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Anjan Deb Ghosh +91 22 3047 0006 aghosh@icraindia.com

Indian Auto Components Industry

Weak demand a bigger concern than rising costs

Contacts: Subrata Ray +91 22 3047 0027 subrata@icraindia.com Jitin Makkar +91 124 4545 368 jitinm@icraindia.com Ashish Modani +91 20 2556 1194 ashish.modani@icraindia.com K Srikumar +91 44 4596 4318 ksrikumar@icraindia.com

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WHATS INSIDE?
1. Overview 2. Revenue growth drivers of auto component industry in 9m 2012-13 Auto component manufacturers whose revenue growth suffered in 9m 2012-13 Auto component manufacturers that maintained steady revenue growth in 9m 2012-13 3. Quarterly trend in profit margins of auto OEMs and auto component manufacturers Trend in margins over last three years EBITDA margin influencers in 9m 2012-13 Auto ancillaries that reported forex losses in 2011-12 and 9m 2012-13 Interest coverage movement of auto component manufacturers 4. Outlook for supplies to the domestic OEM segment 5. Outlook for component exports 6. Outlook for domestic replacement market sales 7. Weak Global Demand: Acquisition Opportunity 8. Back Home: Trends in JVs and Technical Collaborations 9. NEMMP 2020: A sunrise electric vehicle opportunity for OEMs and suppliers 10. Q3 2012-13 performance of auto component manufacturers Asahi India Glass Limited Banco Products (India) Limited Bharat Forge Limited Exide Industries Limited Gabriel India Limited Hinduja Foundries Limited Lumax Industries Limited Mahindra Forgings Limited Motherson Sumi Systems Limited Munjal Showa Limited Sona Koyo Steering Systems Limited Sundaram Clayton Limited Sundram Fasteners Limited Wheels India Limited ZF Steering Gear (India) Limited
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INDIAN AUTO COMPONENTS INDUSTRY

Weak demand a bigger concern than rising costs
MARCH 2013

Overview
Revenue Growth Trends and demand outlook The Indian auto and auto components industry is currently facing its most formidable challenge that of slowing demand; and that too across the board. After a frenzied period of 2009-10 and 2010-11 when all automotive spots - domestic OEMs, exports and replacement market - shone bright, the year 2011-12 marked the commencement of a slowdown phase as volumes in the domestic Passenger Vehicle (PV) and Medium & Heavy Commercial Vehicle (M&HCV) segments began to stutter. If the year 2011-12 was bad, the year 2012-13 has turned out to be worse as other segments too including the domestic Two-Wheeler (2W) segment as also exports to overseas OEMs and tier-1 players have come into the grips of the slowdown. While the revenue growth of diversified auto component manufacturers had been steady till Q1 2012-13, the across the board weakness in demand witnessed during the last two quarters has tended to neutralize this structural advantage otherwise enjoyed by such players. On the exports front, auto component supplies to Europe had already been witnessing sluggish growth over the last few years, but steady expansion in demand for Light Vehicles and Commercial Vehicles (CVs) in North America was adequately offsetting the overall exports weakness. However, starting Q2 2012-13, auto parts exports to USA also have declined significantly, particularly related to parts meant for CV applications due to sharp contraction in demand (partly due to inventory correction due to build-up during H1CY2012). Component suppliers to the domestic replacement market have also been experiencing moderation in growth, but this segment, as expected, has been relatively more resilient if not fully immune. As per our sample of 35 publically-listed auto component manufacturers, the average revenue growth of these select entities (during the last eight quarters) has been steadily declining with YoY growth being lower in each passing quarter since Q1 2011-12. Yet, the revenue growth of select auto component manufacturers has been much higher than the industrys on the back of market share gains, favourable change in model mix, rise in content per vehicle, besides revenue accretion due to corporate actions such as acquisitions and amalgamations. Over the short term, we expect the auto component industrys revenue growth to r emain weak in the absence of immediate demand triggers for end-users across domestic automotive segments, besides an uncertain global economic environment resulting in slow automobile demand recovery and hence faltering export volumes. Profitability Till 2011-12, the auto component manufacturers were grappling with a rising cost structure arising from volatile currency movements, firm interest rates and inflation in other overheads including employee costs and power costs. However, since raw material cost environment was relatively benign, it allowed auto component manufacturers to have one less worrisome variable to contend with. While there has been no significant change in character of any of the above forces during 2012-13, the biggest trepidation for auto parts makers currently springs from tepid automobile demand, dreaded to remain weak even in the near term. Decline in revenues (on YoY basis) had significantly hurt both profits as well as margins of auto component manufacturers in Q2 and Q3 2012-13. We expect operating earnings growth of auto component manufacturers to be the weakest in Q4 2012-13 given the high base of the corresponding previous quarter, continued anaemic demand conditions and unyielding pressures stemming from various other cost overheads mentioned above. While auto OEMs face similar challenges, the profitability of auto component manufacturers may be hit harder due to their smaller scale of operations and limited operational and financial flexibility. Net Profits One of the primary reasons for the subdued net earnings growth of auto component manufacturers since Q2 2011-12 has been adverse currency movements. The net profits of auto component manufacturers with foreign currency loans has been weighed down by sharp appreciation of the USD against the INR since the second fortnight of September 2011, resulting in MTM losses on restatement of foreign currency loans and higher interest outgo. While the currency cycle supported the industry in short periods, like in Q4 2011-12, the USD/ INR rate has generally remained in the vicinity of 54-55 in 9m 2012-13. The balance sheets of several auto component manufacturers feature ECBs, FCCBs, Buyers Credit and other foreign currency borrowings that remain unhedged. This apart, while a large number of entities that import raw materials do generally get compensated by OEMs at the prevailing exchange rate (although compensation is with a lag), given the long payables cycle with overseas suppliers (30-90 days payment cycle), the importing entities do remain exposed to forex risk on unhedged payables (as also on exports receivables). In the current uncertain global environment, exchange rate volatility may be here to stay, making effective management of forex risk an imperative. While interest costs of most players have stayed high in the last several quarters, the possibility of further policy rate cuts and their eventual transmission to corporates may provide some relief to industry participants, going forward.

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Capital Expenditure Plans The capacity expansion programme of auto component manufacturers generally tends to follow that of their key customer OEMs. With OEMs such as Maruti Suzuki, Hero MotoCorp and Ford, planning to establish greenfield facilities in Gujarat; and Honda Motorcycles and Scooters being in the process of establishing a new plant near Bangalore, their respective suppliers of key components are also currently at various stages of making investments in close proximity to these new facilities or in the OEMs vendor parks. As per ICRAs estimates, the above greenfield investments may entail total investments of Rs. 70 billion to be incurred by auto component manufacturers over the next three years. These investments apart, the quantum of capex otherwise planned to be incurred by auto component manufacturers over the near term remains conservative with several entities deciding to significantly scale-down the capex from the levels earlier budgeted. With the industry going slow on investments towards capacity expansion, we do not expect any major incremental term debt burden to ride on the balance sheet of auto component manufacturers over the near term. However, the large debt-funded capital expenditure executed by auto component manufacturers during the boom period of 2009-10 and 2010-11 means that repayment obligations of the term loans availed then will fall due now. In the absence of sufficient cash flow generation visibility, the industry, in our view, may be exposed to refinancing risks. The prevailing weak demand environment has had a more deleterious impact on lower-tier auto component manufacturers, who due to their smaller size suffer from lower bargaining power and weaker access to capital. In this context, initiatives such as the proposal to enhance the refinancing capability of SIDBI as well as the recent MoU signed between ACMA (the apex body of auto components industry) and SIDBI to provide easier credit access to the formers members are likely to provide benefici al support to smaller entities in the automotive value chain.

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CORPORATE OFFICE Building No. 8, 2nd Floor, Tower A, DLF Cyber City, Phase II, Gurgaon 122002 Ph: +91-124-4545300, 4545800 Fax; +91-124-4545350 REGISTERED OFFICE th 1105, Kailash Building, 11 Floor, 26, Kasturba Gandhi Marg, New Delhi 110 001 Tel: +91-11-23357940-50 Fax: +91-11-23357014 MUMBAI Mr. L. Shivakumar Mobile: 9821086490 3rd Floor, Electric Mansion, Appasaheb Marathe Marg, Prabhadevi, Mumbai - 400 025 Ph : +91-22-30470000, 24331046/53/62/74/86/87 Fax : +91-22-2433 1390 E-mail: shivakumar@icraindia.com

CHENNAI Mr. Jayanta Chatterjee Mobile: 9845022459 Mr. D. Vinod Mobile: 9940648006 5th Floor, Karumuttu Centre, 498 Anna Salai, Nandanam, Chennai-600035. Tel: +91-44-45964300, 24340043/9659/8080 Fax:91-44-24343663 E-mail: jayantac@icraindia.com d.vinod@icraindia.com KOLKATA Ms. Vinita Baid Mobile: 9007884229 A-10 & 11, 3rd Floor, FMC Fortuna, 234/ 3A, A.J.C. Bose Road, Kolkata - 700020 Tel: +91-33-22876617/ 8839, 22800008, 22831411 Fax: +91-33-2287 0728 E-mail: vinita.baid@icraindia.com

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GURGAON Mr. Vivek Mathur Mobile: 9871221122 Building No. 8, 2nd Floor, Tower A, DLF Cyber City, Phase II, Gurgaon 122002 Ph: +91-124-4545300, 4545800 Fax; +91-124-4545350 E-mail: vivek@icraindia.com

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