Indian Auto Ancillaries Industry Report - Auto Ancillaries Sector Research & Analysis in India - Equitymaster
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Auto Ancillaries Sector Analysis Report 

[Key Points | Financial Year '17 | Prospects | Sector Do's and dont's]

  • The fortunes of the auto ancillary sector are closely linked to those of the auto sector. Demand swings in any of the segments (cars, two-wheelers, commercial vehicles) have an impact on auto ancillary demand. Demand is derived from original equipment manufacturers (OEM) as well as the replacement market.
  • Margins in the replacement market and exports are higher than the OEM market. The OEM market is very competitive and component manufacturers have to compromise on margins to bag bulk orders. Moreover, delivery schedules and quality standards have to be adhered to very strictly.
  • Auto ancillary face pricing pressure from OEMs. In order to negate that these players have a challenge of continuous cost reductions through innovations to stay innovative.
  • Indian auto ancillary sector has traditionally suffered from poor quality. One of the key reasons for this has been that the companies in the sector are either customer anchored or product anchored with majority of its revenue coming from a product or customer. While this still holds true for the unorganized sector, the organized sector has been resorting to increased automation to reduce the defect levels.
  • Lower labour costs give Indian auto ancillary companies an absolute cost advantage. To put things in perspective, ACMA numbers suggest that wage cost accounts for 3% to 15% of revenues for Indian manufacturers as compared to 20% to 40% for US players. India's strength in exports lies in forgings, castings and plastics historically. But this is changing with more component manufactures investing in upgradation of technology in recent years.

How to Research the Auto Ancillaries Sector (Key Points)

  • Supply
  • Low for high technology products. Unorganized sector dominates the domestic component market due to excise benefits. Generally, excess supply persists.
  • Demand
  • Linked to automobile demand. Export demand is linked to the increasing acceptance towards outsourcing.
  • Barriers to entry
  • Capital, technology, OEM relationships, customer service, distribution network to meet replacement demand.
  • Bargaining power of suppliers
  • Low with OEMs. Relatively high in the replacement market.
  • Bargaining power of customers
  • Companies operating in the export market face competition at a global level. At the domestic level, market structure is fragmented for a large number of ancillary products. Most companies adopt low cost and differentiation strategies. In some products (like batteries), only two or three companies control over 80% of the market.
  • Competition
  • Will intensify, as global players will enter the market leading to consolidation. Dereservation of SSI will result in access to capital and technology

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Financial Year '17

  • FY17 was a relatively subdued year for the Indian automotive industry. In FY16, it was the MHCV space that emerged as the strong performer of the lot. In FY17, however, growth in MHCVs was flat, while LCVs grew by 7% YoY during the year. Passenger vehicles and two-wheelers grew in higher single digits.
  • As per IBEF, the total value of India‚Äôs automotive aftermarket stood at Rs 561 billion (US$ 8.4 billion) in FY17. Exports stood at Rs 731 billion (US$ 11.2 billion), up by 3.1% YoY.
  • As the growth of the auto industry remained muted and demonetization negatively impacted the Indian economy, the auto ancillary industry also struggled a bit during the fiscal. For instance, for Bharat Forge, it was a challenging year because of weak export demand and disappointing growth in the Indian M&HCV space.

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Prospects

  • There has been a conscious effort by manufacturers to improve productivity of the suppliers in the past few years. Though the number of active vendors has declined significantly for auto manufacturers, technology transfer and fresh fund infusions have resulted in improved productivity in the remaining ones. Relaxation of FDI norms for the small-scale sector could emerge as one of the key growth drivers in the long run. The Indian automotive components industry has lined up sizeable investment schedules for the next few years.
  • The automobile sector is cyclical and dependent on the growth of the economy and improvement in infrastructure. Factors like increased public spending, favorable interest rates and general improvement in per capita income point towards higher demand for automobiles in the future. Also, government's initiatives in the infrastructure sector such as the Golden Quadrilateral project and NHDP (National Highway Development Programme) are likely to give boost to four-wheeler sales especially CVs. Just to put things in perspective, we expect CV segment to grow by 7% to 8%, 2-wheeler demand to increase by around 12% to 15% and passenger car sales growth at 10% to 12% over the medium to long term. This is a positive for auto ancillary manufacturers.
  • In the long term, the growth of this sector will depend partly on pace of indigenization levels across all segments. The prospects look bright as most companies are increasing the indigenous components, in an effort to reduce their currency losses and remain competitive. Also, the fact that auto manufacturers like Ford, Hyundai and Maruti are exporting cars, make the prospects look encouraging.
  • Margins are likely to come under pressure in the long term because as competition increases, manufacturers will find it difficult to increase prices and will try to cut costs. The burden will eventually fall on auto ancillary players. In the near future though, companies will need to have manufacturing lines that can be adapted for new models, have strong technology backing, an ability to export to developed markets, market dominance in specific products and a growth plan driven by volumes and product innovations. Companies will have to focus on quality and abide by delivery schedules if they want to survive. As manufacturers sourcing components are keen to get components from fewer sources in future, this will lead to consolidation in the sector.
  • The growing number of Free and Preferential trade agreements being signed by India with countries like Thailand, Singapore and other ASEAN countries will hurt the cost competitiveness of Indian companies as Indian players play significantly higher duties than their Asian counterparts. Therefore, Indian companies might lose out on big orders if the duty structure is not rationalized.

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