Auto components: Slow Drive
Revenue to decline 4-6%, margins to be under pressure in fiscal 2020
Companies will have to realign product strategy to deal with regulatory changes
Shifting to lower gear
A slowdown in demand across vehicle categories, has led to production cuts by leading automobile original equipment manufacturers (OEMs) over the last 12 months. The slowing vehicle demand and the consequent piling up of inventory with dealers have meant moderation in orders for the automobile components sector. CRISIL Research sees the auto components sector’s revenue declining 4-6% in fiscal 2020 as against 15% growth in fiscal 2019. Despite the fall in raw material prices, which are typically passed on with a lag, players are also seeing pressure on their operating margins as utilisation rates are on the decline.
The health of the domestic automobile sector is a key factor in the growth of the auto components sector. This is because about 65% of the revenue of auto component firms come from domestic OEMs. The remaining 19% come from export and about 16% from replacement. So any sales decline or production cut in the automobile sector is bound to impact the components makers. Within the OEM segment, passenger vehicles (PVs comprising cars and utility vehicles) account for about 51% of auto component demand, two-wheelers around 26%, commercial vehicles (CVs) around 16% and tractors about 5%.
We believe credit quality of the auto components sector would be stable to moderately negative in fiscal 2020. The good thing is that component firms’ balance sheets had been strengthening over the past decade, and capital spending will be curbed until demand revives. Having said that, we believe, the companies with higher concentration either by product, especially CVs, or by client may face pressure on credit quality.
Steep rise in ownership cost of vehicles
The automobile industry was in good shape until the first half of fiscal 2019. The sales slowdown started from the third quarter of the fiscal after the Insurance Regulatory and Development Authority (IRDA) revised the insurance norms by the end of September 2018. The move pushed up the insurance cost for two key sub-segments – two-wheelers and PVs. This coincided with a surge in petrol and diesel prices. As a result of these, the cost of ownership of two-wheelers rose 13%, of which 8% in absolute terms was the insurance cost. Similarly, PVs saw a cost increase of around 7% – attributable to both insurance and fuel price hike. In fiscal 2018, the cost had already increased 7% for two-wheelers and 6% for cars after a rise in fuel prices. On a compounded basis, the cost of two-wheelers increased 20% and that of cars 12-13%, much higher than the 2-4% increase usually seen in a year. In addition to this, PV OEMs had been focusing more on facelifts than new model launches. This strategy did not pay off. While in fcal 2017 about 18% of sales was through new models such as the Brezza and Baleno, in fiscal 2019, the corresponding figure was only 3%. This further impacted retail demand.
Meanwhile, demand for CVs also took a hit due to two reasons: 1) The new axle norms; and 2) liquidity crunch for non-banking finance companies (NBFCs). The new axle norms, which became effective in August 2018, increased the freight carrying capacity of the trucks by 20%. As a result of this, lesser trucks were required to move the same amount of load and hence fleet operators’ demand for new vehicles came down. NBFCs, which have traditionally provided funding to dealers and smaller component firms, witnessed higher costs, and curtailed lending, impacting fund availability for their customers.