he outlook for the Indian auto component sector derives from Fitch Ratings’ outlook on domestic original equipment manufacturers (OEMs), as well as the agency’s outlook on the global automotive sector.
With substantial demand and margin pressures being faced by both Indian and international OEMs, the domestic auto component sector is also likely to face substantial operating pressures in calendar year 2009 (CY09). Component players will likely face demand pressures in line with their customers, although the impact on cash flows could likely be more severe in view of OEMs lengthening their payment periods.
Export-focused players are likely to face additional pressure from receivable risks on the back of the deteriorating credit profiles of the large international auto majors. The risks are accentuated by the relatively higher leverage amongst many players – a consequence of the additional debt taken on to finance their capex to meet the increasing capacities of OEMs.
Demand Pressures in Domestic and Export Markets
The demand outlook for the component sector remains negative, reflecting the ongoing pressures being faced on both the domestic and international scene. With the depressed scenario likely to continue over the short to medium term, and a softer recovery curve, the auto component sector is also likely to face significant demand pressures over the same timeframe. Many component manufacturers had anticipated some cushion from export demand, which they believed would be counter cyclical to the domestic cycles and result in better earnings stability.
However, the international markets have also faced severe pressure over end CY08, which will most likely extend over CY09 as well; and, as a result, Fitch does not expect any major positives on the demand front over the near term. Fitch notes that those players more focused on the commercial vehicle (CV) market are likely to be more severely impacted than those with more diversified product and customer profiles. Component manufacturers with a strong after-market component of sales could also be in a better position and be relatively less affected by the ongoing slowdown.
Whilst the recent decline in the Indian rupee/US dollar exchange rate will make Indian components cheaper for the international auto majors, Fitch does not believe that the impact will be sufficient to boost export demand. The positives could likely be offset by the ongoing decline in volume.
Margin Pressures on Low Capacity Utilisation
With most auto OEMs in India and abroad facing difficult markets, attempts are being made to mitigate the impact on their margins by demanding more price cuts from vendors. In addition, with lower capacity utilisation for the sector following production cut-backs at the OEMs, overheads are likely to remain high in relation to existing volumes. Many companies are also sitting on idle capacity built over CY08, in anticipation of export orders which have not materialised.
The higher fixed costs without commensurate volumes will likely have a further adverse impact on component makers’ operating margins. However, some relief from softer commodity prices could be expected over the short to medium term, once the higher cost inventories are liquidated. Fitch believes, however, that further price cuts beyond current levels (barring a pass through of commodity price benefits) would probably be limited, as many component makers have already given major price concessions in CY08.
Cash Flow and Liquidity Pressures from Working Capital
The OEMs are attempting to alleviate their own liquidity pressures by increasing their payable periods to auto component players. This has resulted in a significant increase in working capital requirements for most operators. In the case of exports, the risks are accentuated by the deteriorating financial profile of international majors such as General Motors Corp. (‘C’) and Ford Motor Company (‘CCC’), which has, in certain cases, limited the availability of export credit from banks.
Working capital has also increased due to high inventories – a consequence of the cut-backs in production at the major OEMs. This has put significant pressure on component makers’ short-term liquidity. These companies have increased utilisation of their working capital limits, and in some cases taken ad hoc limits from their bankers.
Capex and High Leverage Accentuate Financial Risks in the Near Term
The cash flows of most component makers are likely to come under pressure over CY09 in light of slower demand and higher working capital requirements. Much of the increased working capital requirements is also likely to be financed through debt, which will further increase leverage and lower interest cover ratios for many players. Many component players also have large term debt on their books, which was used to finance capex. Anticipating a substantial spurt in export orders, coupled with the expansions announced by domestic OEMs, component makers entered into large debt-led capex programmes.
A part of this capex was also required to meet the requirements of the new product launches scheduled by the OEMs. While some of the component manufacturers have deferred some of the expansion (in line with that of the OEMs), those which have already commissioned capacity have not achieved the targeted utilisation levels. In these cases, the repayments have started to fall due over CY09 and CY10, which exposes the companies to refinancing risks as current cash flows are not adequate to finance the repayments.
Credit Profiles to Remain Under Pressure over the Short to Medium Term
The profitability and financial profile of the auto component manufacturers are expected to worsen over the near term, in light of Fitch’s expectation of a subdued demand environment, and in line with its outlook for OEMs. Margins and credit metrics are also likely to remain under pressure. A soft recovery, lagging that of the OEMs, is anticipated only towards CY10. Exports are likely to remain subdued for longer, reflecting the agency’s expectation of a delayed recovery (only towards CY11) in most developing markets.
While Fitch has factored these short term pressures in its ratings and expects ratings to re