In the past ten years, the top 100 auto component companies’ revenue growth has outpaced that of original equipment manufacturers (OEM) by >500 bp. We expect this trend to accelerate. As all the large Indian auto component companies have a very high exposure to global markets, and thus are not plays on an Indian recovery, we met managements of 15 small-cap Indian auto component companies over the past month. Within our coverage of the auto component sector, we prefer companies having: exposure to passenger and commercial vehicles; products with technological edge; dominant share in key products; diversified customer base; opportunity to expand into new products; improving product mix; and low margin volatility.
The gap between the top-line CAGR of auto components industry and that of auto OEMs is expected to widen further on: a consolidation of the industry as OEMs increasingly move towards a single/lesser supplier model—share of top ten players is up >500 bp in the past five years; the rising share of exports as foreign-based OEMs look to source greater components from India—exports have increased from $3.5 bn in FY07 to $10 bn in FY14; sizeable growth opportunity in the replacement segment (margins are 300-400 bp higher than the OEM segment) as consumers up-trade from the unorganised segment; GST implementation can reduce the pricing gap (~40%) between organised and unorganised, and CCI clampdown on OEMs regarding spares’ availability could expand the market; Indian arms of foreign OEMs increasing localisation in the wake of rising costs in a competitive environment (gap of almost ~15% between Maruti and other MNCs); and increasing content per vehicle, driven by regulation and consumer aspirations.
Our analysis of the consolidated industry financials indicates that the components sector is well placed to tap into this future growth; utilisation rates remain low (~70%), indicating margin expansion from operating leverage as the cycle recovers. Despite slowing top-line growth, components companies managed to improve gross margins, driven by export profitability and some raw material benefit. PAT margins are though only steady because of negative operating leverage.
Our discussions with managements indicate that while demand is improving with suppliers across segments, they are still not outright bullish. We believe the auto component sector can be assessed on the following parameters: On growth parameters, we like companies having: larger exposure to the India OEM space (particularly PVs and CVs), product offerings with a technological edge, dominant market share positioning in key segments with entry barriers, a diversified customer base with low exposure to a single customer, and the potential to outperform market growth from untapped opportunities such as new product, and new segment. Based on margin lever parameters, we like companies that can improve margins in the near term on: operating leverage benefit from an uptick in utilisation, as growth returns and other margin levers such as movement towards better mix, and benign raw materials. On financial parameters we like companies that have: high return ratios and higher asset turns, and low margin volatility across cycles, denoting stable model and high pricing power.
We remain very constructive on the CV cycle but our preferred play on this theme, Ashok Leyland, is now already pricing in the best-case scenario; hence, we are downgrading it to NEUTRAL. We think investors should instead switch to a basket of component names that are supplying to the CV industry. We are increasing our target price for Apollo Tyres (OUTPERFORM) to R266 and for Bharat Forge (NEUTRAL) to R830. Apollo Tyres remains our preferred pick in the components space, and we initiate on Wabco as well. We initiate coverage on Wabco with an OUTPERFORM rating and a TP of R4,820: Wabco is the largest player in the CV braking industry in India with a >80% market share. We believe Wabco is one of the best structural plays in the Indian auto components space, with safety and emission content per vehicle in India being a tenth of European markets. Wabco India also has a prominent position in Wabco’s global scheme of things. CV cycle recovery and mandatory ABS implementation are near-term triggers for the stock, in our view.
The Indian auto components industry is highly fragmented, consisting of ~500 players in the organised sector and many more in the unorganised sector. The top 50 companies contribute 85% to the total revenue. Industry consolidation is a global phenomenon and the trend is now catching up in India as well. In India, the share of the top 10 companies (excluding tyres) has increased by more than 500 bp in the past five years.
A number of OEMs have announced plans to cut suppliers. One reason that necessitated the need for larger numbers of suppliers was the wide number of designs required for each component given the large number of models of each OEM. As each manufacturer had multiple models, it traditionally required different suppliers to cater to the components for each of these. But now with car manufacturers moving towards a modular design and platform consolidation (a number of models sharing the same platform), economies of scale should become more relevant. Globally, there is a trend towards commonality: common platforms, common parts. This should also help larger auto component companies and also result in share swinging from the unorganised to organised.
Indian companies have a huge cost advantage over their Western peers on labour costs with wage costs in India being a tenth of those in Europe and the US. The primary reason for this is the large availability of highly skilled labour in India.
The slowdown in growth in developed markets has also put great cost pressures on OEMs in developed markets and they are thus looking at increasing their sourcing from lower cost countries like India. India’s auto component exports have grown at a ~20% CAGR in the past decade with the share of exports in revenues of Indian auto component companies increasing from ~15% to ~30%.