Rating Outlook
Stable Outlook for 2011: Fitch Ratings expects the growth momentum in Indian automotive sales volumes will continue during 2011 with commercial and passenger vehicles (CV and PV) witnessing a growth of about 10%-12% and 12%-15% respectively. The large-scale capex plans of original equipment manufacturers (OEMs), coupled with inflationary cost pressures could stretch the credit metrics compared with 2010 levels, but the growth in sales volumes will have a positive impact on operating cash flow. As a result, the agency expects the credit profiles of OEMs to largely remain stable over 2011.
Growth to Propel CV Sales: CV manufacturers are likely to benefit from domestic economic growth (particularly industrial production) and infrastructure development, both of which have shown a high degree of correlation with CV sales volumes in the past. The switchover to stricter emission norms for CVs from October 2010, which resulted in pre-emptive CV purchases during 2010, might only have a marginal adverse impact on CV sales in 2011. While the agency expects amoderate increase in domestic interest rates, a favourable operating environment for transporters will have a positive impact on sales volume growth in 2011.
Favourable Scenario for PV: The growth of the Indian middle class together with the easy availability of consumer finance will continue to drive the sales volume growth for PVs in 2011. Though the stricter emission norms pushed up product prices to some extent, OEMs are likely to address price sensitivity by partially absorbing cost increases and offering other benefits in 2011. This could reflect negatively on their profit margins, but volume growth is likely to negate some ofthe impact on operating cash flows.
Recovery in Exports: The global automotive markets are expected to record growth in 2011 after showing initial signs of recovery during 2010. The agency expects the US and Europe, which constitute the largest markets for Indian automotive exports, to post growth of 9% and remain stable respectively during the year.
Capex and Cost Pressures: Fitch expects that capex plans aimed largely towards capacity additions could create a demand/supply mismatch in the short-to-medium term, thus affecting capacity utilisation rates. The input costs linked with commodity prices such as steel and rubber have started rising. These rising input costs combined with the limited ability of OEMs to pass these increases on to customers, and lower capacity utilisation levels, are likely to moderate profit margins in 2011.
What Could Change the Outlook
The sector may move to a negative outlook on account of the weakening of credit metrics either due to an increase in debt-funded capex plans significantly above Fitchs current expectations, or a deterioration in operating performance driven by cost pressures and demand contraction.
Fitch notes that a move to a positive outlook is unlikely based on expected overcapacity in the medium term owing to significant capex plans and increasing competition constraining the ability of OEMs to pass on cost increases to customers.
Key Issues
Favourable Domestic Demand Scenario
Fitch expects a favourable domestic demand scenario for automotive sales during 2011 on the back of improved economic growth. Inflationary pressures are likely to lead to higher interest rates. As a result, the cost of consumer finance, which largely remained stable in 2010, could increase moderately in 2011, but the agency does not anticipate significant weakening in demand owing to this.
Besides the cost of consumer finance, the easy availability of such finance and the disposable incomes of consumers are equally important factors driving vehicle demand. With an improving operating environment for transporters as supported by rising freight rates and trade volumes, CV demand is likely to grow in 2011.
Moreover, rising per capita income combined with economic stability should continue growth momentum in the PV segment. Since the customers in the compact and mid-size sub-segments (classified by the SIAM, as A2 and A3 respectively) exhibit higher price-sensitivity, the PV manufacturers are offering many choices at various price points in these sub-segments to ward off the negative impact of the higher cost of finance.
Inflationary Cost Pressures Due to Rising Commodity Prices
The prices of key input commodities rose sharply during the latter half of 2010, after remaining subdued for more than 12 months, and are expected to remain high during 2011. The resurgence in demand from end-consumer segments, coupled with signs of global economic recovery has pushed up prices for steel, an input constituting more than half of the total vehicle cost.
In addition, the price of rubber rose in 2010. This has caused the tyre manufacturers to pass on price increases to OEMs, on the back of strong demand from OEMs and in order to protect their own cash flows.
Fitch notes that growing competition in the Indian auto sector with the entry of many new players in the last two years in both the CV and PV segments, each of whom is vying to gain market share, will limit the ability of OEMs to pass on these cost increases to customers in 2011. Moreover, 2010 also saw some price revisions on account of the change in emission norms and input cost increases. Consequently, the agency expects that the OEMs may absorb a part of these cost increases during 2011, fearing the negative impact on demand of such frequent price increases.
Shortage in Component Supplies to Subside
The sharp recovery in auto sales volumes caused some imbalances in the supply chain of the industry with component suppliers struggling to keep pace with the demand from OEMs during last year. Furthermore, the slowdown in the sector during 2008 and the early part of 2009 had forced the component suppliers to adjust to a lower operating scale. It then took them time to ramp production up again to the highest-ever levels, thereby causing some transitory mismatches.
With demand moving to higher levels and component suppliers also undertaking significant capacity expansion to meet the OEM requirements, Fitch expects these supply-side issues to subside in 2011.
Large Capacity Additions Could Affect Utilisation
The last two years have seen significant investments by a large number of global PV and CV manufacturers in India towards setting up full-fledged production units instead of the assembly operations they had been engaged in. To counter the competition from new players, the incumbent OEMs have also stepped up their expansion plans in order to protect their market share.
This, collectively, is likely to result in capacity additions of about 1.2 million units in the PV segment (about 40%-45% of current capacity) and about 0.5 million units in the CV segment (estimated to be around 70%-75% of current capacity) by 2012.
Fitch notes that such large capacity creation will create a demand-supply mismatch in the short-to-o]medium term until demand rises sufficiently to fully absorb the new capacity. As a result, 2011 could see a drop in capacity utilisation in the auto sector, though the impact could vary across OEMs, with a few leading OEMs still witnessing long waiting periods for some of their products.
Capex Plans Coupled With Cost Pressures Could Alter Credit Metrics
Besides the large scale capacity expansion plans, the OEMs are also focusing on new product development and technology innovation which entail significant investments. In order to sustain customer interest and maintain their competitive edge, PV manufacturers are investing in new product platforms besides redesigning existing products at regular intervals. CV manufacturers are also investing a great deal in product extension and new model development.
Moreover, the increasing environmental concerns and rising fuel costs are forcing vehicle manufacturers to develop cleaner and more fuel-efficient technologies. Apart from these, the compelling cost pressures and increasing volumes are resulting in localisation of certain key components by OEMs, which could further boost the capex requirements of the OEMs.
Fitch notes that these significant capex plans, along with pressure on profitability of the OEMs could result in significant negative free cash flow (FCF) over the medium term. The agency notes that a large part of this negative FCF is likely to be funded through borrowings which will result in higher financial leverage in 2011 compared to the previous year, though leverage is likely to remain compatible with the current rating levels and sector outlook.
In view of this large scale capital commitment and growing competition within the sector, many OEMs have initiated collaborative models of operations across various functions such as shared production facilities, common distribution channels, and joint product development. This trend is likely to gain further steam during 2011.
2010 Review
Fitch observes that automotive sales demand in 2010 benefitted significantly from pent-up demand from the previous year, 2009, and pre-emptive buying in the wake of the switchover to new emission and safety norms in the initial part of the year. This set the tone for the growth momentum during 2010, which sustained itself throughout the year on account of the improving economic environment and the largely stable consumer cost of finance.Overall, this caused total PV sales volumes to grow at about 28.8% and CV sales at an even higher growth rate of 54% during January-October 2010 y-o-y. Though a part of this growth is attributable to a low base in 2009, it remained significantly higher than the agency’s estimates for the year.
The working capital pressures, which had mounted due to an increase in inventories in 2009, eased off in 2010 on account of shorter cash conversion cycles. This led to a better liquidity position for OEMs, allowing them to shift their focus to capex plans.
Stable Outlook for 2011: Fitch Ratings expects the growth momentum in Indian automotive sales volumes will continue during 2011 with commercial and passenger vehicles (CV and PV) witnessing a growth of about 10%-12% and 12%-15% respectively. The large-scale capex plans of original equipment manufacturers (OEMs), coupled with inflationary cost pressures could stretch the credit metrics compared with 2010 levels, but the growth in sales volumes will have a positive impact on operating cash flow. As a result, the agency expects the credit profiles of OEMs to largely remain stable over 2011.
Growth to Propel CV Sales: CV manufacturers are likely to benefit from domestic economic growth (particularly industrial production) and infrastructure development, both of which have shown a high degree of correlation with CV sales volumes in the past. The switchover to stricter emission norms for CVs from October 2010, which resulted in pre-emptive CV purchases during 2010, might only have a marginal adverse impact on CV sales in 2011. While the agency expects amoderate increase in domestic interest rates, a favourable operating environment for transporters will have a positive impact on sales volume growth in 2011.
Favourable Scenario for PV: The growth of the Indian middle class together with the easy availability of consumer finance will continue to drive the sales volume growth for PVs in 2011. Though the stricter emission norms pushed up product prices to some extent, OEMs are likely to address price sensitivity by partially absorbing cost increases and offering other benefits in 2011. This could reflect negatively on their profit margins, but volume growth is likely to negate some ofthe impact on operating cash flows.
Recovery in Exports: The global automotive markets are expected to record growth in 2011 after showing initial signs of recovery during 2010. The agency expects the US and Europe, which constitute the largest markets for Indian automotive exports, to post growth of 9% and remain stable respectively during the year.
Capex and Cost Pressures: Fitch expects that capex plans aimed largely towards capacity additions could create a demand/supply mismatch in the short-to-medium term, thus affecting capacity utilisation rates. The input costs linked with commodity prices such as steel and rubber have started rising. These rising input costs combined with the limited ability of OEMs to pass these increases on to customers, and lower capacity utilisation levels, are likely to moderate profit margins in 2011.
What Could Change the Outlook
The sector may move to a negative outlook on account of the weakening of credit metrics either due to an increase in debt-funded capex plans significantly above Fitchs current expectations, or a deterioration in operating performance driven by cost pressures and demand contraction.
Fitch notes that a move to a positive outlook is unlikely based on expected overcapacity in the medium term owing to significant capex plans and increasing competition constraining the ability of OEMs to pass on cost increases to customers.
Key Issues
Favourable Domestic Demand Scenario
Fitch expects a favourable domestic demand scenario for automotive sales during 2011 on the back of improved economic growth. Inflationary pressures are likely to lead to higher interest rates. As a result, the cost of consumer finance, which largely remained stable in 2010, could increase moderately in 2011, but the agency does not anticipate significant weakening in demand owing to this.
Besides the cost of consumer finance, the easy availability of such finance and the disposable incomes of consumers are equally important factors driving vehicle demand. With an improving operating environment for transporters as supported by rising freight rates and trade volumes, CV demand is likely to grow in 2011.
Moreover, rising per capita income combined with economic stability should continue growth momentum in the PV segment. Since the customers in the compact and mid-size sub-segments (classified by the SIAM, as A2 and A3 respectively) exhibit higher price-sensitivity, the PV manufacturers are offering many choices at various price points in these sub-segments to ward off the negative impact of the higher cost of finance.
Inflationary Cost Pressures Due to Rising Commodity Prices
The prices of key input commodities rose sharply during the latter half of 2010, after remaining subdued for more than 12 months, and are expected to remain high during 2011. The resurgence in demand from end-consumer segments, coupled with signs of global economic recovery has pushed up prices for steel, an input constituting more than half of the total vehicle cost.
In addition, the price of rubber rose in 2010. This has caused the tyre manufacturers to pass on price increases to OEMs, on the back of strong demand from OEMs and in order to protect their own cash flows.
Fitch notes that growing competition in the Indian auto sector with the entry of many new players in the last two years in both the CV and PV segments, each of whom is vying to gain market share, will limit the ability of OEMs to pass on these cost increases to customers in 2011. Moreover, 2010 also saw some price revisions on account of the change in emission norms and input cost increases. Consequently, the agency expects that the OEMs may absorb a part of these cost increases during 2011, fearing the negative impact on demand of such frequent price increases.
Shortage in Component Supplies to Subside
The sharp recovery in auto sales volumes caused some imbalances in the supply chain of the industry with component suppliers struggling to keep pace with the demand from OEMs during last year. Furthermore, the slowdown in the sector during 2008 and the early part of 2009 had forced the component suppliers to adjust to a lower operating scale. It then took them time to ramp production up again to the highest-ever levels, thereby causing some transitory mismatches.
With demand moving to higher levels and component suppliers also undertaking significant capacity expansion to meet the OEM requirements, Fitch expects these supply-side issues to subside in 2011.
Large Capacity Additions Could Affect Utilisation
The last two years have seen significant investments by a large number of global PV and CV manufacturers in India towards setting up full-fledged production units instead of the assembly operations they had been engaged in. To counter the competition from new players, the incumbent OEMs have also stepped up their expansion plans in order to protect their market share.
This, collectively, is likely to result in capacity additions of about 1.2 million units in the PV segment (about 40%-45% of current capacity) and about 0.5 million units in the CV segment (estimated to be around 70%-75% of current capacity) by 2012.
Fitch notes that such large capacity creation will create a demand-supply mismatch in the short-to-o]medium term until demand rises sufficiently to fully absorb the new capacity. As a result, 2011 could see a drop in capacity utilisation in the auto sector, though the impact could vary across OEMs, with a few leading OEMs still witnessing long waiting periods for some of their products.
Capex Plans Coupled With Cost Pressures Could Alter Credit Metrics
Besides the large scale capacity expansion plans, the OEMs are also focusing on new product development and technology innovation which entail significant investments. In order to sustain customer interest and maintain their competitive edge, PV manufacturers are investing in new product platforms besides redesigning existing products at regular intervals. CV manufacturers are also investing a great deal in product extension and new model development.
Moreover, the increasing environmental concerns and rising fuel costs are forcing vehicle manufacturers to develop cleaner and more fuel-efficient technologies. Apart from these, the compelling cost pressures and increasing volumes are resulting in localisation of certain key components by OEMs, which could further boost the capex requirements of the OEMs.
Fitch notes that these significant capex plans, along with pressure on profitability of the OEMs could result in significant negative free cash flow (FCF) over the medium term. The agency notes that a large part of this negative FCF is likely to be funded through borrowings which will result in higher financial leverage in 2011 compared to the previous year, though leverage is likely to remain compatible with the current rating levels and sector outlook.
In view of this large scale capital commitment and growing competition within the sector, many OEMs have initiated collaborative models of operations across various functions such as shared production facilities, common distribution channels, and joint product development. This trend is likely to gain further steam during 2011.
2010 Review
Fitch observes that automotive sales demand in 2010 benefitted significantly from pent-up demand from the previous year, 2009, and pre-emptive buying in the wake of the switchover to new emission and safety norms in the initial part of the year. This set the tone for the growth momentum during 2010, which sustained itself throughout the year on account of the improving economic environment and the largely stable consumer cost of finance.Overall, this caused total PV sales volumes to grow at about 28.8% and CV sales at an even higher growth rate of 54% during January-October 2010 y-o-y. Though a part of this growth is attributable to a low base in 2009, it remained significantly higher than the agency’s estimates for the year.
The working capital pressures, which had mounted due to an increase in inventories in 2009, eased off in 2010 on account of shorter cash conversion cycles. This led to a better liquidity position for OEMs, allowing them to shift their focus to capex plans.
Thank you for sharing this informative post about India auto sector. This sector is growing very fast in India and now more foreign investor want to come and invest in this sector.
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