Even as most industry sectors are reeling under a debt burden, auto component firms’ balance sheets are in the pink of health. Yes, the sector has always been less leveraged than most others, but its debt-equity ratio had risen in the aftermath of the Lehman crisis in fiscal year 2008 (FY08), when auto sales too turned south.
Since then, however, the sector has steadily improved leverage ratios. Crisil’s data of 66 rated and unrated listed component firms shows a steady decline in the average debt-equity ratio from 1.93 in FY08 to 0.69 at the end of September 2017. The chart above shows the ratio at a healthy level below 1, since FY15.
To be sure, auto component makers’ fortunes are tied closely to that of auto firms. And simply put, the demand for vehicles in the country as well as exports has been steadily rising over the last few years, leading to growth opportunities for component makers too.
Even a few months ago, auto demand bounced back after a host of economic and regulatory challenges such as demonetisation, BS-IV emission norms compliance, and the transition to the goods and services tax (GST). When sectors such as infrastructure, realty and cement saw revenue and profit growth fall in the September quarter, auto firms posted double-digit sales growth.
Data from 50 listed auto component firms in Capitaline (in descending order of market capitalization) shows an impressive 20% average revenue growth year-on-year. The rise was partly due to an increase in realizations on account of price hikes taken to accommodate changes in GST and increase in raw material costs. Yet, the rise in sales volumes cannot be ignored.
Another reason for large auto component firms posting impressive growth is the recovery in the US and European markets that together account for nearly two-fifths of the country’s component exports. Strong cash flows and operating profits in the last five years are mirrored in the sharp rise in interest cover (operating profit/interest outgo), as seen in the chart.
However, there is a lingering concern on rising raw material costs. Commodity prices ruling high for nearly a year will impact profitability as auto firms pass it on with a lag to component makers. Capitaline data shows a 110 basis point year-on-year jump in average raw material cost as a percentage of sales in the September quarter.
Hundred basis points make one percentage point.
“Nevertheless, improved operating leverage with higher sales and operating efficiencies can help offset the impact of higher commodity prices," says Pavethra Ponniah, analyst at Icra Ltd.