Rising costs pose a threat to profit margins of auto component makers
Strong domestic demand for automobiles promises to propel revenue growth for auto component companies during fiscal year 2018 (FY18). But this does not mean that operating margins will keep pace, given that input costs have spiralled over the last 12-18 months.
Revenue growth is being pushed up by 8-10% growth estimated for passenger vehicles and two-wheelers on the home turf. After all, these two segments together comprise about two-thirds of the total demand for components from original equipment makers. That apart, growth forecasts for other auto segments like tractors and commercial vehicles (except medium and heavy commercial vehicles) are decent too.
This augurs well, especially since export markets have been unexciting. The prolonged slowdown in the North American auto market, especially for trucks, and in Europe, which has become complicated due to Brexit issues, has weighed on component exports from India. These headwinds are unlikely to change course and could challenge export growth in the next couple of years. Data from Automotive Component Manufacturers Association of India shows that export growth rate has ebbed from 40% in FY12 to single digits in the last two years, albeit on a larger base.
Be that as it may, from an investor standpoint, one must note that in spite of the overall growth in revenue, there could be stress on profitability. A report by Icra Ltd points out, “After five to six quarters of benign raw material prices, the input cost trend reversal in January 2016 is likely to hurt profitability of auto component firms.” The credit rating agency forecasts operating margin to be rangebound at 13-14%, coming off from the peak of 16%—the average recorded in FY16 by 48 large listed companies.
However, the Street has been discerning in its view too. For instance, shares of companies such as Bharat Forge Ltd, with a significant business exposure to the North American truck market, fell for several quarters, as falling exports hurt profitability. Exide Industries Ltd did well on the bourses as its robust domestic market sales gave a leg-up to revenue and profits.
On the whole, the near- to medium-term prospects may be better for automobile component makers who have a decent exposure to domestic markets, where growth rates in revenue and profit are likely to be stronger than in international markets.