India's auto sector is about to be hit with a sledgehammer | Economic Times

Mumbai: The Indian automobile industry may post an aggregate drop of 20%, or Rs 75,000 crore ($10 billion), in revenue and a decline of 40%, or Rs 15,000 crore, in operating profit with factories set to operate at record low utilisation levels this fiscal year. Automakers could witness a margin compression of 2-5%, according to an analysis by ETIG, as India emerges from the lockdown. FY20 revenue and operating profit are pegged at about Rs 3.5-3.7 lakh crore and Rs 38,000-42,000 crore, respectively, based on volumes and the average selling price of vehicles. In the past few years, more than 1.2 million units in passenger vehicle capacity has been added by the likes of Suzuki Motor Gujarat, PSA and Kia, while about 3 million units of fresh two-wheeler capacity was brought on stream by the top five motorbike makers. However, the market has already dropped by an equivalent level or more. At the end of FY20, the Indian auto market dropped to FY16 levels and with the first quarter almost washed out, it is set to drop to 2010 levels by the end of FY21.Capacity utilisation by passenger car makers is expected to drop to 45%, to 39% for commercial vehicles and 50% for two-wheelers, according to Crisil. Overall utilisation will be just a few percentage points higher than the break-even level. Therefore, several companies that had thin margins in the pre-Covid era could post operating losses. 76206261Operating margins for commercial vehicles will be the hardest hit followed by two-wheelers and cars, said Hetal Gandhi, director at Crisil Research. “CV industry margins could drop by 500 basis points to negative 2.9% in FY21 compared with 3.1% in the previous year due to capacity utilisation (dropping) to 39%,” she said. The segment is likely to post losses in FY21. A basis point is 0.01 percentage point.To be sure, in the third quarter of FY20, Ashok Leyland’s operating margin shrank 470 basis points to 5.6% when the volume drop was 28%. Tata Motors’ commercial vehicle operating profit dropped to 2.2% in the third quarter of FY20, declining 940 basis points due to a 24% fall in volume and a one-time tax settlement. CLSA recently ascribed zero equity value to the India business of Tata Motors because the equity infusion between FY15 and FY22 will exceed the growth in net worth over the same period. With cash running out and operations losing money, some companies may need to increase borrowings to meet short-term commitments and prune capital expenditure. For Maruti Suzuki, a volume drop of 16% led to a margin erosion of 310 basis points in the fourth quarter of FY20. Ebitda per vehicle was the lowest in the past five years. COST OF NEW EMISSION NORMS Two-wheelers may also have to bear the incremental cost of new emission norms for entry level bikes, a segment that’s price sensitive, and this will result in additional margins slippage of around 100 basis points, Gandhi said. The deterioration in operating leverage may mean making hard choices — exits, sell-offs or consolidation in the form of partnerships. It may also lead to closure of factories, job losses and salary cuts. Skoda Auto Volkswagen India managing director Gurpratap Boparai said the resumption of its plants is linked to market revival.“We can go on for a few months to manage our costs at current capacity utilisation, but beyond that we need the demand to revive the business,” he said. “Some of the overseas market have got auto sector-specific stimulus package and in India too, we need a package to create demand.” The Society of Indian Automobile Manufacturers told minister for road transport and highways Nitin Gadkari recently that the market could shrink 40-45% in the worst-case scenario if GDP contracts 2%. In its most optimistic scenario, the market will decline 18-20% with 2% GDP growth. Two consecutive years of doubledigit decline in sales will pull back the market back to 2010 levels. GOVT SUPPORT NEEDED Toyota Kirloskar vice chairman Vikram Kirloskar urged the government to provide support. “It is difficult for me to imagine anyone wanting to buy a new car or bike right now,” he said. “I am an eternal optimist, but this time I am feeling a little uncomfortable, hence a stimulus in form of GST cut, scrappage policy will be welcome.” Experts said the long-term story remains intact. With lower costs and demand returning eventually, companies that can endure the current downturn will emerge stronger, they said.Existing capacities have been built keeping in mind the market potential for 2025-2030, said Som Kapoor, partner, automotive sector, EY. “Pre-Covid Indian market potential was different for 2030 and post-Covid-19 it is different. Fundamentally, the growth in motorisation is directly linked to the GDP and per capita,” he said. “Eventually, the GDP growth will come back and so will the growth in the motorisation. However, till then competitive pressure will further intensify and yet automakers will have to rely on significant cost reduction and rationalisation to absorb the market decline shock and grow.”