Profitability woes hit sector leaders IndiGo, Maruti, Hero, Asian Paints

Industry leaders in auto, aviation and paints sectors are focused on improving market share rather than margins

Despite dominating the sectors they are in, industry leaders have been eyeing market share and volume gains at the cost of profitability. This is the case across the two-wheeler, passenger car, aviation, and paints sectors. 

For auto companies, for instance, maintaining volumes while passing on the hike in raw material prices is tough. Most companies in the sector, however, have been cautious, preferring to absorb some of the costs rather than risk losing volumes amid demand worries.

Consider the country's largest car maker Maruti. While the company has done much better than the sector, gaining market share to the tune of 170 basis points year-on-year to 52.1 per cent in the September quarter, it has not been able to use this to improve its margins or take aggressive price hikes. 
 

To improve its volumes amid weak demand, the company has been offering higher discounts to the tune of Rs 18,750 per vehicle on an average, up Rs 3,500 from last year. Coupled with commodity prices, adverse currency movement (rupee vs yen) and higher marketing spends, the volume focus led to operating profit margins falling 160 basis points year-on-year to 15.3 per cent in the September quarter. With the festival season likely to be a washout and product prices higher on account of upfront insurance payment, the market leader could end up sacrificing margins even more by offering higher discounts and avoiding price hikes. Chirag Shah and Jay Mehta of Edelweiss Securities believe that near-term cost pressure due to currency and steel prices could squeeze margin in a weak demand environment. 

For the largest two-wheeler maker, Hero MotoCorp, margins dipped by 225 basis points to 15.2 per cent in Q2 even though volumes and realisations were up 3- 5.5 per cent. While the company did hike prices in October, its third hike since April, the previous hikes (till September) were not enough to overcome the raw material costs increase (by 115 basis points to 69.3 per cent of sales) and the end of tax breaks for the Haridwar plant. Analysts at Morgan Stanley expect operating profit growth to remain weak on account of competitive and inflationary pressures. Further, the launch of two new scooters and a motorcycle is expected to keep Hero MotoCorp's marketing costs high, adding to the pressures on profitability.

The aviation sector is another example of strong volume growth but little pricing power. InterGlobe Aviation (IndiGo) has a market share of 44 per cent and reported a volume-led revenue growth of 17 per cent in the September quarter. Despite this and market share gains in the quarter, Indigo reported an operating loss of Rs 10 billion. The sharp rise in fuel costs and fierce competition have meant that the market leader is matching the fares of much weaker opponents. With record capacity additions planned by IndiGo and the need to keep the planes occupied, expect pricing pressure (at a time of high costs) to continue. This will dent profitability both for IndiGo and the aviation sector. 

The largest listed retailer by market capitalisation, Avenue Supermarts (operator of DMart stores), too, reported disappointing margins on the back of a volume-led growth strategy. The company reduced prices across categories driving customer walk-ins and improving revenues by 39 per cent year-on-year. Low prices led to a sharp erosion in gross and operating profits. Operating profit margin, which was over 35 per cent in the last four quarters, came down to 23 per cent in the September quarter. Near-term earnings growth, according to analysts at JM Financial, is likely to be under pressure. Volume gains/operating leverage is insufficient to overcome gross profit compression, believe analysts.  

Finally, the paint sector leader, Asian Paints, saw margins fall by 188 basis points year-on-year to 16.9 per cent despite registering an estimated 11 per cent growth in volumes for the September quarter. Though the company has taken three price hikes so far in CY18, ICICI Securities believes that the hikes are not enough to offset the increase in raw material costs. Given the high crude oil prices and a depreciating rupee, the pressure on input costs, and thus margins, is expected to continue as the company puts off any price hikes to the post-Diwali period.