Lower steel prices are good for autos but not good enough
Summary
- Domestic steel prices have declined from the high levels seen in the month of April
- Impact of lower commodity costs would reflect in financials of auto cos with a lag
The fall in steel prices brings some relief for the Indian automobile industry, as the commodity forms a significant portion of the raw material basket of automakers. Prices have corrected since the government levied export duty on steel effective 22 May.
The domestic hot rolled coil (HRC) price on 8 June was ₹63,100 per tonne, a fall of ₹6,200 per tonne from 18 May, according to SteelMint. The HRC domestic assessment is carried out every Wednesday.
With this, steel prices have plunged by about 20% from the highs seen in early April. “For every 1% decline in steel price the improvement in gross margin is 10-15 basis points (bps) for the two-wheeler and passenger vehicle segments. For commercial vehicles (CV), the benefit is in the range of 15-20bps. Also, prices of aluminium and other precious metals have softened from the peak seen in March," said Varun Baxi, analyst, Nirmal Bang Equities. One basis point is 0.01%.
Elevated input costs and supply chain constraints posed key headwinds to most automakers’ margins in FY22. For instance, Mahindra and Mahindra Ltd saw about 570bps and 300bps drops in standalone gross margin and Ebitda (earnings before interest, tax, depreciation and amortization) margin respectively in FY22.
Even so, the recent drop in steel prices is unlikely to have an immediate effect on auto companies’ margins. This is because the impact of lower commodity prices reflects in the financials with a lag. Analysts reckoned that the June quarter (Q1FY23) margins should compress sequentially as higher raw material prices in the second half of Q4FY22 would reflect in Q1. Thus, margins can be expected to improve from Q2.
When steel prices fall, the CV segment is relatively better placed as this input constitutes roughly 70% of its raw material basket, the highest among segments, according to Baxi.
This coincides with a recovery in demand for CVs on the back of increased infrastructure activity, strong traction in the e-commerce segment and impending replacement demand. While the demand in the passenger vehicle segment is firm, a semiconductor shortage is restricting the ability of passenger vehicle makers to meet demand.
Demand for two-wheelers is recovering steadily on the back of improving rural demand and the festive season but is still far from the highs seen in 2019. Hero MotoCorp’s domestic volumes in May are lower by 27% vis-a-vis May 2019.
Moreover, steel prices are still high vis-à -vis historical levels. SteelMint data shows that the average domestic HRC price in FY21 was ₹44,698 per tonne, far below current levels. Meanwhile, higher fuel prices mean a hike in cost of ownership, which primarily impacts demand for entry level passenger vehicles and two-wheelers. The excise duty cut offered some respite but fuel prices are still higher than historical levels. Also, energy prices continue to remain elevated, which is a concern.
As such, analysts do not see companies reducing the prices of products but expect a hiatus in further hikes. “If commodity prices continue to soften, it will offset auto manufacturers’ prior quarters’ under-recovery of input cost inflation. If so, we may not see any broad-based price hikes. In case of a higher commodity price correction, we could see it getting passed on to consumers indirectly via discounts, incentives or better features in vehicles," said Kumar Rakesh, an automobile and technology analyst at BNP Paribas Securities.
For now, the extent of worries over input costs has eased. The Nifty Auto index is up 1.7% versus a drop of 3.3% in Nifty50 index since export duty was levied on steel.