India Ratings and Research (Ind-Ra) believes that the 4QFY21-1QFY22 standalone EBITDA margins of auto original equipment manufacturers (OEMs) could be 100-200bp lower than 3QFY21’s, on account of the recent spike in input prices. The vehicle price hikes coupled with the cost rationalisation measures taken by OEMs to counter the sharp rise in the prices of commodities (including steel, aluminum, copper and other components) might not be adequate to sustain margins at the 3QFY21 levels (industry margin of 11.9%). While operating leverage is likely to remain favourable due to the demand rebound witnessed in most of the industry sub-segments, 4Q being a seasonally lower quarter, operating leverage could remain lower on a quarterly basis. Furthermore, the shortage of components such as semi-conductors and other electronic components could impact the overall vehicle production and hence limit the potential demand upside.

Overall, for FY21, Ind-Ra does not expect significant deviation in the industry EBITDA margins from its earlier expectations. Ind-Ra believes that although the increasing input prices would impinge on the near-term profitability of auto OEMs, they are likely to benefit from these corrective measures including cost rationalisation over the medium term, as the input prices normalise.

 
Increasing Input Prices: The cost of raw materials account for 65%-70% of the total revenues, depending on industry segments. The proportion of metal components (such as steel, aluminum, copper and other precious metals) is over 95% in commercial vehicles (CVs) and tractors (by weight), while it is 65%-70% in passenger vehicles (PVs) and two-wheelers (2Ws). In terms of value, metals cost directly account for 8%-16% of revenues on parts such as body/chassis, powertrain/engine components, wheel rims. Additionally, metals are used in certain other components, child parts, sub-assemblies which is difficult to quantify. The prices of these commodities have been on an increasing trend. In YTDFY21, the average cost of steel increased 12.6% compared to the FY20 average, while the prices of aluminum and copper increased 8% and 5%, respectively. In 3QFY21 alone, the prices for steel, aluminum and copper had increased by 29%, 19% and 9% yoy, respectively (18%, 10%, 7% on quarterly basis). In January 2021, the prices of steel were hovering at historically high levels of INR73,843/tonne.

While OEMs import only 5%-10% of the total raw materials consumed, the imported content is higher at ancillaries’ level. Nevertheless, majority of the steel used in vehicle production is domestically procured with only some specific requirements being imported. Ind-Ra believes that the reduction in steel import duty under the Union Budget 2021-22 proposal would not have any material impact on commodity prices as domestic steel prices, despite being at peak levels, are still below the landed import prices. Ind-Ra expects commodity prices to remain range-bound for the next few quarters, before correcting gradually. 

Moreover, after the implementation of BS-VI norms, the proportion of precious metals such as palladium, platinum and rhodium has also increased, thus increasing the cost of vehicles. The rising prices of these precious materials adds to the overall cost of vehicles.

Favourable Demand and Price Hikes to Support Absolute EBITDA: Certain OEMs have considered a price increase in the range of 2%-3% in the domestic market over 3QFY21-4QFY21 due to the rising input costs. Moreover, the discounts have been on a lower side amid a fairly strong rebound in the demand, since relaxations of the lockdown restrictions, especially in PVs and tractors. Companies in the 2W space have also taken hikes in exports market as the Merchandise Exports from India scheme expired on 31 December 2020, while Remission of Duties or Taxes on Export Products is yet to be implemented. Given the low inventory levels as well as supply-side issues related to certain components, especially in the PV market, OEMs are also prioritising their production basis demand. The CV industry has also started showing signs of recovery with improving marco-economic fundamentals, reviving of capex cycle by industrial sectors and a pick-up in construction activity. The demand revival across industry segments is also evident from 3QFY21 revenues, which are in line with the quarterly historical highs seen during FY18-FY19. Ind-Ra expects the overall demand to remain robust in 4QFY21-1QFY22 and to remain more than the supply, which is in line with improving consumer sentiments and improving macro-economic fundamentals. As such, Ind-Ra does not expect price hike to weaken consumer sentiments materially.

Cost Rationalisation Measures to Help Profitability: 4QFY21 demand is likely to be lower than that in 3QFY21; however, it is likely to be higher on a yoy basis especially due to the weak 4QFY20. While this may constrain the operating leverage compared to 3QFY21’s, it is likely to be better on a yoy basis. Moreover, the companies have worked on reducing fixed cost, which account for 25%-30% of the total cost, as could be seen from lower operating expenses as a % of revenue. The companies have taken measures across all line items, including employee cost rationalisation, value added/value engineering to lower material cost, contract renegotiation and control on discretionary spend. On the raw materials front, the companies are also increasing localisation, as it reduces the exposure to forex risk and alleviates the import related risk. Thus, the attempts to achieve a leaner cost structure should also help OEMs to partly offset the increase in raw material costs. 

Auto Ancillaries Cash Flows could be Impacted: For auto ancillaries, majority of the price escalations are passed on to OEMs, though with a lag of a couple of quarters. Basis Ind-Ra’s discussion with some of the ancillaries in its rated portfolio, the companies are trying to fasten the negotiation cycle; however, their margins could remain impacted for the next two quarters. This is given the limited bargaining power of ancillaries compared to OEMs. While in a normal scenario, ancillaries would have increased the quantum of raw materials to be stocked in a rising input cost scenario, higher stocking of raw materials such as steel, and certain electronic components looks unlikely, given the supply constraints. However, the higher valuation of inventory could lead to higher working capital requirements and thus cash flows could witness some pressure until prices normalise. Nevertheless, the strong demand and high capacities utilisation should help to offset some of these risks. Ind-Ra does not expect any material impact on Ind-Ra’s rated portfolio due to this. 

OEMs might also have to increase their inventory holding, however, given their fairly robust liquidity position and ability to borrow, Ind-Ra does not expect the current situation to impact Ind-Ra’s rated portfolio. 

Additional information is available at www.indiaratings.co.in.

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