-December 2019, sales volumes fell 16% year-on-year. The report states that industry volumes in FY20 may decline by 12%-15% year-on-year. It expects limited rating movements in the sector in FY21 and thus has maintained a stable rating outlook. Revenue growth and margins will be subdued and companies will continue to incur capex in view of ongoing regulatory changes, development of an electric vehicle platform and continued new product launches.
However, the credit ratings of most original equipment manufacturers (OEMs) rated by India Ratings and Research are likely to be unaffected due to their robust liquidity positions and low-leverage profiles that provide them strong financial flexibility. After the adoption of BS-VI from April 1, 2020, the prices of vehicles would increase. However, the agency does not expect any meaningful pre-buying as OEMs have already started launching their BS-VI variants and reduced production of BS-IV variants to manage inventory pile-up.
Pre-buying is likely to be more in 2W and CV, where price differential is higher, while it would be insignificant in PVs. As consumers would take some time to accept the increased pricing, India Ratings and Research believes sales in Q1 FY21 would be minuscule, especially in CVs. The demand is likely to pick up from the start of festive season in H2 FY21. In CVs, the implementation of axle load norms, low industrial output and a reduction in transit time after GST implementation have resulted in excess capacity in the system.
While infrastructure spending could increase in FY21, this would consume some of the spare capacities in the system and thus is unlikely to create an incremental demand of vehicles. Furthermore, limited credit availability, particularly from NBFCs, would contain CV growth in FY21. The government’s thrust to improve farm income coupled with high Rabi crop output should help to revive demand from the rural sector to a certain extent. This would benefit light CV and motorcycles’ segments in particular.
Automotive ancillaries
As for the automotive ancillaries sector, the agency has maintained a negative outlook for FY21. India Ratings and Research expects flat-to-low single digit growth in domestic original equipment manufacturers’ (OEM) volumes in FY21 on weak sales amid unfavourable macroeconomic factors, uncertain regulatory environment and limited credit availability along with increased cost of ownership after BS-VI implementation. It expects subdued vehicle sales in H1 FY21 after BS-VI implementation as consumers would take time to accept the revised pricing and a recovery only after the start of the festive season.
In the first nine months of FY20, OEM sales volumes declined 16% year-on-year. Furthermore, a correction in dealer level inventory has constrained demand for ancillaries. Hence, the report states that sector revenues may post a high single digit decline in FY20 before recovering to modest record mid-single digit growth in FY21. Demand is likely to receive an impetus from higher content per vehicle on the back of evolving regulatory norms and capabilities developed for BS-VI and electric vehicles, which could also be used to service other markets with similar regulatory requirements.
The margins of automotive ancillaries may improve modestly in FY21 due to an improvement in operating leverage, but will remain below the FY19 levels. Downside risks could arise from pricing pressure from OEMs, primarily in H1 FY21, as they may not be able to fully pass on price increases on account of BS-VI norms in a subdued demand scenario. Most ancillaries entered FY20 after a period of elevated capex spending. With the demand decline, they have deferred non-essential capex and only committed capacities are likely to be executed. The report further states that the credit metrics of automotive ancillaries may remain elevated in FY21, post deterioration in FY20, on the back of lower profitability and continuing, albeit lower, debt-funded capex.
The agency expects the capex to resume once the demand conditions improve, likely post FY21. Cost control and working capital management remain key factors in this environment.
The agency has also maintained a negative outlook on its rated portfolio for FY21, based on the expectations of a continued weaker-than-envisaged operating performance and credit metrics in FY21 amid a challenging economic environment. However, some of the companies are taking steps to rationalise capex to improve cash flows and are also diversifying so as to reduce exposure to the domestic automotive market.