A few speedbreakers ahead

Written by Shweta Bhanot | Updated: Dec 30 2009, 05:03am hrs
The profitability of Indian automobile majors could be under pressure in 2010-11 with raw material prices hardening, an expected hike in the excise duty and new emission norms set for next year. Operating margins for major players are expected to come in at between 10% and 12% and may be lower than those that they report for 2009-10. So far, margins in the current year have been reasonably good at around 14%, thanks to lower prices of steel, plastic and natural rubber.

Raw material costs, which accounted for 66% of net sales last year, fell to around 55% in the first six months this year. As Credit Analysis & Research Limited (CARE) points out, steel prices for the six months to September 2009 have been around Rs 37 per kg, 25% lower than the price in the same period last year.

However, input prices are beginning to look up and the December 2009 quarter could be the first quarter when margins would start showing signs of weakening after a fairly good September quarter. Indeed, smaller players may see their margins dip. Steel prices, which account for 60-65% of the raw material bill, are expected to average Rs 41-42 per kg next year, an 11% jump from the levels of Rs 38 per kg this year.

Moreover, excise duty for small cars are likely to go back to the level of 14% soon with the stimulus package being withdrawn from the discounted 8% rate at present. Also, the new emission norms (Bharat Stage IV) that would come into force in April next year will mean more expenses for manufacturers. They may not look at passing on the entire increase to the end user. This, coupled with the increase in raw material prices and intensifying competition in the segment, will impact the margins of the makers in FY 11, said Mahantesh Sabarad, senior research analyst, Centrum Broking.

Further, the expected increase in interest rates by the Reserve Bank of India (RBI) to control inflation could impact volumes, since auto loans will become costlier. RBI is expected to withdraw liquidity from the system through a hike in the Cash Reserve Ratio for banks and hike rates gradually beginning with a 25-basis point policy hike in January 2010, says the Goldman Sachs Global Investment Research report. Cumulatively, RBI is expected to hike effective policy rates by 300 basis points in 2010.

Since 65-70% of domestic car sales are financed by banks, tightening measures can potentially impact the cost and availability of financing to the sector, says the Goldman Sachs report, noting that this could have a lagged impact on demand in FY 12.

The auto industry has been showing signs of recovery with domestic sales in the April-November period going up by 18% year-on-year. Passenger vehicle sales grew by 21%, while commercial vehicle sales grew by 12.44%. The fairly strong demand has brought inventories in the industry close to levels where there are no stocks, pushing up the demand for raw materials. This mismatch in demand and supply has led to a scarcity of auto components.

Revati Kasture, head, industry research, CARE, points out that raw material costs account for approximately 70-85% of revenues and, therefore, manufacturers try to keep costs down so as to improve margins. The best year for companies was 2003-04 when margins crossed over 11%, while the worst was probably 2008-09 when they crashed to 5.2%.

Maruti Suzuki, which commands a share of close to 50% in the passenger car market, could see margins coming off by about 50 basis points next year. Other players such as tractor and utility vehicle maker Mahindra & Mahindra (M&M), too, could feel the pinch. Interestingly, Tata Motors may buck the trend next year since higher sales of Jaguar and Land Rover, on a low base, could neutralise the weaker margins in the home market.

Of course, its possible manufacturers have been talking of increasing prices of vehicles by 2-3% from January in a bid to pass on higher costs to buyers. Pawan Goenka, president, automotive sector, M&M, and also president, Society of Indian Automobile Manufacturers (Siam), has expressed concern over the rising raw material prices, especially those for sheet metal and tyres. Goenka had conceded that prices may need to be increased, should the trend persist.