| Back on track |
| Ram Prasad Sahu / Mumbai February 1, 2010, 2:01 IST |
Higher volumes and investments in the auto sector augur well for auto ancillary companies, which were struggling with poor demand and increased working capital cycles.
Buoyed by rising sales of automobiles and increasing demand for their products, the fortunes of the auto ancillary sector are looking up. Not long ago the sector was struggling with high inventories, poor demand, especially in the export markets and thin margins. While export markets, which constitute a fifth of the $19 billion (Rs 85,500 crore) auto component industry, continue to be sluggish, the revival of demand in the domestic markets has come as a boost for the sector. If sales in the nine months of the current fiscal (FY 2010) are any indication, the demand at least on the domestic segment should be quite robust going ahead.
Domestic boost
The domestic auto sector saw a 20 per cent year-on-year jump in sales volumes to 10 million units in the April to December 2009 period. Of all the segments, the recovery was more marked in the case of medium and heavy commercial vehicle space (M&HCV), which was the worst affected during the downturn. The turnaround in the M&HCV segment can be gauged from the fact that the December 2009 volumes at 24,000 units is thrice that recorded a year ago.
Although the year ago monthly volumes had fallen drastically, December 2009 volumes are the highest in 21 months. The commercial vehicle (CV) segment is a key contributor to the revenues of auto component players such as Bharat Forge, which gets about 60 per cent of its standalone revenues from this space. With the recovery in place and about 9 per cent growth year-on-year for April-December 2009 period, expect the CV segment to record a healthy double-digit growth in 2010-11.
Companies such as Amtek Auto, which get over two-thirds of the revenues from the passenger vehicle (PV) segment, were better off as domestic sales of passenger vehicles were up 26 per cent to 1.5 million units during the period as compared to 2008-09. Similarly, Rico Auto, which gets over half its revenues from the two wheeler segment (largely Hero Honda), should see a 33 per cent sales growth year-on-year in the current fiscal riding on the robust 20 per cent increase in two wheeler sales to 7.6 million units. While demand for ancillary companies is likely to come from their existing clients, new investments by Indian and multinational companies in the sector is a clear indicator that demand is likely to move up and will mean more opportunity for the suppliers.
Setting up base
The size of the auto component sector which has grown by about 17 per cent annually over the last three fiscals is currently pegged at $21 billion. Over the next two years, the sector is expected to grow by about 28 per cent to touch about $27 billion in 2011-12. Investments which have grown by about 16 per cent annually between FY2002-09 are expected to grow steadily going ahead. High demand and a low penetration in the country has prompted many multinational as well as domestic companies to expand capacities as well as set up greenfield units, largely to cater to demand in the compact car segment.
Auto MNCs such as Ford, Nissan, Renault, Volkswagon, General Motors and Toyota are expanding existing capacities or setting up units with total investments to the tune of $4 billion. Nissan and Volkswagon are planning to source components for their global operations as well. To service some of their clients, auto components such as Rico Auto, Apollo Tyres and Sona Koyo are expanding and setting up new capacities.
Also, to avoid exchange rate fluctuations auto companies are sourcing a larger share of components locally. Maruti Suzuki for example, sources about 80 per cent of its requirement from local suppliers. While the domestic market is expected to grow thanks to large scale investments and an uptick in demand, the scenario in the export market does not look as robust. Margin pressures on account of higher raw material costs are also an issue that the industry has to contend with.
Exports, margin pressures
With about two-thirds of the revenues coming from the US and European markets, which are experiencing a downturn, exports revenues of component companies are estimated to have grown just over 5 per cent to $3.8 billion. ICRA says that commercial vehicles and off-roaders were the worst affected in these markets. The European CV market, for example, saw 18 months of consecutive decline to November 2009 with exporters such as Bharat Forge, Rane Engines and Wheels India bearing the brunt of the slowdown. Analysts believe that the situation could worsen once governments in developed markets withdraw the scrappage incentives available to customers, in March this year.
The situation, especially in the CV segment, is unlikely to improve as a lot of production capacity in overseas markets is lying unused. Bharat Forge currently operates its overseas plants at about 40-45 per cent capacity. Most analysts contend that a recovery in the US and European markets is likely to happen in later half of 2010-11. Says Yezdi Nagporewalla, executive director, KPMG, “While demand revival is taking place, it will take at least three quarters before things stabilise.”
While exports are likely to be sluggish, auto manufacturers will also have to contend with margin pressures as raw material costs are increasing and OEMs are on a cost cutting drive. Says Vishnu Mathur, executive director, ACMA, “Any steep rise in raw material costs will certainly impact the margins of the auto-component manufacturers very adversely as it is extremely difficult to seek price increases from the customers on account of raw material price enhancement.” Moreover, while the credit situation has improved and companies are able to fund their expansion plans, component makers are still not out of the woods. Says Pragya Bansal, associate director, Corporates, Fitch Ratings India, “Higher borrowings coupled with margin pressures are expected to keep credit metrics (such as financial leverage) stretched for the component manufacturers.” Lastly, any spike in interest rates could hurt domestic demand for automobiles and increase finance costs for companies as well.
| FUTURE PROMISE | ||||||
|
in Rs crore | ||||||
* Calendar year ended, numbers of CY09 and 10
** Fiscal ends in June
Source: Bloomberg and analyst reports
Valuations
While the sector is out of the low volumes and high overheads scenario which prevailed for a large part in 2008-09, how companies fare on revenues and margins front will depend on their ability to meet demand while keeping costs low. Companies covered in this story (see table) are expected to report year-on-year sales growth of 14-27 per cent for 2010-11 while Ebidta margins should see a flattish to 200 basis point improvement. Higher revenues and operating leverage should translate into better bottom lines for most companies in the sector. While stocks of most auto component companies have gained over 20 per cent in the last six months, considering the demand potential and earnings growth expected in the medium-term there is still scope for appreciation. We highlight the prospects of five companies in this space.
Amtek Auto
Aided by buoyant domestic auto market, which contributes around three-fourth of its consolidated sales, Amtek Auto saw its December quarter sales move up 6 per cent year-on-year to Rs 900 crore. Though overseas revenues were a dampener, higher volumes from the passenger vehicle and CV segments helped the company post operating profit margins (OPMs) to 21.5 per cent. The company will be banking on higher sales in the domestic market going ahead as OPMs here at 25 per cent are more than three times those of overseas operations. Better operational performance and a lower base led to a four-fold increase in its consolidated net profit to Rs 65.2 crore. While the domestic story looks good, an improvement in the developed markets coupled with news on the merger with group companies (called off recently on valuations-related issues) could be positive catalysts for the stock. At Rs 170, it trades at just over 10 times 2010-11 estimated EPS of Rs 16.8 and should fetch about 20 per cent over the next one year.
Apollo Tyres
An improvement in auto demand in the domestic market, robust sales at the overseas subsidiaries has helped the country’s largest CV tyre maker report a 12.2 per cent sequential growth in consolidated revenues for the December 2009 quarter to Rs 2,296 crore. At the standalone level, higher raw material (natural rubber) costs meant that OPMs fell 90 basis points to 15.4 per cent though the company increased prices by 5-10 per cent. With natural rubber prices at historical highs, expect margins to be under pressure in the fourth quarter unless the company hikes its tyre prices further.
With the commissioning of its Chennai plant in the first quarter of 2010-11, and completion of a brownfield expansion by the end of the current fiscal should help the company meet the increased demand for radial tyres. The company expects to improve the utilisation levels and OPMs at its South African plant by outsourcing a part of the production of its Dutch subsidiary, Vredestein, which it acquired in May 2009. The South African operations have an Ebidta margin of 10.9 per cent, the lowest in Apollo Tyre’s global operations. Apollo’s valuations at 7.2 times 2010-11 earnings are not demanding and investors with a two year perspective can consider buying the stock.
Bharat Forge
Led by a sharp improvement in demand from the domestic CV business and an uptick in sales from the US M&HCV market, India’s largest forging company, Bharat Forge’s standalone December quarter sales grew 19 per cent sequentially and 12 per cent year-on-year to Rs 507 crore. Exports, which form about 40 per cent of standalone revenues, jumped 34 per cent on a sequential basis. Despite input costs pressures, the company was able to hold on to 23 per cent Ebidta margins.
On a consolidated basis, revenues have grown by 14 per cent sequentially, while Ebidta margins improved from 12.5 per cent to 15.5 per cent for the same period due to a leaner cost structure and higher volumes. Going ahead, the restructuring of its operations (closure of facility in Scotland and shifting production to Sweden), should see its European business improve its performance in 2010-11. While the company has won several orders in the non-automotive business, analysts expect the orders to ramp up faster only in 2011-12 when utilisation, too, would move up from the lower levels currently. At Rs 275, the stock is trading at an expensive 27 times its 2010-11 consensus estimates of Rs 10.3 and the upsides have been priced in.
Exide Industries
Strong growth
