Two-Wheeler Industry: Growth Drivers Intact

Two-Wheeler Industry: Growth Drivers Intact

ICRA Rating Services

This is the first part of lCRA's report on medium-term Growth Prospects of Indian Two-Wheeler (2W) Industry.

Overview


▪	The Indian 2W industry has shown a strong volume growth over the last two-years, having grown by 25% in 2009-10 and 27% in 2010-11 to reach 13.3 million units. This strong double-digit growth has been driven by multiple factors. One reason, of course, is statistical as this period of high double-digit growth has showed up after a rather sedate previous two years, when the 2W industry volumes had shrunk by 5% in 2007-08 and had grown by a mere 5% in 2008-09. In addition to the contribution of pent-up demand, the 2W industry growth over the last two years has been supported strongly by various underlying factors including India's rising per capita GDP, increasing rural demand, growing urbanization, swelling replacement demand, increasing proportion of cash sales and the less measurable metric of improved consumer sentiment.

▪	Going forward, ICRA expects the 2W industry to report a volume CAGR of 10-12% over the next five years to reach a size of -21-23 million units by 2015-16, as it views the fundamental growth drivers - comprising of expected GDP growth, moderate 2W penetration levels, favourable demographic profile, under-developed public transport system and utility quotient of a 2W - to be intact. Additionally, the entry of new players in the industry, multitude of new model/variant launches, growing distribution reach, cheaper ownership costs on a relative basis are expected to be some of the other prime movers for industry growth over the medium term. In ICRA's view, while the trend in rising commodity prices, hardening interest rates and increasing fuel costs may lead to some moderation in industry growth over the short term, the growth over the medium to long term is expected to remain in double digits.

▪	ICRA believes the landscape of the Indian 2W industry is set to evolve as several new players are keen to enter into the Indian market which would further intensify competition; most existing players plan to extend/ strengthen their reach into the rural and semi-urban markets to harness incremental growth opportunities; and manufacturers are showing increased thrust on new product development and repositioning to tap new customer segments. These dynamics would ensure that business does not remain as usual for the large incumbents as market share may change hands to some extent. Nevertheless, the existence of strong product capability, wide distribution network and established supply chain will continue to be the necessary conditions to sustain competitive advantage and achieve economies of scale.

▪	In view of the higher than expected demand last year, several OEMs had faced capacity constraints in their supply chain for select components which resulted in persistent demand-supply gap for few models, reflected in long waiting periods at dealers' end. To overcome supply constraints and also to gear up for meeting the continued buoyancy in demand, most players currently have plans to expand production capacity which would entail large capital expenditure (capex) both by OEMs as well as suppliers. While this may pull down the profitability metrics of industry participants over the short term, the anticipated strong volume growth should enable them to tide over the short term pressures and emerge with a bigger scale and a relatively stronger credit profile over the medium term.

▪	Also, ICRA views the current asset-light business model of OEMs as a key positive as most of the players source a majority of components from suppliers and in-house facilities are generally limited to component assembly (or manufacture of select parts). Thus, capacity expansion in existing facilities by OEMs is likely to involve only moderate incremental capex; although the quantum is expected to be much higher for OEMs who plan to establish greenfield facilities to augment existing capacity which may impact RoCE to some extent. Further, for suppliers engaged in capital intensive product segments like castings, forgings and machining, the payback is expected to be accomplished over a relatively longer time horizon.

Demand drivers for the 2W Industry

On one hand, growing economic well-being reflected in rising per capital GDP is likely to make 2Ws more affordable; on the other, various fundamental drivers such as low 2W penetration (in relation to several other emerging markets), favourable demographics, growing urbanization and swelling replacement demand are expected to enable the growth momentum to sustain over the medium term.

Rise in GDP per Capita has increased affordability of 2W

India's per capita real GDP growth of 7% (CAGR) over the last six years (refer Chart 1) has contributed substantially towards raising the standard of living of households, which in turn has been one of the key drivers of growth for the country's automobile industry. However, income growth is likely to have been uneven across the different income deciles. Income at the lower end of the distribution scale, which comprises the 2W target segment, is likely to have grown at a rate below the overall per capita income growth rate. Yet economic well-being has led to a significant increase in the number of households coming within the 2W target segment over the past few years. As per NCAER's estimates, the number of households having annual income between Rs. 200,000 - 500,000 is estimated to have increased to 22 million in 2009-10, a scale-up by a factor of 2.5x over 2001-02 (refer Chart2). Incidentally, this scale-up is almost similar to the expansion in the domestic 2W industry size (by volumes) during this period. Given that economic and population growth would further expand the universe of low to middle income earners who have the threshold purchasing power to buy a 2W, the pattern of healthy industry growth is likely to hold in the foreseeable future as well. Also, significantly, 2W purchase prices and operating expenses (inflation adjusted) are now around 36% lower than they were a decade back, considering that vehicle prices have not escalated much over the years, indicating increasing in affordability of 2Ws (refer Charts3).

Under-penetrated market as compared to other emerging markets to provide adequate headroom for future growth

Although India is the second largest 2W market in the world in terms of sales volumes (after China), the 2W household penetration level in the country is much lower at around 36% than in some of the other emerging markets such as Brazil, Indonesia, Thailand and Taiwan. Also, the penetration rates differ between India's rural and urban areas, with the rural areas being under-penetrated by a factor of 3x as compared to larger cities. That said, assuming that households having annual income less than Rs. 90,000 do not have the ability to own a 2W, the existing household 2W penetration in India in the addressable income segment of households (i.e. income greater than Rs. 90,000) is estimated to be around 74% (refer Table 1). Prima facie, this appears to be a large figure and suggests that penetration-driven growth may be difficult for the 2W industry to accomplish over an extended time horizon. However, the fact that in absolute terms there are still 28 million households at present in the primary target income segment that do not own a 2W, the scope for penetration-led future growth continues to be reasonably large. Additionally, the social trend in favour of nuclear families coupled with expected expansion of the target income segment pie going forward is expected to further increase the number of households which could be potential targets for the 2W industry.

Table 1:2W Penetration in India

(Figures in million)

2009-10

Total number of house holds

222

-Households (with annual income<90,000)

114

-Households (with annual income between 90,000-1,000,000

104

-Households (with annual income>1,000,000)

2W population in India

2W Penetration

Based on total number of households

36%

Based on addressable income levels

74%

The low to medium per capital income strata remains the primary target market for 2W OEMs, since the high income category is more likely to bypass the 2W mobility alternative altogether and graduate directly to cars.

As per estimates, the 2W penetration in the greater than Rs. 10,00,000 income segment is over 7.2%.

Favourable demographic profile to continue to feed the consumption cycle

A large youth population potentially offers a sizeable market for consumer products. India currently has a very favourable demographic profile with average age of 25 years, which is 9 years younger than China, and more than 12 years and 19 years younger than the US and Japan, respectively. As per ICRA's estimates (based on Census 2001 and Census 2011 data), around 33% of India's population of 1.2 billion (in 2011) belongs to the age bracket of 20-40 years. Within this, the population of males, which is the key target segment for motorcycles, is estimated to be 206 million (refer Table 2); and the population of females, which is the key target segment for scooters, is estimated to be 189 million, suggesting existence of large size of the addressable market. On conversion of even 20% of this youth population into 2W owners, a demand for ~80 million 2W (6.8x domestic 2Wsales in 2010-11) is estimated to get generated over the medium term.

Further, with the youth population estimated to increase to 229 million by 2015, a cumulative increase of 11% over 2011, the 2W consumption cycle appears strongly sustainable. This age group is also characterised by a combination of earning power and high spending propensity, which would increase the likelihood of conversion of potential ownership into actual ownership.

Interplay of growing urbanization and rising rural incomes augurs well for domestic 2W demand

As per Census definition, an area is classified as urban if it has a population of more than 5,000; has a population density exceeding 400 persons per square kilometer; and 75% of its male workers are engaged in a non-agricultural profession. Nevertheless, state governments have the flexibility to declare an area as urban for administrative purposes.

Urbanisation has drawn people living in India's rural and semi-rural hinterland to cities and towns at a steady pace (refer Table 3). The need for mobility in most Indian cities and towns, therefore, has increased substantially, yet the proliferation of public transport system has not kept pace. This is where the utility of a 2W as the most affordable mode of private transport comes to the fore. Empirical data suggests that there is a strong positive correlation between urbanisation and 2W demand, particularly in the initial stages of economic growth. For instance, 2W penetration in states like Delhi, Tamil Nadu and Maharashtra is much higher than the pan-India penetration due to the relatively higher degree of urbanisation in these states. With urbanisation expected to rise progressively, around 89 million people are estimated to be added to India's urban spaces over the next decade (78 million people are estimated to have got added over the last decade), which could potentially be one of the most defining changes likely to transpire. Especially so, since this would add fuel to allied drivers, including increase in proportion of working women and rise in wage and salaried people that is expected to have a strong positive impact on the demand for consumer durables.

In 2010-11, scooters accounted for 18% of total 2W domestic sales volumes (16% in 2009-10) of 11.8 million units.

Table 3 : Trend in Urbanisation in India

Figures in million	Rural Population	Urban Population	% Urban Population
1991 2001 2010E 2015E 2020E	629 742 819 853 879	217 286 358 401 447	25.7% 27.8% 30.4% 32.0% 33.7%

Source: Census 2001, Statistical Outline of India 2009-10

Further, to the extent the rise in urbanization is contributed by migration of people from rural and semi-rural regions, it would in turn support increase in remittances to the rural markets enhancing rural incomes. Industry estimates suggest that around 60% of the rural economy now depends on non-agricultural sources of income, such as remittances from cities, trading, and employment in the manufacturing sector. While the increase in crop prices during the last three years has left larger disposable incomes with rural customers, non-agrarian sources of income have also played an important role in supporting consumption by rural masses. The interactions between rural and urban centres could be part of a virtuous cycle, as cities have benefits beyond their boundaries. This is validated by studies which show that rural populations adjoining large urban centres have around 20% higher income than the rural average. Thus, the legacy of lower penetration levels in the rural market, scarcity of public transport infrastructure and the rising income levels would be positive triggers for rural 2W demand, going forward. At the same time, rising salary levels in urban areas, shortening replacement cycles, increasing traffic congestion in cities would be factors augmenting 2W demand in urban areas.

Replacement demand to be a key contributor to 2W industry volumes going forward

According to estimates, around 50% of the total domestic sales of 2W are now made to first-time buyers, 30% to customers looking to upgrade from their existing vehicle, and 20% to buyers seeking a second vehicle for the household. The break-up suggests that currently around 50% of the sales in the domestic 2W market are made to replacement buyers. Industry estimates also suggest that the 2W ownership cycle has now shrunk to less than five years. Considering that the industry has sold around 79 million 2W in the domestic market since the turn of the century, the total replacement demand works out to a fairly large number (refer Table 4). Add to this, the healthy growth in sales to first-time buyers in recent years, driven in particular by sales to the rural market, the replacement opportunity could only increase in the future.

Table 4 : Age Profile of 2W in India

	Motorcycles	Scooters	Mopeds	Total
> 10 years^ 6-10 years 0-5 years Total	11% 34% 55% 100%	42% 23% 35% 100%	55% 19% 26% 100%	22% 33% 48% 100%

^Refers to the period from 1983 to 2000-01
Source: SIAM, ICRA's Estimates

From the consumer perspective, although replacement involves fresh capital spending, the inducement of upgrading to an improved technology 2W, having better performance, features and more attractive styling; complemented with increased spending propensity are expected to be the prime ingredients feeding replacement demand.

To be continued