A moderation in industrial activity and an expected slowdown in infrastructure spending are likely to restrict medium and heavy CV (MHCV) volume growth to between three per cent and five per cent this year. Light commercial vehicles (LCVs), which are more dependent on consumer non-discretionary activities and less on industrial activity, are expected to achieve volume growth of 18-20 per cent this year.
The increasing number of competitors (currently 27 players in the cars/utility/commercial vehicles segment and nine in the two-wheeler segment) may structurally affect operating margins in the industry. Players are likely to face difficulties in passing cost increases on to customers, and instances of prices being cut to boost demand are likely to rise.
Overcapacity
Significant increases are expected in production capacity for PVs (10 per cent) and CVs (25 per cent). As a result, industry utilisation rates should decline considering muted demand growth. Capacity additions to protect market share in the face of increased competition are likely to continue in 2013-2014. The capacity overhang in the medium term should add to pressure on margins, which are already being hit by cyclical factors such as demand moderation and structural changes such as increased competition.
A continuation of the high interest rate environment or a downward revision in economic activity would significantly affect the credit metrics of companies, particularly the original equipment manufacturers (OEMs) in the MHCV segment. In the case of PVs, the volume growth rate may be negative if consumer purchasing power is further weakened due to continued high consumer inflation coupled with a less-than-commensurate rise in income levels.
At the same time, a revision in the outlook to positive is unlikely in the medium term even if interest rates are reduced, due to the adverse impact of competition-led pricing pressure on the financial profiles of OEMs.
Historically, LCV sales volume growth has shown higher stability than MHCV volume growth across entire business and interest rate cycles. In India, LCVs are more often linked to economic activity in the non-discretionary segment and used mostly for intra-city shipments. MHCVs are more often used for inter-city or inter-State transportation of mostly industrial goods.
Given the current interest rate scenario and expected levels of industrial activity, MHCV sales are unlikely to recover and should be driven more by replacement demand than fresh capacity additions.
Heightened competition in the Indian auto market may lead to a fall in operating margins. In addition, with overall demand in the industry likely to remain muted, OEMs are likely to respond with price discounts to shore up volumes. This is likely to further stress industry players’ operating margins this year.
Further, profitability margins of foreign auto OEMs and JV companies may be pressured by limited indigenisation levels. If the rupee continues weak against the US dollar, import costs for companies would be higher, with exports providing only a partial hedge.
Competitive pressure in the past five years has restricted the ability of auto OEMs to pass on increases in the cost of key inputs such as steel, aluminium and rubber. The prices of these commodities may fall slightly, in line with lower industrial offtake globally, providing some respite to OEMs. The net impact of all of the above factors will be a 250bp-300bp reduction in industry average operating margins.
Considering the adverse impact of the economic slowdown on MHCV volumes, companies with a presence mainly in this segment are likely to see their financials coming under stress. Companies with a large presence in LCVs could meanwhile maintain their credit profiles at current levels based on a lower impact of economic cycles on LCV volumes.