The operating margin for component manufacturers (excluding tyres) is likely to return gradually to pre-Covid levels of 10.5-11%
ICRA expects its sample of 49 auto ancillaries with aggregate annual revenues of close to Rs. 3,00,000 crore to grow by 8-10% in FY2023, supported by healthy demand from the domestic OEM segment along with pent-up demand from aftermarket even as headwinds persist on the exports front. In addition, growth for auto component makers is also favourably aided by rising content per vehicle, resulting in an increasing share of the premium and feature-packed vehicles in the overall mix, besides greater thrust by OEMs to locally source components. Furthermore, select companies have also started witnessing a healthy ramp-up in revenues with a steadily rising share of Electric Vehicles (EVs), where content per vehicle is expected to rise considerably. These trends will translate into healthy growth for auto component suppliers over the medium-to-long term. For H1 FY2023, ICRA’s sample reported a growth of 29% on a YoY basis. Aided by the benefits of operating leverage and easing commodity prices and supply chain disruptions, ICRA expects YoY improvement of 50-75 bps in operating margins in FY2023, with margins for the ex-tyre sample likely to return gradually to pre-Covid levels of 10.5-11%. That said, certain headwinds will persist, especially for companies with a high share of imports (owing to rupee depreciation vis-a-vis USD) and elevated cost of raw materials linked to crude oil derivatives. For H1 FY2023, the operating margin for ICRA’s sample of component manufacturers (excluding tyres) stood at 10.1%, 30 bps lower on a YoY basis.
Giving more details, Vinutaa S, Vice President and Sector Head, ICRA, says, “Domestic OEM demand constitutes almost 50% of sales for the Indian auto component industry. This is likely to remain healthy in FY2023, with double-digit growth expected in both passenger vehicle and commercial vehicle segments. Further, demand for public and private transport is expected to remain healthy with an increase in mobility, supported partly by the reopening of schools and offices. This, along with steady freight movement, is likely to aid replacement volumes in the near term. The replacement segment is also expected to benefit from the likely postponement of new vehicle purchases due to an increase in vehicle prices with cost inflation and elongated waiting periods, especially in the PV segment, because of supply-chain issues being faced by OEMs on account of semi-conductor shortage. The export orders have slowed down in the last few months, impacted by inflationary pressures, geopolitical tensions, and supply-chain issues. While it remains in the positive zone on a YoY basis currently despite the slowdown, partly aided by delivery to some new platforms because of China+1 strategy and the depreciation of the INR against the USD, this would remain monitorable.”
Cost inflation continues to be a key headwind for the industry. While there has been an easing in YTD FY2023, and this is expected to result in YoY margin improvement, commodity and freight costs remain at elevated levels compared to the pre-pandemic lows. Ancillaries are looking at enhancement of product portfolio and increased value addition/content per vehicle. The new products targeted are largely EV agnostic or for EVs. Further, companies have adopted consolidation of delivery and optimization of routes to the extent possible to reduce freight expenses. Increased usage of power from renewable sources, factoring arrangements to reduce working capital requirements, and other measures like improvement in output per employee through automation/technology enhancement are likely to support margins going forward.
On the impact of INR depreciation on the industry players, Vinutaa says, “Imports are an integral part of the auto component industry, especially with the increase in electronics and advanced technology components. While a gradual increase in usage of advanced components unavailable in India has contributed to import increases over the years, supply chain disruptions and domestic market recovery contributed to an increase in imports in FY2022. The auto component imports in India stood at USD 18.3 billion in FY2022, with China and Germany being the largest source markets, contributing 30% and 11%, respectively, in FY2022. While the depreciation of INR against USD is a worry for net importers, forex hedging measures adopted and alternate local sources have mitigated the risk to an extent. In case of components unavailable in India, ancillaries are exploring alternate materials and localisation options as measures to mitigate forex and supply-chain risks going forward.”
Liquidity position remains comfortable for auto ancillaries, especially across tier-I players, and ICRA expects coverage metrics for the sector to remain comfortable going forward as well, aided by healthy accruals and relatively low incremental debt funding despite the expectation of an increase in the cost of borrowings. Most auto ancillaries rated by ICRA are in investment grade, reflecting a healthy credit profile and stemming from healthy cash accruals and a steady decline in debt levels.
ICRA’s interaction with large auto component suppliers indicates a cautiously optimistic approach toward CAPEX/investment plans for FY2023. ICRA Research expects auto component suppliers to gradually increase their CAPEX/investment outlay to 6-6.5% of operating income in FY2023 and 7-8% in FY2024, though most of these investments will be largely funded by internal accruals. The incremental investments will be primarily towards capability development, i.e., new product additions, product development for committed platforms, and development of advanced technological and EV components, unlike the investments towards capacity expansion witnessed in the past. The recently announced PLI scheme will also contribute to accelerating CAPEX over the medium term, besides investments by new entrants in the EV segment.