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Auto: Identifying men from the boys… - Views on News from Equitymaster
 
 
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  • Nov 24, 2004

    Auto: Identifying men from the boys…

    Followers of the global auto industry need little introduction about Nissan, the Japanese auto major that is revered in the autobahns of the world for the amazing turnaround story that it has scripted for itself. Much of it could be attributed to its great focus on costs and subsequently its operating margins, believed to be among the best in the world.

    Equally respected are names like Toyota and Honda, companies that pioneered lean manufacturing and astute inventory management systems. Inspired by the success stories of these auto majors, their counterparts across the world also started adopting similar strategies and have been fairly successful in their efforts. Indeed, with autos being increasingly rendered as commodities and economies of scale as given, companies will have to look at ways and means to cut costs so that they are able to plough back more into their product development and R&D operations. Little wonder that analysts of auto companies pay so much of attention to cost structures to separate the wheat from the chaff. In other words, identify the good companies from the bad.

    Entry of some of these very global companies in India in recent times has also resulted into a wake up call for the Indian auto majors. Knowing full well that if they are to hold their own against these global players, manufacturing operations will have to be lean and cost structures highly competitive. The table below details the break-up of FY04 cost structures of three of the leading passenger vehicle companies in the country.

    (Rs m) Maruti M&M Tata Motors
    Raw materials 66,317 33,529 83,414
    % of net sales 71.0% 68.1% 63.1%
    Wages 1,779 4,175 8,825
    % of net sales 1.9% 8.5% 6.7%
    No. of employees (000') 3.3 12.4 21.3
    sales per employee 33.9 4.0 6.2
    Administration and selling 10,397 926 21,205
    % of net sales 10.6% 1.9% 16.0%
    Operating margins (%) 11.1% 10.1% 14.9%
           
    Depreciation 4,949 1,652 3,826
    % of net sales 5.3% 3.4% 2.9%
    EBIT (% of sales) 5.8% 6.7% 12.0%

    As is evident from the chart below, all the three companies had their best operating margins during FY04. This could be attributed to the fact that almost all the segments of the auto industry witnessed one of their best growth rates ever during the year. Moreover, the industry operates on a large amount of fixed costs and hence the higher the volumes sold, the better it is for the company so that production is spread over a larger base. Not surprisingly then the industry players recorded one of their best profits during FY04, as volumes in majority of segments grew by as high as 30% YoY. This despite higher steel prices is commendable.

    Another strategy that the auto companies resort to is that of maximum platform utilisation. In other words, companies strive to produce different variants or different models on the same platform so that once again high fixed costs are taken care of by spreading them over a larger base. Ideal example of this would be Tata Motors, which produces Indica and Indigo on the same platform and in this way is able to exploit its production facilities to the maximum possible manner. Little wonder that the depreciation cost of the company is a mere 3% of its sales as compared to 5% for Maruti, which has different platforms namely for it’s A, B and C segments offering. Part of the low depreciation of Tata Motors could also be attributed to the old age of its CV plants since it has been into existence for quite a long time now.

    One area where relatively older companies like Tata Motors and M&M suffer is the employee base. While sales per employee for Tata Motors and M&M stand at Rs 4 m and Rs 6 m respectively, Maruti at Rs 34 m per employee is way ahead of its rivals. While the other two companies have made some improvement on this front, they still have a long way to go before they can catch up with Maruti.

    Material cost accounts for nearly 2/3rd of the total cost of operations for all the auto companies and hence it is obviously the key area of focus for any auto company that wants to bring down its expenses. With companies these days outsourcing most of their manufacturing requirements, bargaining power with vendors has assumed importance in the process of material cost savings. As is clear with the table, among all the three auto companies, Tata Motors seems to have better systems in place since its material cost as percentage of sales in the lowest of the three. Besides, sales of CVs, its high realisation product have also been robust and this has also helped the company to score better on the raw material cost front.

    Maruti, on the other hand, had to undergo some price repositioning strategy where it had to cut costs of some of its products and thus while the growth in volumes have been robust, low realisations on some of its products has not been able to make up for it and hence the higher raw material cost relative to sales for the company.

    As evident from the above write-up, close scrutiny of the cost structure can throw some valuable insights into the strategies and business models adopted by the different auto companies and hence can be important criteria for investment. Thus, a small extrapolation based on the above information can go a long way in making sound investment decisions.

     

     

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