Auto component companies are hemmed in by lacklustre domestic auto sales and recession-hit export markets.
On the back of an economic slowdown and credit crunch, the wheels have come off the global automotive sector. The $13.4 billion bailout package to two of the America’s Big Three (GM, Chrysler and Ford), which control over half of the US auto sales, means that they are on life support. This could spell trouble for the Indian component players as a substantial chunk of $972 million exports to the US goes to these three companies.
The situation is no different in India with major players cutting production, laying off people and postponing investments. The auto component sector, which depends on original equipment manufacturers (OEMs) for its growth, is stuck in the middle of a sluggish domestic sector and a recession-hit global export market. The impact of all this will be two-fold, says Sanjay Labroo, MD and CEO of automotive glass maker AIS.
While companies are postponing, cancelling and sharply curtailing their capex, they are now forced to reduce their fixed cost (plant and shift rationalisation) and improve margins by lowering material cost through design changes and entering niche markets. While these changes will take time to reflect on the numbers, the short-term looks bleak. The auto component sector, which has grown at a 27.2 per cent CAGR over the last five years, is likely to register a single digit or flat growth for FY09.
The problem
The domestic market, which accounts for over 80 per cent of the Rs 90,000 crore Indian auto component sector, is experiencing one of its worst phases due to the dip in auto sales. While car and two wheeler sales dropped 24 per cent and 15 per cent y-o-y in November, commercial vehicle (CV) sales slumped 48 per cent. While year-to-date (YTD) sales till November are up just 6 per cent, a seasonally low December is unlikely to boost auto numbers for the full year.
Expect auto sales to close the year at about 8.5 million units (almost the same in FY08) on the back of high inventory, economic slowdown, higher interest rates and lack of finance. While the government’s move to reduce Cenvat by 4 percentage points will have little impact (due to huge stock of unsold vehicles), reduced interest rates, higher liquidity, lower inflation and lower fuel prices will translate to a growth of about 10 per cent in FY10.
Exports
With the US contributing about 27 per cent of India’s total component exports worth Rs 18,000 crore and the Big Three (which also source components for their plants in Europe and Asia) taking a significant combined share, export earnings are likely to be severely affected. India’s largest auto component exporter,
Bharat Forge (global revenues: Rs 4,752 crore) has a 10 per cent exposure to US auto sector and about three per cent to the Big Three.
What is making matters worse for exporters is the lack of export credit. Says Yashika
Singh, head, Economic Analysis, Dun & Bradstreet India, “the Export Credit Guarantee Corporation of India is refusing credit cover to around 50 auto components companies in
India who are suppliers to the Big Three as ECGC is not being able to judge the creditworthiness of GM, Ford and Chrysler in the present scenario.”
At a conservative 50 per cent exposure out of total revenues of $972 million auto component exports to the US, in the unlikely scenario of the three major companies going under, the stakes for Indian companies is pegged at about Rs 2,500 crore.
With a reworked package, too, there might be a drastic reduction in value and volume of orders as well as pressure to rework the contracts. European auto sales, which grew just 2 per cent y-o-y in CY07 to about 19 million units, might register a decline in the current year.
On the positive side, with pressures to cut costs and outsourcing being one of the key levers to achieve this, expect the outsourcing trend to continue going forward, says Manish Mathur, principal, A T Kearney.
Indian companies with a diversified presence and a low cost base will stand to gain the most once demand picks in CY2010. Opportunities through free trade agreements and acquisitions will also help component players to market their products in different geographies and use offshore plants to supply to their subsidiaries abroad.
New markets, new segments
In light of the current scenario, manufacturers are looking at alternative markets to boost sales. “Auto parts players are looking for other destinations such as West Asia and Africa to boost their exports,” says Singh. Asia and Africa contribute about Rs 4,000 crore to auto component exports. For companies with significant exposure to the export market, the rupee’s depreciation against the dollar (down 19 per cent YTD) and other currencies should help them remain competitive vis-à-vis competition.
Auto component manufacturers are trying to insulate themselves from the cyclical nature of the auto industry by diversifying into non-auto segments such as aviation, defence, rail, tractors, construction equipment, material equipment and power. In addition, there is also a focus on new product development. While larger players like Bharat Forge are diversifying into the power sector (alliance with Alsthom, NTPC), smaller players such as CV clutch maker Setco Automotives plans to develop clutches for higher tonnage vehicles and LCVs over the next two years.
The hazy road ahead
The spike in prices in the prior period and economic slowdown has lead to erosion in margins in Q2 for the top players (Amtek Auto and Bharat Forge saw EBIDTA margins drop 300 bps each). Although raw material prices have been coming down over the last few months (steel prices down 45 per cent from peak levels), they are still to reach levels they were over a year ago. In any case, a part of the gains may also be passed on the customers.
Auto component companies are finding it difficult to make future projections as its two key markets, OEM and replacement segments, have been affected due to poor demand and there is instability in final product prices, which are trending downward. Analysts say the companies in sub-segment of the auto component sector such as tyres, bearings and batteries with a larger share of revenues from replacement and domestic market will be less affected than those that supply exclusively to the OEMs. Larger players such as Bharat Forge (high CV exposure) and Amtek Auto with a substantial chunk of revenues coming from export market could see a further fall in margins and revenues due to a drop in volume growth.
While analysts say that the downturn is factored in for most auto component companies with prices falling by more than half from their 52-week highs (see table), they prefer players such as Exide, Bosch and Motherson Sumi from a two-year perspective.
Bosch
With over 90 per cent coming from automotive segment, the company's fortunes are directly linked to those of the auto sector. For Q3, FY09, while the company’s sales suffered due to poor OEM offtake of diesel fuel injection systems (63 per cent of revenues) in CVs, three wheelers and tractors, a hike in raw material (steel) costs and a weak rupee (high import content) impacted margins. A higher growth of about 20 per cent in the replacement market (a fifth of total revenues) helped increase sales by 16 per cent to Rs 1,219 crore. With preference for common rail system (CRS) diesel engines, demand for the company's diesel fuel injection system, where it has an 84 per cent market share, should be strong as about 40 per cent of new diesel cars by 2010 are expected to be on CRS.
With non-automotive business growing at 25 per cent plus rates and the company planning to increase its share of it, investments in increasing the indigenous content and sourcing of components by its parent, points to strong diversified revenue growth for the company. The company plans to use its Rs 1,700 crore cash hoard to buyback up to 5 per cent of its shares, which will push up the parent’s stake to about 74 per cent and boost Bosch’s EPS going ahead. At Rs 3,036 (PE of 15 times estimated CY09 EPS), the stock offers about 25 per cent over the next fifteen months.
| TOUGH TIMES AHEAD | ||||||
| Rs crore | Sales | Net profit | OPM (%) | Exports | % YTD ch in pr. | P/E FY10E (x) |
| Amtek Auto | 1,286.21 | 247.34 | 35.02 | 354.10 | -84.39 | 2.13 |
| Bharat Forge* | 5,376.25 | 187.00 | 11.02 | 950.16 | -74.61 | 5.91 |
| Exide Ind | 3,320.23 | 278.02 | 15.88 | 135.97 | -33.56 | 10.6 |
| Bosch | 4,752.48 | 664.05 | 27.68 | 672.95 | -37.54 | 15 |
| Motherson Sumi* | 2,335.01 | 175.59 | 13.12 | 244.41 | -39.66 | 9.7 |
| Sundram Fasteners | 1,361.48 | 45.48 | 12.13 | 341.92 | -67.15 | 4 |
| Rico Auto* | 914.02 | 15.09 | 12.52 | 134.99 | -70.55 | 2.86 |
| Wheels India | 1,325.44 | 28.62 | 8.71 | 221.42 | -57.05 | 4.83 |
Exide Industries
Despite the fact that over half its sales come from the automotive sector, a diversified presence in the OEM as well as the replacement sector across the automotive (CVs and passenger vehicles) and industrial segments (telecom towers, UPS-commercial and residential) would mean that the company is less affected than most component players. While OEM sales have been muted, a 40 per cent sales boost in the industrial segment has helped Exide post a 35 per cent growth in revenues in H1, FY09 to Rs 1,807 crore.
Going ahead, a steep decline in lead prices and acquisitions (two lead smelting units) will not only ensure a steady supply of lead, but also help cut raw material costs. With cash of about Rs 500 crore, high growth industrial segment and assured raw material supply, a 50 per cent share in ING Vysya Life Insurance, the company is on a strong wicket. At Rs 48 (PE of 10.6 times estimated FY10 EPS), the stock should give about 18 per cent return over the next one year.
Motherson Sumi
A 65 per cent share in wiring harness (vehicle lighting systems), presence in high margin assembly and modules, and diversification into non-auto segments make Motherson Sumi a good pick. Thanks to its dominant position, it is well positioned to gain from expansion of key clients, Maruti and Hyundai. While the company gets about 37 per cent of its revenues from the export market currently, it expects this to increase to about 60 per cent by FY10 with revenues being contributed from its operations in the UAE, Europe, Sri Lanka and Australia.
Going ahead, while the company will benefit from drop in copper prices, prospects will hinge on the growth in polymer (plastic moulds) processing and rubber/metal parts businesses. The company has diversified into manufacturing components for mobile handsets in a JV with Balda of Germany and garbage disposable equipment for the Australian market. While sales in H1, FY09 have seen a 33 per cent jump to Rs 1,239 crore, expect overall growth to hover around 25 per cent for FY09. At Rs 68 (PE of 9.7 times estimated FY10 EPS), the stock should fetch 25-30 per cent returns over the next one year.
