Revised ICRA outlook projects 16-18% growth for Indian auto ancillaries in FY2022

After a Covid-hit calendar year that impacted human health and businesses together in what could be termed as one of the worst natural calamities to have happened to humankind, 2021 is set to bring a lot of hope, especially with the promising vaccine to Covid-19 finally looking realistic in the near horizon.

The Indian automobile industry was also one of the several severely impacted businesses, with sales declining by up to 40 percent in the first half of the ongoing fiscal (FY2021) to 7,087,439 units, and casting a direct impact on the production and supplies of auto component makers, which together recorded a 34 percent loss of revenue in the H1 of FY2021 to land at a net income of Rs 119,529 crore.

While a strong demand recovery during the festive season in October-November did pep up the industry’s mood, experts are still cautiously optimistic about the future, given that there’s the lurking fear of a second wave of an more infectious strain of Covid-19 coming to India, which is already making rounds in the UK and other parts of the world.

In its revised outlook for the Indian automotive component industry’s performance, credit rating agency ICRA has improved the rating from ‘Negative’ to ‘Stable’ based on demand revival across OEMs, as well as in the replacement market and exports.

In its latest release, the agency cites that OEMs which have a lion’s share of over 56 percent of the demand for auto components have recorded a sharp increase in demand since September 2020 across all vehicle segments, barring just the medium and heavy commercial vehicles (M&HCVs) which are reported to have bottomed out in Q3 FY2021.

While it mentions a stable credit outlook for tractors and two-wheelers based on thriving demand from rural India, the outlook for the passenger vehicle industry has also been revised from negative to stable in December 2020.

Aftermarket on the rise
Coming to the aftermarket, which accounts for roughly 18 percent of India Auto Component Inc’s turnover and had recorded a 15 percent slump in H1 FY2021, is also learnt to have picked up during Q2 and Q3 after the sharp decline in Q1 due to the lockdown. The latest ICRA outlook suggests that an uptick in freight activities across the country since August 2020, corroborated by diesel consumption and toll collection has triggered the demand in the replacement market. On the other hand, it also mentions that while shared mobility continues to suffer, demand for personal mobility has increased replacement demand.

Echoing his views, Vinnie Mehta, director general, Automotive Components Manufacturers Association of India (ACMA), had recently said during the component industry’s H1 performance overview that “The aftermarket segment was particularly impacted due to the lockdown, owing to the short supply of working capital with the small distributors and retailers controlling this space. Having said that, the segment came to pre-Covid levels as early as June because of the resurging demand for replacement parts in the repair market.”

Raw material and related challenges
While on the exports front too, ICRA has confirmed a recovery of industrial revenue from the early lows brought by the pandemic, there is a bigger challenge in sight, which is the constraint in raw material availability.

According to the outlook, the global demand-supply imbalance in the recent months and rising up of commodity prices, especially that of steel, copper and rubber since early Q3 FY2021, are set to trigger a price hike across most OEMs from January 2021, which could potentially hamper retail offtake warns the agency.

As per Mehta, “There is a challenge in terms of the raw material prices going up steadily. The prices of steel, which forms 70 percent of a vehicle’s construction, have risen between 5 and 7 percent in the Q2 of FY2021 and so have prices for non-ferrous materials as well, notwithstanding the fact that compared to last year, the Rupee has fallen significantly too. Moreover, we are also seeing the cost of iron ore and cooking coal simultaneously rising, and with these being the input materials for the manufacturing of steel, there is a direct correlation in the price rise.”

“While on one end, the cost is going up, with the economic recovery in India being steeper compared to other parts of the world, demand is also growing higher. And as a result, there could also be constraints regarding raw material availability in the near future,” he added.

Moreover, logistics for imports / exports (availability of containers) and supply chain for import of critical components such as electronics, are also reported to have been disrupted in the recent months, which again could impact production and sales in FY2021.

A brighter 2021
Even though there are aforementioned operational and logistics challenges for the industry to face off, ICRA has reported signs of demand sustenance supported by rural cash flows, ease of liquidity in the market and the increasing need for personal mobility.

The industry’s efforts in significantly reducing expenses on other cost heads in H1 FY2021 is bound to be carried forward in the coming quarters, and particularly, the credit rating agency has projected a brighter future for India Component Inc.

The agency has forecast a growth of 16-18 percent in FY2022, supported by growing content per vehicle, a low base-year effect and higher realisations partly from the pass through of commodity price hikes. It suggests that the operating margins of the industry are likely to revert to the normal level of 13 percent after hitting multiple lows in FY2021. Furthermore, cost-control measures undertaken by OEMs, increasing localisation as well as improved economies of scale will support margin expansion.

The road ahead
While capex too will return to normal levels of 6-7 percent range in a gradual manner during FY2022-23, volumes of the automotive industry will take another two-to-three years to revert to pre-Covid highs. Any debt-funded capex and investment is projected to be unlikely, but schemes like the production-linked incentive could encourage OEMs and large auto component companies to advance their investment plans, targeted at exports.

Long-term demand drivers include increased focus on localised supply chains by Indian OEMs, while diversification of supply chain risk by global OEMs is also expected to lead to increased sourcing from India in the coming years.