BackComponent firms to prune capex as hope of a revival in auto sector wanes
Weak original equipment sales are already trickling down to component manufacturers, simply because they account for about two-thirds of total demandThe only silver lining is that the sector is not financially vulnerable
PremiumNormally, when the auto industry faces a slowdown in sales, recording high inventories and production cuts, it is bound to have repercussions on ancillary units.
Therefore, it is no surprise that Indian auto component makers are bracing for one of the sharpest slowdowns seen in the sector. A recent Crisil Research report said component makers are holding back their expansion plans, with the hope of a near-term revival in vehicle sales ebbing. The analysis of about 300 Crisil-rated component firms, which account for almost 40% of the industry’s revenue, reveals that capex spend will be discretionary and could be about 15% lower at ₹12,000 crore in FY20 and FY21, compared with the preceding two fiscal years.
This is understandable considering that an increase in retail vehicle sales during the festive season looks unlikely. In fact, sales continue to tank. A report by Nomura Research dated 27 August says while commercial vehicle sales will decline by 44% year-on-year in August, passenger vehicle sales may drop by 31% and two-wheelers by 22%.
Therefore, most auto segments will clock low single-digit growth or even contract in FY20. Even the recent relief measures by the government are unlikely to lead to a sharp reversal.
Weak original equipment sales are already trickling down to component manufacturers, simply because they account for about two-thirds of total demand. Even exports are forecast to grow at 10-12% over the next two years, indicating a slowdown from the 18% levels seen in the past. This is due to the economic and political turmoil in large markets such as Europe, the UK and the US.
Analysts fear that even after-market sales may get impacted if the downturn in auto sales continues. This impacts profitability, too, as after-market sales enjoy better margins.
Meanwhile, June quarter results portend a weak FY20. Most firms, including those with high exports, have reported 100-150 basis point drop in Ebitda (earnings before interest, taxes, depreciation and amortization) margins.
Crisil estimates the ₹3.5 trillion automotive components sector to log 5-7% compound annual growth rate over FY20 and FY21, down from 12% in the preceding two fiscal years, due to the steep decline in domestic vehicle sales. Negative leverage will dent margins further.
The only silver lining is that the sector is not financially vulnerable. “Most component firms have strengthened their balance sheets significantly in the past 3-4 years, and average gearing (debt/net worth) stood at around 1 time in fiscal 2019, the lowest in a decade," said Crisil.
Yet, the challenges in the auto sector, technology disruption and the demand slowdown will weigh over investor sentiment for a few more quarters.
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