Auto component firms’ margins have peaked as raw material costs rise
While chances of raw material costs ebbing are bleak, upsides for component makers will come largely from higher auto sales—lower interest costs should help achieve that
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After a cushy ride on the back of benign raw material prices for nearly two years, auto component firms have hit a hard shoulder.
Their December-quarter performance is likely to show that peak margins are behind them, since raw material prices have been rising steadily over the last six months.
For instance, price of lead, a critical input in making batteries, is up by about 20%. So is copper, which is used in making most auto parts. Other commodities like steel and rubber, too, have rallied. A report by Icra Ltd spells out that in the last three months, there has been a reversal in commodity prices and they are up by about 25%.
Such a steep rise in costs would normally tell on profitability of auto component firms. Of course, those that are tier-I suppliers will pass on cost increases to the original equipment manufacturers. But those with significant replacement market mix in their revenue like tyres, batteries and other segments have not been able to pass on higher costs to consumers, especially during the December quarter.
This is because of two reasons. One, replacement market sales have not been very robust due to the demonetization-linked cash crunch. Moreover, the current replacement market mirrors the weak auto sales between fiscal years 2011 and 2015, since parts are normally replaced after two years. Two, most component makers could not raise prices to cover higher costs, in a weak demand environment.
Therefore, the robust operating margins are unlikely to move further north from current levels. If at all, what may prevent a steep fall in margins is that supplies of original equipment have been growing as auto sales have been better than a year back. Some analysts expect the positive effect of higher operating leverage to kick in for some component makers. This, in turn, could minimize the impact of higher raw material costs on operating performance.
That said, the December-quarter performance is likely to be a mixed bag. Those with higher exposure to passenger vehicles and commercial vehicles may fare better both on revenue and profit margins when compared to the two-wheeler segment, where growth rates have been on the ebb.
Meanwhile, most large-sized auto component firms are also exploring international waters and diversifying into industrial products. With European and US auto sales looking up, component makers who supply to these markets will get a leg-up through improving exports.
In fact, component stocks like Motherson Sumi International Ltd, MRF Ltd, Suprajit Engineering Ltd, Bosch Ltd and Amara Raja Batteries Ltd are some who have had a good run in the last year, with valuations touching reasonable levels. While the chances of raw material costs ebbing are bleak, upsides for component makers will come largely from higher auto sales. Lower interest costs should help achieve that.