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Boomtime for India's auto parts industry
Atul Sathe | June 06, 2006
More and more vehicles around the world from Europe to China and South Africa to USA are gradually sporting their tri-colour origins, from nuts and bolts to steel forgings.
One of the sectors that has been surging ahead in the India outsourcing story, is auto ancillary. Exports of components from India as a percentage of total sector revenue are expected to nearly double over the next five years.
Further, at a time when the markets have applied brakes on the long-drawn bullrun, this is one promising sector that could accelerate faster in future, even as it could have its share of rusty patches.
Analysts are particularly bullish on frontline auto ancillary companies like Bharat Forge, Rico Auto, Sundaram Fasteners, Amtek Auto, Sona Koyo, Munjal Showa, Motherson Sumi and Mico Bosch, on the back of factors like diversified product baskets and aggressive growth plans.
The bottomline growth of these companies in FY06, although a little muted, gives some idea of the future (See table).
India continues to be a low-cost outsourcing destination for global auto companies, with its strong engineering skills. For instance, Gabriel India recently signed a global supply contract with Arvin Meritor of USA for supply of two million shock absorbers valued at around $ 12-15 million per annum.
Sourcing parts from India is 10-20 per cent cheaper for American auto makers and about 50 per cent cheaper for European auto makers, according to an analyst. Exports, which at present constitute 15-20 per cent of the industry size of about $10 billion in FY06 (Rs 45,000 crore), are likely to reach 50 per cent in another five years.
Even Exide Industries, whose exports at present account for only four per cent of its business, plans to take it to at least 10 per cent over the next 3-4 years. However, Indian auto ancillary companies cannot ignore competition from other outsourcing destinations like China and Brazil.
FY06 and beyond
The "average" performance of this sunrise sector in FY06 was primarily due to higher raw material costs, higher costs involved in new client acquisition and capex (to meet growing demand), according to Dipesh Sohani, research analyst-institutional equities at Anand Rathi Securities. Moreover, there were delays in executing overseas orders in some cases.
Ramnath S, VP-research at SSKI Securities says, "FY06 results showed good domestic growth, even as export performance was not up to mark. For instance, the industry major - Bharat Forge - faced margin pressure due to higher raw material costs and capex.
"Moreover, some smaller auto ancillary companies failed to get follow-up export orders because many foreign original equipment manufacturers themselves faced financial problems. Conversion of trial orders to final orders from foreign OEMs also takes time. Increased interest and depreciation costs for many Indian auto ancillary companies was another setback."
However, Ramnath is bullish about FY07 and FY08 with an expected 20 per cent growth in topline as well as bottomline, as the above issues get addressed.
Foreign OEMs (original equipment manufacturers) had started their restructuring process (including measures like prepaying high cost debts) last year and would get over by the end of Q1 FY07. After that they are expected to resume their normal outsourcing orders.
PK Kataky, director-automotive SBU of Exide Industries pegs the annual revenue growth for his company at around 12 per cent over 4-5 years and expects the industry to grow at around 10 per cent. Some companies foresee even 30-35 per cent growth over the coming years.
Alpa Shah of Khandwala Securities expects the forging and machining segment in India to grow at 35 per cent CAGR over the next 10 years. Gears and brakes are also witnessing a lot of outsourcing opportunities.
A spokesperson from Munjal Showa says that the company's revenues should grow by around 15 per cent per annum over the next 4-5 years, despite a squeeze in margins due to high metal prices. He expects a similar growth for the shock absorber industry, in which it operates.
Many auto ancillary companies in India continue to look at the inorganic route to expand further into western markets. By acquiring existing brands there, Indian companies would make further inroads.
Ramnath feels, "Acquisitions, especially of companies in Europe, will be the mantra for Indian players. This is because the OEMs in Europe have been facing crisis. Outsourcing to Indian companies reduces their costs significantly and simultaneously Indian companies gain control over the strong local brands."
Shah says that the delivery time is significantly reduced by supplying from the plants of acquired companies in the West. At least a part of the orders can be satisfied immediately, before the shipment from India reaches.
Indian companies have made over a dozen acquisitions or tie-ups abroad in the past couple of years. For instance, Exide Industries has a 61 per cent share in a joint venture company in Sri Lanka. It is upgrading this factory and plans to source some batteries from this plant the Indian market.
While Omax Auto is acquiring a company in the US, Bharat Forge is said to be eyeing one more acquisition after Carl Dan Peddinghaus GmbH, Federal Forge, Imatra Kilsta and the Chinese JV with FAW. M&M may also augument its components business inorganically.
Companies across most segments of auto ancillaries are expanding capacities to tap the growing demand. According to Acma (Automobile Components Manufacturers Association), the investment in the sector has risen by about 107 per cent from 1997-98 to 2004-25.
A report by SSKI expects capex plans for FY07 of Rs 300 crore (Rs 3 billion): Bharat Forge, Rs 275 crore (Rs 2.75 billion): Mico, Rs 100 crore (Rs 1 billion): Rico Auto, Rs 53 crore (Rs 530 million): Sona Koyo, Rs 45 crore (Rs 450 million): Omax Auto and Rs 250 crore (Rs 2.5 billion): Amtek Auto.
The growth in India would be driven by the 9-10 per cent expected growth in medium & heavy commercial vehicles, 15 per cent growth in cars, 15-17 per cent growth in two-wheelers and about 20 per cent growth in light commercial vehicles.
Moreover, cars, utility vehicles and CVs made in India are increasingly getting acceptance in foreign markets, thus driving the demand further. Even Indian two-wheeler majors are targetting markets abroad. Simultaneously, foreign auto majors like Ford and Hyundai are making India its manufacturing base for several models.
Although the sky is the limit, for many smaller players in India which collectively control barely one per cent of the global market share, it is a challenge to avoid issues like delay in follow-up orders, inability to service large orders due to lack of scale and delay in shipments.
An analyst points out that Sona Koyo had to suffer an outgo of Rs 1 crore (Rs 10 million) in Q1 FY06 as it had to airlift certain components due to a delay in shipment.
Raw material prices have been going up over the past one year. For instance, prices of lead, which constitute 70 per cent of the cost for battery manufacturers, have been sky rocketing for the last one year and companies like Exide have not passed on the entire cost pressure to the consumer.
But the company, which has a 80 per cent market share, has been able to grow its bottomline, with value engineering and improved design.
Similarly, international steel prices have risen 11 per cent in first two months of the current fiscal. However going forward, margins, especially of the bigger players, are unlikely to get affected. OEMs allow about 80-85 per cent of the cost hike to be passed on to them in most cases, according to Ramnath.
Shah says, "FY07 and FY08 would be the true test of most Indian companies. While the export potential exists, it is important to deliver on time with the required quality. It takes 18-24 months for the approvals and capex plans to materialise." Thus, even as the sector has a lot of upside, some small and mid-cap stocks may suffer during volatile markets.
According to the SSKI report, the P/Es of most auto component companies on FY07E earnings are comparable, except for an occasional high valuation for an industry leader like Bharat Forge at 16.5x.
Amtek Auto trades at 10.9x, while Rico Auto trades at 13.5. The sheet metal and machine components manufacturer - Omax Auto - trades the cheapest at 9.5x, while Mico trades quite high at 15.9x. The valuations of other major players are Sona Koyo: 11x, Sundaram Fasteners: 13.7x and Balakrishna Industries: 15.5x.As Sohani says, "Outlook still is bright, with the theme of outsourcing properly addressed by full capacities utilisation, new client acquisition, inorganic growth in developed countries and cost reduction measures on fronts like quality, delivery, design and management."