New Delhi: India’s car sales show little sign of slowing and the country’s top two manufacturers are running at full stretch, trying to meet burgeoning demand for some models.

But car companies lower down the pecking order may be overreaching with their capacity-addition plans, some analysts say.

The resultant glut could make things difficult for small-car makers as increasing competition and hardening raw material costs are expected to lead to tighter margins in the next three years in the price-sensitive category.

In anticipation of shrinking margins, at least five analysts have downgraded auto stocks. “When you look at the announced plans, there will be excess capacity," said Rakesh Batra, national leader at Ernst and Young (E&Y), a consultancy.

Graphic: Yogesh Kumar/Mint

Growing at an average of 12%, car sales in India are expected to rise by at least 300,000 units a year for the next five years. An E&Y forecast puts car sales in 2015 at 3.75-4.5 million units.

Last fiscal, car makers sold 1.9 million units, up 25% from the year before as pent-up demand and cheap loans got buyers back to dealerships.

Exports rose 34% to 446,146 units as several European governments offered incentives to buyers to sell their old cars and buy smaller and more fuel-efficient vehicles.

In March, the country’s biggest car maker Maruti Suzuki India Ltd kicked off a 250,000-unit expansion at its Manesar facility in Haryana, which will bring its installed annual capacity to 1.25 million units in 2012.

Also in March, Nissan Motor Co. Ltd started a plant that has the capacity to make 400,000 cars a year at Oragadam, near Chennai.

In 2009, Volkswagen opened a 110,000-unit plant at Chakan, near Pune.

Two-wheeler maker Hero Honda Motors Ltd is working on a feasibility study for its fourth plant. The company plans to make an announcement in the next month.

CSM Auto Inc., a forecasting agency, expects capacity utilization to be 84% in 2015. A January survey by consultancy firm KPMG showed that 43% of auto executives said India may suffer from a capacity glut by 2015.

Maruti needs higher capacity on stream as quickly as possible, managing director Shinzo Nakanishi said. “I would like to put forward installation of the capacity even if it is by only one day," he said in New Delhi last week.

Maruti has had to ask buyers to wait for up to three months for its Swift, Swift Dzire and Eeco models.

Typically, auto plants run optimally at 85% capacity. It takes two years to add a new assembly line while building a new plant from scratch can take two-four years.

?To be sure, overcapacity isn’t as damaging to a company as being forced to cope with a shortage.

“If I am a manufacturer, I can deal with overcapacity," said Deepesh Rathore, lead automobile analyst at IHS, Global Insight, a research firm.

Putting up with production constraints is a far tougher problem, he said.

The government’s automotive mission plan forecasts that the auto sector will account for $35-40 billion (Rs1.6-1.8 trillion) in investment by 2016, with the bulk of it going towards producing small cars and components for them.

Still, with small car exports growing, the industry may be able to make better use of capacity.

Toyota Motor Corp. recently said it is looking to export the Etios, its small car, to Europe in addition to the previously announced target areas of South Africa and India’s neighbours.

samar.s@livemint.com

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