Indian Passenger Vehicle Industry: Growth Momentum to Continue

ICRA Rating Feature

This is the second & concluding part of the report by ICRA on Indian Passenger Vehicle Industry. The first part of the Report published in the previous issue brought forth the following facts/observations on Indian Passenger Vehicle Industry, viz. -

▪	Strong growth drivers are in place to support demand and augur favourable prospects for the Indian passenger vehicle market;
▪	India is likely to emerge as a small-car production hub;
▪	Competition is set to rise in the small car segment; higher priced small-cars gaining traction;
▪	Small car portfolio and extensive marketing & servicing network key to succeed in India;
▪	New small car entrants also have aggressive dealership expansion plans;
▪	International OEMs entering volume segment are making efforts to increase localization for cost competitiveness and hedging against currency fluctuations.

 
The second part covers Demand-Supply scenario, Trends in JVs/collaborations, Favourable impact of impending GST rollout, Scenario with regard to UV segment, Competitive pressures and their impact on profitability, and Medium-Term Outlook for Indian Passenger Vehicle Industry.

Demand-Supply Scenario: Managing constraints at suppliers' end and finding enough skilled labour gaining priority over anything else

In line with the strong growth witnessed by the industry and strong prospects, capacity creation has been at the core of each OEMs strategy for the Indian market. In fact, at this stage, OEMs have been more concerned about managing production levels amid bottlenecks at suppliers' end and labour shortages. Given the capacity expansion plans, we expect capacity addition in excess of 50% between FY09-13. Between FY09-11 over 50% of the incremental capacities have been added by international OEMs who have entered the Indian market over the last 2-3 years. Although manufacturing capacities are fairly flexible, majority of the capacity creation has been keeping in mind opportunities in the small car segment and exports market. In the medium-to-long run, although strong domestic demand and export potential is likely to keep capacity utilization over 70%, we expect increasing competitive intensity to restrict the pricing power with OEMs and subsequently, put pressure on their profitability indicators particularly, in the current inflationary scenario.

 
Trends in JVs/Collaborations

Globally, the automobile industry is going through a phase of consolidation and collaboration, triggered by stagnating demand, industry-wide overcapacity, increasing commoditization/reducing pricing power and rising cost of implementing safety features and emission norms. As more global players enter the Indian market, the impact of this trend of partnership would be increasingly visible in this market too. Some of the active alliances in India include Fiat-TML (manufacturing JV and distribution sharing arrangement); Renault-Nissan (proposed facility share); SAIC-GM (Indian operation under JV, to bring products from SAIC stable), VW-Suzuki (likely collaboration in small car), Renault-Bajaj (small car). The number and scope of such alliances are expected to increase going forward as OEMs aim to rationalise their investments and maximise reach through alliances spanning technology, manufacturing and distribution.

Unlike the Chinese automotive market, where leading passenger vehicle players are mostly Joint Ventures (JVs) between global OEMs and local players due to ownership constraints, in the Indian context, most of the JVs in the passenger vehicle space have not been able to make meaningful presence in the Indian market. These JV entities have either parted ways or restructured their product portfolio and business plans to meet Indian consumers' preferences. In contrast, however, most of the Global OEMs now have a direct presence in India.

In addition to contract manufacturing, the industry is also witnessing other collaborative arrangements such as sharing engines/platforms and distribution and service network. For instance, Fiat's diesel engines are being used in some of Maruti Suzuki's and Tata Motors' cars. Similarly, Tata Motors manages the service and distribution facilities for Fiat in India. Furthermore, developments at global level, such as acquisition by Volkswagen's of 20% stake in Suzuki reflect some further potential collaborative arrangements given Volkswagen's increasing focus and Suzuki's strong presence in the Indian market. We expect such alliances to gain momentum driven largely by the need to access technology (as we move towards developing hybrid vehicles) and distribution and service network. However, at the same time, consolidation in the form of entire companies being acquired as has been seen globally is unlikely.

GST rollout to benefit the industry with reduced outgo

In addition to the fundamental factors driving demand, the likely roll-out of Goods and Services Tax (GST) would create one time spurt in passenger car volumes as the average duties would come down substantially (refer to table). At present, the effective tax rates (including excise duty, CST, and VAT) applicable on passenger vehicles range between 21-38% depending on the size of the car. With implementation of GST, we expect OEMs to pass on the benefit of lower taxes at least some extent to induce higher volumes.

 
Utility Vehicles Segment: New model launches likely to pick-up

With volumes of 275,556 units in FY10, the Utility Vehicles (UVs) accounted for little over 13% of the total market with growth averaging around 9% over the past five years. In India, the UV segment is primarily dominated by SUVs priced in the range of Rs. 7-11 lakh. In line with the passenger car segment, top three players in the UV segment account for over 85% of the market, of which two are domestic players. A sizeable part of the UV market also caters to the people mover segment, which has also been one of the key growth drivers striving on demand from the growing IT/ITES sector. In this segment, the industry is witnessing an increasing preference towards smaller MUVs such as Maruti Suzuki's Eeco for intra-city movement. More players are expected to launch models in this segment with major ones being Tata Motors' (Venture) and GM (through its collaboration with SAIC).

 
With the acquisition of Land Rover (by Tata Motors) and Ssangyong (by M&M), we expect Indian OEMs to consolidate their position in the UV segment with launches in the premium segment, leveraging on the platforms and technological expertise of the acquired entities. While Land Rover would largely cater to high-end segment, given the product profile, synergies with M&M's existing models, Ssangyong is likely to compete in the upper-end segment, which is currently dominated by GM's (Capitva), Ford's (Endeavour) and Honda's (CR-V). Both Tata Motors and M&M have expressed intentions not just to launch models from the foreign acquisitions in the domestic market but also pursue opportunities to locally assemble the vehicles. Similar to the passenger car segment, the premium SUV segment has also been of interest to the international OEMs with nine players entering the premium segment over the past six years.

Competitive pressures and cost-based headwinds to restrict profitability indicators

The profitability indicators of passenger cars OEMs is influenced by a confluence of factors with predominant ones being fluctuation in input material prices, manpower costs, competitive intensity in the underlying market impacting the ability to pass on cost increases, and volatilities in foreign exchange. For OEMs in India, in addition to fluctuation in key commodity prices, fluctuation in foreign exchange movement has also impacted profitability indicators of OEMs as almost all the players have some import content and some of them significant export dependence. In India, leading OEMs derive cost competitiveness from their economies of scale and relatively high localisation content backed by efficient supply chain system. The profitability of OEMs without a meaningful presence in the entry-level segment has been particularly volatile due to poor scale economies. In this context, some of the foreign players have had volatile earnings profile in their Indian operations driven largely by foreign exchange exposure, large one-time costs (related to platform development, marketing/launch expense) not being spread over large volumes and high import content. Now, with most OEMs targeting the highly competitive small-car segment, thrust on localisation of key components forms an integral part of international OEMs strategy to compete on cost.

 
Given the commodity-based headwinds being witnessed at present, rising labour cost (which results in cost increases across the supplier network) and limited flexibility to raise prices owing to increasing competitive pressures, we expect the profitability indicators of OEMs to remain under pressure. Although the impact of some these cost-based headwinds could be mitigated by greater economies of scale and higher degree of automation.

Outlook

The passenger vehicle market size in India is now comparable to some of the developed economies of the world and ranks seventh globally. The presence of global players, introduction of global platforms/technologies and stricter emission norms indicate that the market is gradually attaining maturity. A buoyant economic growth, growing middle class population, rising disposable income levels, relatively low penetration of cars and adequate availability of financing are likely to provide an ideal backdrop for a sustained long-term demand growth for the sector. However, with increasing interest from foreign players, competitive intensity is likely to become a key challenge for OEMs. With most major markets facing excess capacity and demand saturation, the Indian market is likely to remain a key destination for global majors over the medium term. With most of the international players eyeing the small car market, we expect the competitive intensity to increase in this segment resulting in greater fragmentation of market share, especially, over the long-term. Apart from pricing pressure that is likely to increase with competition, the rising quality expectations and tightening regulatory norms on emission and safety are likely to push up cost pressures on OEMs. We estimate that the Indian passenger vehicle industry will reach 4.86 million in annual sales by FY16, representing a growth of 10.8% CAGR over the next five years.

With global demand shifting to smaller cars, global players are likely to focus on strategies of producing cars of the same platforms in low-cost countries like India, Thailand and Mexico. In terms of cost competitiveness, India has built up the scale and significant competencies and cost advantages in the production of small cars. It benefits from lower development and labour costs, and improving auto component manufacturing base. Maruti Suzuki and Hyundai have already established meaningful presence in exports out of India, and now many other global players including Renault-Nissan, VW, Ford have either adopted strategy or are in the process of exploring opportunities to develop India as part of their global manufacturing hub. Interestingly, China, despite being known for its low-cost manufacturing capabilities and large automotive market supported by presence of international players, is yet to establish a meaningful presence in exporting cars, though the situation may change over the medium term, especially, considering rising capabilities and aspirations of its large local players.

With most of the global players targeting the most competitive, small car segment, increasing localisation remains critical for OEMs to establish profitable business given the competitive intensity in the small car segment. As a result, most OEMs are focused on increasing localization content to reduce costs and thereby, compete with market leaders. Additionally, auto ancillaries will have to ramp up their capital investment as OEMs continue to develop new platforms and increase their localisation contents.

Besides localisation of components, key challenges facing new entrants would be establishing a strong service/ distribution network, which has become increasingly prohibitive due to rising real estate costs in many markets. Going forward sharing and co-operation on distribution network and service facilities could play a significant role in rationalising cost structures. In terms of product launch, while most global majors are likely to choose from their existing portfolio for launch in India, key to success would be the ability to incorporate changes necessary to meet Indian preferences and market conditions.