Capital expenditure (capex) by the domestic automotive components companies is expected to remain high at around ~Rs 24,000 crore over fiscals 2019 and 2020, to meet tightening regulations, research and development requirements, and capacity expansion.
Capex continues to be substantial considering that it represents close to 20% of the existing investment in fixed assets by component manufacturers.
Strong balance sheets and a recovery in business prospects in fiscal 2020 will help firms absorb the investments without materially affecting their credit risk profiles.
An analysis of ~225 automotive component firms (accounting for over 60% of sector revenue of ~Rs.3.2 lakh crore in fiscal 2018) shows their capex in fiscals 2017 and 2018 increased by more than 20% compared with the two fiscals preceding to nearly Rs 23,000 crore.
Despite this high base, capex across sub-segments will remain elevated until fiscal 2020, driven by regulatory changes necessitating technology upgradation and product development (~35-40% of spend), even as majority spend will be incurred for incremental capacity.
New regulations include transitioning to Bharat Stage VI (BS VI) fuel norms by April 2020, increase in truck axle loads, suspension equipment for two-wheelers above 125 cc, air-conditioned cabins for trucks, and crash tests.
“To meet regulations and demand, CRISIL1 expects capex spend by vehicle makers to rise 30% over fiscals 2019 and 2020, compared with the preceding two fiscals,” says Anuj Sethi, Senior Director, CRISIL Ratings. “That will mean component makers will also have to ramp up on investments - in product development, and acquire technology faster than before - in order to remain relevant.”
Besides, the government is also encouraging a shift to electric vehicles. However, given inadequate infrastructure and raw materials, transition is likely to be gradual, thereby limiting the impact on component makers in the near to medium term.
CRISIL expects the automotive component sector’s revenues to grow at ~10% between fiscals 2018 and 2020, compared with 11.5% in preceding two fiscals.
The OEM segment, which accounts for about two-thirds of revenues of component makers, could see a 10-11% growth until fiscal 2020, driven largely by healthy demand from commercial vehicles, and better passenger vehicle (PV) and two-wheeler sales due to increased affordability. There will also be a last-minute rush across segments to beat the BS VI transition deadline.
Growth in the second half of fiscal 2019, though, would moderate temporarily due to lower PV and two-wheeler sales stemming from higher insurance cost, interest rate, fuel prices and dealer stocks.
While aftermarket demand will remain steady, exports should continue to grow at almost similar rates as OEMs, on the back of steady demand for Class 8 trucks in the US, for petrol-engined PVs in Europe, and increasing penetration in Asia.
The credit risk profiles of CRISIL-rated component makers have been improving steadily over the past few years, with the credit ratio (number of upgrades to downgrades) reaching a 6-year high of 2.1 times in fiscal 2018. Balance sheets were the strongest in a decade in fiscal 2018, with gearing levels at a comfortable 1 time for CRISIL’s portfolio.
“Steady cash flows over the next two years will help component makers offset the impact of continuing large investments and ensure stability in their credit profiles,” said Sameer Charania, Director, CRISIL Ratings.
1Refer to CRISIL’s press release titled, ‘For vehicle makers, capex to rise over 30% in next 2 fiscals’ dated June 18, 2018