Mumbai/Singapore: Subdued demand conditions that led to weak performance by Indian automakers in the first quarter of the financial year ending 31 March 2020 (FY20) will likely persist, adding to the challenges from the implementation of stricter emission norms under BS6 from April 2020, says Fitch Ratings. Most auto OEMs reported lower volumes and profitability in 1QFY20 as domestic sales volumes of passenger vehicles and medium and heavy commercial vehicles fell by 18.4% and 16.6%, respectively, according to the Society of Indian Automobile Manufacturers.
Domestic sales trends have weakened since 1HFY19 as the constrained liquidity at non-bank lenders reduced credit availability to buyers and the cost of ownership rose due to new regulations mandating enhanced vehicle insurance cover and additional safety features. In addition, the sales volume of commercial vehicles was also affected by easing in axle load standards in July 2018, which resulted in additional freight capacity in the system. The decline in sales in 1QFY20 was much sharper as it coincided with India’s general elections in April and May 2019. Monthly volumes weakened further in July 2019 with yoy decline of more than 25% each in the passenger and commercial vehicle segments.
Sales volumes in the two-wheeler segment have been more resilient than passenger and commercial vehicles due to their lower prices and non-discretionary demand, particularly in rural areas where they serve basic commuting needs and enable income. Nonetheless, volumes fell by 11.7% yoy in 1QFY20 and 16.8% in July 2019.
We expect overall domestic auto sales volume to decline in FY20, although volumes may stabilise in the coming quarters due to government’s focus on improving liquidity at lenders and recent measures to revive auto demand. The improved likelihood of adequate rainfall and recent cut in interest rates should also help demand in 2HFY20. However, the lower volumes will weigh on automakers’ profitability in FY20 and could offset the benefits from lower commodity prices.
The implementation of BS6 emission standards will require automakers to make changes to vehicle platforms ahead of March 2020 – the regulatory deadline after which sale of older models will not be allowed. This will require significant investments to upgrade existing vehicle models and assembly lines, which will put pressure on free cash generation. Automakers will also need to realign their portfolios, particularly for the diesel variants of smaller cars, which will cost more to move to BS6 compared with ‘cleaner’ petrol variants. This could lead to changes in the competitive dynamics in the mass segment.
Fitch estimates the additional components and design changes will raise production costs by 10%-15%. This could squeeze automakers’ profitability in FY21 if automakers are not able to fully pass on costs to buyers. Increased vehicle prices after March 2020 could spur some buyers to bring forward their purchases, but we do not expect this to be material. Automakers appear to be cautious about production and inventory management amid weak demand conditions, and they have announced production and work force cuts.
Weaker auto sales volumes are likely to have a bigger impact on auto suppliers, especially the smaller and less diversified players that have lower bargaining power in negotiating prices and passing on input price volatility. Motherson Sumi Systems Limited (MSSL) enjoys strong market position in its wiring harness business in India and its diversification outside India through its subsidiary Samvardhana Motherson Automotive Systems Group BV (SMRP BV, BB+/Stable) will help to alleviate the impact of weak demand in India. Nonetheless, SMRP BV remains exposed to slowing auto volumes globally, with profitability, excluding recently set up plants, narrowing during 1QFY20.
Tata Motors Limited’s (TML, BB-/Negative) sales volume fell by more than 20% yoy and profitability weakened for the Indian business in 1QFY20. This was driven by a 16% fall in commercial vehicle volumes that was in line with the industry trend and a sharper 30% drop in passenger vehicle sales volume. Consolidated volumes and margins were affected by challenges at wholly owned Jaguar Land Rover Automotive plc (JLR, BB-/Negative). Fitch’s recent one-notch downgrade of TML factors in weakness in India and the JLR business, and the Negative Outlook underscores limited rating headroom due to a large investment plan and risks in JLR.