Despite higher commodity prices, operating leverage from healthy volumes support industry performance
The Rs 2.90 trillion (FY2017) domestic auto component industry is expected to grow by 9-11% during FY2018e, driven by robust growth expectation in domestic passenger vehicles (PV)s and two wheelers (2W) segment. As per an ICRA note, after 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’s sample of 48 auto ancillaries, constituting around 25% of the industry’s turnover, witnessed revenue growth of about 13.5% (revenue) during Q2 FY2018e. The same was driven by higher realization in the backdrop of steady increase in commodity prices, whereas volumetric growth was in the mid-single digit. Overall, during H1FY2018, the sample space grew by 9.5% which is in line with 9%-11% growth estimate for FY2018.
Says Mr. Subrata Ray, Senior Vice President and Group Head, Corporate Sector ratings, ICRA, “Domestic original equipment manufacturers (OEMs), especially 2W and PV industry which together constitute about two-third of overall domestic OEM demand is expected to grow at a healthy pace in FY2018. Moreover, expected recovery in rural income will provide upside for sub-segments like light commercial vehicles (LCVs), motorcycles and tractors. Though PV exports indicate some aberration and thereby has some bearing on production volumes, domestic PV demand remains strong during Q2FY2018. Exports related aberration is likely to abate during coming quarters and will be more than offset by robust domestic demand. As regards medium & heavy commercial vehicles (M&HCVs), their Q1FY2018 demand slowdown affected ancillaries’ performance, but strong double digit growth during Q2FY2018 has resulted in superior performance of ancillaries. Going forward, pickup in infrastructure activity will further drive growth in construction & mining equipment as well as the tipper segment (classified under M&HCVs).”
Exports which accounts for 28% of industry’s demand, with USA and Europe making up for 60%, witnessed a decline. This was sharper in the US M&HCV market during H2 CY2015 and CY2016. However the trend seems somewhat reversed now with incremental order inflow for class-8 trucks being encouraging over the last six months. As for European markets, new PV and CV registration numbers have witnessed marginal growth YTD CY2017 and their growth outlook remains tepid over the near to medium term. Exports will also be affected by rupee appreciation.
Commodity prices have been rising over the last 4-5 quarters, thereby pressurising industry’s profitability. Amongst all ancillaries, tyre manufacturers were the worst impacted due to sharp volatility in rubber prices which has peaked around Rs 160/Kg in Q4FY2017, though it subsequently moderated to around Rs 130/Kg level at present. Easing rubber prices has helped operating margins to recover during Q2FY2018 after a five year low level during Q1FY2018. Other commodities like steel and lead also remained at elevated level and continued to pressurize profitability of players. Nevertheless, strong revenue growth during Q2FY2018 has offset some impact of commodity price pressure. Though overall OPM continues to remain lower than last year’s level, most auto ancillaries have witnessed sequential improvement in operating margins.
ICRA expects industry-wide credit profile trends to remain stable, supported by robust demand from the OEM segment in the near term. Supported by healthy cash accruals, gearing as well as coverage indicators for the industry have improved considerably over the past two years. However given surplus capacities, the industry has been on a consolidation mode over the last two years, taking steps towards deleveraging their balance sheet. With select OEMs exploring inorganic growth opportunities in India as well as in overseas market to support growth, as well as to diversify its clientele and product portfolio, some incremental leverage may be expected. Overall ancillaries are concentrated on moving up the value chain to mitigate profitability and competitive pressure in the intensely competitive industry.
Incremental investments by auto ancillaries are primarily towards new order/platform related requirement or debottlenecking of existing capacity. Few have started investing keeping in mind the requirements for BS VI (in 2020), CAFE norms and electric vehicles in 2030.
“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. In line with ICRA’s previous forecast, OPMs dipped below 15% level during FY2017 and it is likely to moderate further in FY2018. Nevertheless we maintain our medium term margin outlook of ~13%13.5% as compared to earlier sub-12% level witnessed prior to FY2012 owing to a richer product mix and rising revenues from the profitable aftermarket segment. We maintain our 10-12% long term (5 year) CAGR expectation for Indian auto component industry,” concludes Mr. Ray.