The agency has also revised the rating outlook on sector companies to Stable from Stable to Negative driven by the resilient performance of its rated entities during the downturn. Ind-Ra's analysis indicates that despite the muted environment over FY13-FY14, around 70% of its rated issuers in the auto ancillary segment were either affirmed or upgraded.
The auto ancillary sector witnessed a slowdown over FY13-FY14, driven by weak auto sales domestically. An expected revival in auto demand in FY16 will benefit the industry. In addition, continued economic growth in the US and a recovery in European auto market, which together account for around 60% of the auto ancillary industry's exports, are likely to result in higher growth in exports for the segment.
We expect that the government's recent focus to promote domestic manufacturing ('Make in India' campaign) could accelerate investments in the medium to long term. Historically, the automotive sector has been among the top receivers of foreign direct investment in India. Thus, auto ancillary industry could be headed towards a higher growth trajectory, in view of increased investment and India's potentially higher contribution to the global automotive industry. The share of exports in the domestic auto ancillary industry rose to around 29% of turnover in FY14 from around 16.5% in FY08. Ind-Ra's analysis indicates that companies within its rated universe reported stronger growth in export revenue over FY11-FY14 than in the domestic revenue. In addition, exports were margin accretive for many of these companies.
The agency expects limited pressure from imports in FY16, if the rupee remains at around INR63/USD by year end. Sector imports declined around 7% (in USD terms) over FY12-FY14. However, newer free trade agreements particularly with ASEAN (Association of South East Asian Nations) could intensify competition for the domestic auto ancillary industry.
We expect the margin of sector companies to expand by 100bp-200bp in FY16, supported by a revival in domestic demand along with a benign raw material environment. The margins were largely unchanged over FY12-FY14 due to a muted demand environment. However, companies focused on improving cost structures during the downturn, which is visible in a lowering of raw material costs as % of sales.
Auto ancillary companies should report improvements in cash flow and credit profile in FY16. Limited capex as a result of the significant decline in new project announcements in the sector over FY12-FY14 should aid cash flow in FY16. The credit profile of auto ancillary companies has only been marginally impacted by the muted demand environment as they used a cautionary approach to any new capex, unless to support product launches by original equipment manufacturers.
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What Can Change The Outlook?
Aggressive Expansion Plans: Ind-Ra expects that the sector could see a significant uptick in capex announcements in FY16 on the back of favourable policy decisions during FY15-FY16. Any aggressive capex plans without a significant revival in demand could strain the cash flow and stretch the credit profile of sector companies resulting in a negative sector and rating outlook.
Auto Demand: Weaker-than-expected growth in auto sales particularly passenger vehicles could negatively impact the financial profile of sector companies and could lead to the sector outlook being revised to negative.
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