Softening of commodity prices help component-makers’ margins grow: ICRA

Domestic credit rating agency, ICRA’s study of 48 publicly listed auto ancillaries revealed that commodity linked margin expansion has eclipsed the pain of slow growth for the auto component industry in the current fiscal. The sample of 48 listed companies constitutes around 25 percent of auto components industry’s turnover.

With an estimated OE demand growth of 3-4 percent in FY16, and a stable aftermarket, ICRA procjected the auto component industry’s revenue growth to be moderate during FY16 at 3-5 percent, vis-a-vis 10 percent in FY15; performance of automotive segments namely tractor, motorcycles and LCV segment has been subdued during this period. Over the medium to long term, growth in the auto component industry will be higher than the domestic automotive industry growth given the increasing localization by OEMs, higher component content per vehicle and rising exports from India.

Operating margin to be moderate going forward
Auto ancillaries have benefitted from the steady decline in commodity prices, pushing their operating margin significantly up. Despite the demand slowdown, operating margins for several players has continued to expand sequentially. The rating agency’s sample of 48 ancillaries witnessed 180 basis points (bps) YoY improvement in operating margin to 15.7 percent in Q2FY16 in the backdrop of 226 bps correction in raw material cost, and despite employee expense growth of 57 bps over the same period. ICRA expects operating margin to peak out in FY16, as benefits of benign commodity prices are eventually passed on to OEMs, with a lag of a quarter or two, on account of in-built price indexation clause. Over the medium term, ICRA anticipates operating margins to stabilize at 14-14.5 percent level.

Weakness in USA heavy truck sales and Yuan depreciation
Owing to the subdued demand in the domestic OE segment as well as robust export growth, the share of exports increased from 24 percent in FY13 to 29 percent in FY15. Indian automotive exports have a high dependence on the US and European markets, which together account for over 60 percent of overall auto component exports from India. Slowdown in the US M&HCV is a concern for Indian auto component exports; however healthy growth in the US and European PV market is expected to offset the same to an extent. The credit rating agency has projected an increase in thrust on the ‘Make in India’ initiative and depreciation of the INR vis-a-vis USD to support healthy export growth over the medium to long term. Nevertheless, Yuan depreciation and slowdown in US CV sales would be key challenges for Indian auto component exports in the near term.

This is not the first time that Yuan depreciation has affected the Indian auto industry. In August last year, a similar study by ICRA had projected Yuan devaluation to impact Indian tyre and auto ancillary makers. Given the presence of localisation/sourcing centres in China, the continued devaluation of the yuan could lead to global OEMs continuing to use China as a sourcing point for India, instead of developing local Indian suppliers, it had reported.

Credit profile improves
In line with growth projections of various OEMs, auto ancillaries incurred sizeable debt funded capital investments during FY11-FY13 which strained their capital structure and coverage indicators. Given the demand slowdown and surplus capacities, the industry has been in a consolidation mode over the last two years, taking steps to deleverage its balance sheet. Gearing levels and coverage indicators for the industry have improved considerably over the past 12-15 months and ICRA expects industry wide credit profile to strengthen further in the near term.