Automotive Crisis Or Not?

Ernst & Young

The world is facing the impact of the most severe economic downturn of the past 60 years. The global financial crisis and weak GDP growth have severely impacted the global automotive industry, affecting auto manufacturers worldwide. Sales have been falling fast in the US and Western Europe since early 2008 and all auto markets registered a decline in sales and orders in November 2008. The situation worsened in the last quarter of 2008 and overall global automotive sales fell by five to six million units worldwide during the year.

The overall industry is facing an exceptional combination of cyclical and structural issues. In January 2009, for the first time ever, sales of US passenger vehicle was overtaken by another market, China, in terms of the number of cars it sold, with some reports showing sale of 735,000 units in China as compared to 656,976 in the US.

 
Is the Indian automotive industry's dream run set to peter out amidst the global economic downturn? The scenario in the global auto industry is a mixed bag, wherein on one hand there are early signals of recovery, although inconclusive, which was reflected in vehicle sales in January and Feb'09, but on the other, there is the distressing story of last quarter 2008 and the recessionary outlook globally.

The industry, which has grown at a CAGR of over 10% over the last five years, has shown signs of a slowdown, with 2008 total domestic sales declining by 4.7% y-o-y. Worsening inflation amidst rising interest rates in June 2008 began impacting the sector. Thereafter, growth started moderating in October and declining further in the last two months of 2008.

The domestic automotive industry is going through an uncertain period that is mainly affected by depressed consumer sentiments and postponement of purchases on account of a weak income outlook, resulting in a weak demand scenario. Automotive sale is falling, or at best, is flat across the segments; players are trying to offer discounts and attractive packages to boost sales.

The industry is facing a liquidity crunch, with non-availability of credit and stringent lending norms adversely impacting sales. The liquidity crunch has also resulted in an increase in the cash component in car loans as well as a larger number of all-cash buys. According to estimates, PV sales (with financing) have declined from 85% a year ago to around 65% today. It is the same with other segments, wherein commercial vehicle (CV) sales through financing have declined from 90-95% to 50-60%, and that of two wheelers have come down to just around 30% from 60-65% a year ago. In the CV segment, financing for specific customer profiles, such as small fleet operators, has declined significantly. In the PV segment, lending norms in relation to customer profiles, and for models with a lower resale value, have become more stringent. Affected adversely by rising defaults and collection issues, the two-wheeler financing segment has witnessed the exit of major finance players.

 
Original equipment manufacturers (OEM) and automotive component manufacturers are both reworking their strategy to sustain the ongoing slump in domestic and exports markets. Most of them have put on hold their planned investments. There are production cuts, achieved by reducing shifts or temporarily shutting down plants.

Some expansions within the industry that have been put on hold:

▪	Renault India has cancelled its plan of manufacturing cars in India from June 2010. However, the company will go ahead with the construction of its facility at Chennai that is scheduled for completion by end of 2009.
▪	The Rane Group has deferred half of its INR2500 million capacity expansion plans, citing sluggish demand.
▪	Honda Siel Cars has deferred its capacity expansion and assembly operations plans at its new plant in Rajasthan due to poor domestic demand for cars.
▪	The Hyundai Motor Company has deferred its plans to market its buses in India because of the ongoing slowdown.
▪	Volvo-Eicher Commercial Vehicles plans to hold back its capital investment in capacity augmentation. The company had planned to increase its capacity to between 4,500 and 5,000 units per month from its original capacity of 4,000 units a month.
▪	Ashok Leyland's plans to increase the capacity at its Chennai and pantnagar plants have been put on hold.

 
Passenger Vehicles (PVs)

The domestic PV segment recorded a double-digit growth for around five years in a row till FY08, but has slowed down to a single-digit number in 2Q09, and begun to decline since 3Q09. Domestic sales in the PV segment from April to January 2009 declined by 1.2% y-o-y, the worst period being 3Q09, when domestic PV sales declined by 15.5%. While domestic sales in the passenger car and utility vehicles (UV) segments declined by 0.6% and 7.3% y-o- y, respectively, during this period, sales of multi-purpose vehicles (MPVs) rose by 6.3%, reflecting a buoyant rural market.

 
Among passenger cars, domestic sales in the mini, executive and luxury segments registered a decline from April to January 2009, while the mid-size and premium segments recorded a growth in sales during the same period.

 
Three of the five segments had begun declining at the beginning of fiscal FY09. It was however in October 2008 when the fall was most evident with all the segments posting negative growth. The mini segment was the worst hit by the credit crunch in the market. The absence of any new launches also impacted sales in the segment (with Maruti 800 being the only product). The compact and mid-size segment performed relatively better on the back of the launch of multiple offerings in the segment, for instance, the third-generation Honda city (Honda), Corolla Altis (Toyota), Indica Vista (Tata Motors), i20 (Hyundai), A-Star and Dzire (Maruti Suzuki).

The premium segments were the least affected by the slowdown. In this segment as well, new launches played a pivotal role, for example, the new Accord launched by Honda resulted in doubling of sales in June 2008. Financiers were confident while financing high-end vehicles because of the better customer profile. Manufacturers also increased their focus on the evolving commercial market for premium cars, driven by the increasing number of international airlines, hotels and fleet operators in the country.

Exports in the PV segment from April to January 2009 performed significantly better than the domestic market. Driven by the strong growth posted by Hyundai and Maruti Suzuki, exports in the segment grew by 59.5% y-o-y during the period. Passenger cars and MPVs saw an increase in exports of 63% and 15.9% y-o-y, while exports in the UV segment declined by 46.5% during the period. Although the going has been good so far, the global economic slowdown is likely to affect sales in export markets.

Commercial Vehicles (CVs)

The CV segment has been the worst hit, with sales directly related to overall economic activity. Sluggish industrial activity and the unwillingness of banks to lend have severely affected sales in this segment. The CV segment is the most dependent on financing among the other automotive segments, with 90% of vehicles being sold through the financing route.

From April to January 2009, domestic sales in the CV segment declined by 19.8% y-o-y, primarily due to the slowdown in industrial activity, the prevailing liquidity crunch and a drop in cargo availability. The light commercial vehicle (LCV) and medium and heavy commercial vehicle (MHCV) segments witnessed a decline of 8.3% and 29.2% y-o-y, respectively, during the period.

While looking at the classification, based on the nature of the load, the passenger carrier (bus) segment, which is considered to be non-cyclical in nature, saw sales going down by 7.8% y-o-y during the period, while the goods carrier segment was down 21.7% y-o-y.

 
Although the entire goods carrier segment began to fall in July 2008, the negative impact has been more pronounced on higher tonnage vehicles due to the slow- down in mining and infrastructure activities. Within the M&HCV, the 16 tonne-plus category was the worst hit from April to January 2009, falling by 36%, whereas within the LCV segment, the 5-7.5 tonne category recorded the highest decline of 18%.

 
The sale of tippers and dumpers in the HCV segment, which contributes 30% of total truck sales, was impacted by the slowdown in mining activities due to the delay in awarding licenses and construction activities. The sale of trucks in the 7-12.5-tonne category was mainly affected due to the slowdown in retail activity, which was a result of weak consumer spending.

Infrastructure development has been one of the key drivers for the growing demand for CVs in the country. A reduction in private infrastructure investments, due to high funding costs and private operators' scarcity of capital, has impacted the demand for CVs. The current economic slowdown and a lower cargo volume have increased financial pressures, resulting in deferment of new purchases.

Exports in the CV segment from April to January 2009 declined by 18.9% y-o-y. Within the segments, the decline was more prominent in the goods carrier segment, which fell by 21.6%, with trucks in the 26.4-35.2- tonne segment declining by as much as 74%.

 
The passenger carrier segment also tapered down, reporting a decline of 11.7%. All the segments reported a decline, the highest being in the 7.5-12- tonne segment, which fell by 48.6%.

 
Truck sales are expected to get a boost with the implementation of EURO III/IV emission norms in the country in April 2010. However, if industrial activities do not improve, the downturn in the CV segment is expected to last for another year.

Two-wheelers

Two wheelers comprised the only segment in the Indian automotive industry that reported a mild growth in domestic sales from April to January 2009, growing by 1.3% y-o-y, since the segment is now relatively less dependent on financing. All the sub-segments within the two- wheeler segment, except for motorcycles, Le., scooters, mopeds and electric two wheelers, posted a growth of 8.4%, 3.4% and 38.4% y-o-y, respectively. The electric two-wheeler segment recorded the highest growth rate, although on a smaller base of less than 1 % of the total segment, indicating a shift in the demand toward fuel-efficient vehicles, The growth in scooter sales was fuelled by new launches and the growing demand for scooters without gears, primarily from new customer segments, including working/salaried women and older people. Since motorcycles form 78% of the total number of two wheelers sold, the segment could post a mild growth of 1.3%.

 
Over the years, the distribution network in rural areas has increased with 70%~80% of overall dealerships in cities other than the top 20 cities. This is also reflected in motorcycles parc now over 55% in rural areas, based on the latest estimates.

 
To leverage the potential, two-wheeler manufacturers have increased their focus on rural areas, which has helped the segment maintain a moderate growth. The growth in sales in rural areas is driven by the rise in agricultural income, given a good monsoon as well as the government increasing the minimum support price. Further, rural markets are relatively decoupled from factors such as the global slowdown, and the number of cash purchases is very high.

There were some new models launched by players during the year to create excitement in the market. Some launches were in the high performance bike segment to target the "hobby riders." TVS Motor's "Apache," and Suzuki's "Hayabusa" and "Intruder," priced at INR1.25 million, and Yamaha's "Super Sports" and "Torque Sports," priced in the range of INR1.05 million, were a few launches in the premium motorcycle category. Italy-based Ducati entered the Indian two-wheeler segment with the launch of a number of products in the range of INR1.5-5 million. However, sales in urban areas have been impacted by non- availability of credit as well as a weak employment outlook.

 
Exports in the two-wheeler segment from April to January 2009 increased by 30.5% y-o-y. Motorcycles with engine capacity between 125cc and 250 cc recorded the highest growth in exports at 34.9%, followed by motorcycles with engine capacity between 75cc and 125 cc at 32.6%. Export of mopeds and motorcycles with engine capacity above 250 cc recorded a y-o-y decline of 61.7% and 25.9%, respectively. Players in the segment are looking at increasing their focus on exports and plan to scale up their product offerings. However, a larger dependency on exports could be a big risk in this global slowdown.

Three-wheelers

The three-wheeler segment reported the second-highest decline (after CVs) in the industry. From April to January 2009, domestic sales in the segment declined by 6.5% y-o-y. Within the segment, the passenger carrier segment grew by 12.3% y-o-y, while the goods carrier segment declined by 39% y-o-y due to increasing replacement by sub 1-tonner LCVs.

 
Exports in the overall three-wheeler segment increased by 10.9% y-o-y from April to January 2009, driven by a higher quantum of exports in the goods carrier segment, which rose by 66% y-o-y. Exports in the passenger carrier segment also reported an increase of 10.6% y-o-y during the period. As in the other segments, three-wheeler manufacturers have also increased their focus on exports. TVS Motor plans to scale up its product offering in the export segment by launching its three-wheelers in international markets.

Auto Components

In line with the slowdown affecting the automobile sector, the Indian auto components sector has also seen its growth rates coming down from over 20% during 2002-08 to a single digit figure in the current financial year. There have been significant investments in manufacturing capacities in the industry to keep pace with the booming demand in the last five years. This additional capacity that has been created has become a big challenge today. The slowing down of domestic automobile industry and declining exports due to low demand from global markets has resulted in a number of small ancillary units being under severe financial stress.

Auto component players are facing challenges in terms of falling demand and a severe liquidity crunch due to delayed payments from OEMs. Banks are cautious in extending even working capital requirements to component players. Their order books have recorded a 40-60% drop in the case of domestic automobile manufacturers. To survive the slowdown, auto components players have also resorted to production cuts, temporarily shutting down their plants, laying off employees, reducing costs and opting for deferred planned investments.

Companies that have large international exposure, with subsidiaries operating in markets outside the country, are facing a margin squeeze due to the poor performance of their subsidiaries, with low-capacity utilization, as OEMs in western markets are severely impacted. Moreover, the cost structure in western countries, especially wages, are significantly higher when compared to India. With CVs being the most badly affected, companies with a wide exposure to the CV segment are expected to be the worst hit.

Estimates suggest that approximately 50 auto component players, along with their tier-I suppliers, supply components worth USD1 billion to North America, Western Europe and Japan (often called "the Triad"). Of the share exported to North America, General Motors, Ford and Chrysler and their tier-1 suppliers account for 70% by value. In recent months, the demand for their vehicles has come down considerably, which, in turn, is expected to adversely impact the Indian supplier market. During FY09, exports are estimated to amount to USD3.8 billion, but the outlook for next year remains uncertain.

Outlook

2008 was a year of crisis globally. All major markets of the world - financial, commodity and housing - crashed. And this scenario is not going to be reversed very soon. According to the estimates of the World Bank, there will be de-growth in all the developed economies of the world. While some players may go into bankruptcy, relatively stronger ones will opt for restructuring and consolidation.

 
Growth is likely to be led by BRIC countries, which are expected to be more resilient and thus recover faster.

Within the automotive domain, all the developed economies of the world, including the TRIAD, are going to post lower numbers in 2009, as compared to 2008. China and India are the only major automobile markets, which are expected to show some growth, although moderate.

In the Indian context, the automotive industry is expected to see a number of changes across different parts of the business.

▪	Lowering of the break-even point to improve profitability in an unstable demand environment in 2008 has brought an extensive and intensive focus toward efficiency and productivity. All players are working their plans around this theme for the coming year. Inventory is under tight scrutiny and its management is going through a thorough change with concepts such as "Just-in-time inventory" picking up.
▪	Given the liquidity crunch and an uncertain outlook, postponement of capital expenditure is highly likely with players spending only the requisite amount to sustain their business operations. Even their spend on research and development is expected to see some downsizing.
▪	In the marketing arena, there is a squeeze expected in advertisement and marketing budgets. There will be more focus on direct marketing activities. Discounts and other incentives are expected to be continued to boost sales.
▪	We are likely to see the increased involvement by OEMs in consumer financing of autos. Several players are considering entering the space with captive auto finance companies. Others are adopting measures such as tie-ups with a large number of financiers to improve availability of credit for their customers.

 
Despite the slowdown, new models have been able to garner good volumes. A look at the product launch calendar shows a busy schedule ahead for 2009. Starting from the iconic brand Nano that is expected to hit the road very soon, there are several other offerings across segments to cater to the varied needs of consumers. Among compact cars, the launches will include a Jazz variant (Honda), GrandePunto (Fiat) and Ritz (Maruti Suzuki). There will also be new offerings from luxury car makers Mercedes, BMW and Audi.

There are to be a significant number of launches in the alternative fuel segment as well. Many players such as Maruti and Mahindra Renault are planning to introduce their existing models with a factory fitted CNG kit to offer the benefits of lower running costs together with safe fitments. Companies in niche segments, such as Electric Vehicles, are also going to launch more models.

On the policy front, the Government of India and the RBI are playing an active role in helping the industry fight this downturn. To give a boost to overall manufacturing activity in the country, the Indian government announced a fiscal stimulus package In December 2008 and in January 2009, which, among other things, offered a 4% reduction in the CENVAT rate. There has been a further reduction of 2% in the CENVAT rate post the interim budget in February 2009, with an objective to further stimulate demand.

Exports are expected to be under pressure amidst the fall in global markets. However, the silver lining is expected to be the increase in the demand for small and fuel-efficient products worldwide, which will offer a great opportunity to the Indian automotive industry with its low-cost and fuel-efficient product range and manufacturing capabilities.

In the domestic market, two wheelers are expected to outperform in the sector while CVs will continue to face challenges waiting for the economy to revive and witness increase in industrial activities. As per general consensus in the industry, expected growth rates in India for FY10 are as follows:

Segment	Growth
Two Wheelers	3% - 8%
Passenger vehicles	0 - 5%
Commercial vehicles	-8% to - 13
Three wheelers	0 - 5%

 
2009 has come with some early signals of improvement in domestic consumer spending, which is a result of the measures taken by the government along with the initiatives taken by the players. Sentiments have improved at the retail level, but need to be sustained at these levels in coming months for the scenario to be considered a definite recovery.