Indian Passenger Vehicle Industry: Growth Momentum To Continue

ICRA Rating Feature

Summary

▪	With sales of over 2.5 million passenger vehicles in FY11, India's passenger vehicle market ranks as world's seventh largest; larger than markets like United Kingdom, France and Spain by volume.
▪	India has been one of the few markets globally to buck the recessionary trend and record a strong 25.6% volume growth in FY10. The growth momentum continues to be on track with first eleven months of FY11 registering a growth of 29.8% over the corresponding period in the previous year.
▪	Strong economic growth, rising disposable income levels, favourable demographics, easy financing environment and relatively low car penetration have been the prominent growth drivers for the industry.
▪	While at the one end, the growing domestic market is attracting foreign OEMs, on the other, established players are positioning themselves as strong contenders to offer low-cost car manufacturing capabilities to the world.
▪	So far, most foreign car makers, barring Hyundai focused on the sedan and premium segment cars, shying away from the highly competitive small-car segment; with these players now launching small-cars that too designed keeping in mind specifically the Indian consumer, the small-car segment, which has so far been dominated by three players commanding over 80% of the volumes is likely to see increase in competitive intensity.
▪	Some of the newly launched models have had good initial response and have been aggressively priced, indicating new entrants' strategy to grab market share while sacrificing profitability.
▪	Large established incumbents in the Indian passenger vehicle market derive strength from their low-cost manufacturing capabilities (especially in the small-car segment), strong brand recognition and wide distribution & servicing reach, something, which can be difficult to replicate.
▪	We believe, while the incumbents will have these competitive advantage over newer entrants, these are likely to diminish in the long-run as new players with global experience gain brand recognition and expand their network and product offerings.
▪	Superior small-car portfolio, a wide distribution and service network and competitive pricing on the back of locally sourced auto components are going to be the key factors in determining the success of a foreign OEM in the Indian market.
▪	While competitive pressures are likely to intensify, we believe that strong GDP growth, rising disposable income levels, easy availability of finance and more particularly Indian consumers' aspiration to own cars, especially, given the state of public transport, would ensure that the industry will experience strong growth in the foreseeable future.
▪	We estimate the Indian passenger vehicle industry will reach ~4.85 million in annual sales by FY16, representing a growth of 10.8% CAGR over the next five years.
▪	Notwithstanding the strong long-term outlook, the industry faces certain near term challenges in form of rising commodity prices, interest rates, tightening liquidity scenario and increased competitive intensity.
▪	We believe that rising labour costs is also likely to see cost increases across the supplier network, though it is likely to be mitigated by greater scale economies and higher degree of automation.
▪	Within the lower priced segment (mini/compact), the price band is widening, with higher priced but better value products achieving higher volumes than some of the lower priced models. The price range may widen further depending on the success of the 'Nano' segment.

 
Strong growth drivers augur favourable prospects for the Indian passenger vehicle market

The domestic passenger vehicles industry has been on a relatively steady growth phase over most of the last decade and has registered a CAGR of 10.3% during the period. It has been one of the few markets worldwide, which saw growing passenger car sales during the liquidity crisis and recessionary phase witnessed during FY09. Buoyant economic growth, rising disposable income levels, favourable demographics, strong growth from tier I I/lit cities and rural India, together with improving availability of vehicle financing at competitive interest rates have been the key factors fuelling growth in the Indian passenger vehicle market. Among the emerging markets, India continues to have one of the lowest car density, estimated at 13 cars per 1,000 people compared to other markets such as China (45), Brazil (160), and Indonesia (42). The growth has also been supported by OEM led initiatives like whole host of new model offerings from both from existing companies as well as new entrants in the market. Furthermore, in India, the car prices have remained relatively flat over the years (adjusted for the decline in duties) compared to steadily rising per capita income levels.

In addition to the strong domestic demand, the OEMs have also been positioning themselves as competitive small-car makers, benefitting from India's technological capabilities in the manufacturing small-cars, scale economies and a well-established component supplier base. Over the past 10 years, export of vehicles have grown at a CAGR of 31.7% to achieve volumes of 0.45 million units in FY10. ICRA expects overall growth momentum to be sustained driven by strong domestic demand and increased thrust on exports.

 
 
Steady economic growth and favourable demographic profile - Barring marginal blips during the last couple of years, the Indian economy has moved into higher growth (8.5%+) trajectory, which is likely to be sustained over the medium term. In addition to steady economic growth, the passenger vehicle industry is also benefitting from India's favourable demographic profile, which is reflected by its very young population (50% of population under the age of 25), steadily improving dependency ratio, growing urbanisation and trend towards smaller, nuclear families. These trends in turn results in higher savings and increased ability to purchase vehicles, as well as explaining the preference for smaller cars.

In addition to favourable demographic profile, rising per capita GDP levels is also resulting in improvement in vehicle affordability in India, which is estimated to amongst the lowest when compared to other major automotive market. In India, the per capita GDP has almost doubled to US$ 3,270 between 2000 and 2009, while car prices (adjusting for the decline in duties) have remained almost at the same level, as they were five years back, thereby, increasing flexibility to own cars.

Relatively low-penetration levels - In terms of current market size (estimated at ~2.5 million units in FY11), the Indian passenger vehicle market is relatively small compared to other emerging auto markets like China, South Korea and Brazil. Despite strong growth witnessed for a nearly a decade, penetration of cars in India continues to remain the lowest (refer to table above) among emerging markets. As growth in passenger vehicle has been more secular in nature, supported by both major cities and tier It/ III cities, we expect that car penetration levels would continue to improve mirroring the trend witnessed by some of the other markets, particularly China, which witnessed 5x increase in car density between 2002 and 2009.

 
Availability of finance at competitive rates - With over 65-70% of cars being financed in India, availability of financing options at competitive rates has also been one of factors driving growth. In India, the vehicle financing penetration has been steadily rising over the years, facilitated by competition amongst banking and NBFC participants. In comparison to China, where vehicle financing rates are much lower (~10-15%), India scores in terms of higher vehicle financing availability, which combined with increasing disposable income levels provides an ideal platform for strong growth going forward. Barring few instance of rise in interest rates, vehicle-financing cost has declined over a longer period of time supported by favourable interest rate regime and relatively healthy performance of the asset class amongst various consumer finance categories. This has also encouraged lengthening of tenure of financing and LTVs, further, facilitating consumer flexibility.

Favourable demand scenario from smaller towns and rural areas - In addition to demand from urban areas, smaller towns and rural India have been incrementally driving demand for passenger vehicles in India. For instance, the share of sales from top-10 cities has fallen to 40-45% from 60%-65% over the last five-to-six years. Maruti Suzuki, also for instance, now generates nearly 19% of its sales from non-urban areas compared to just 4-5% about five years back. This has largely been prompted by rising disposable income levels in smaller towns and rural areas, improving road connectivity and higher no. of earning members in the family. Industry estimates suggest that approximately 60% of the rural economy now depends on non-agricultural income such as trading, remittances from cities, employment in the manufacturing sector etc. That apart, substantial increase in crop prices, which has been moving up over the past three years, has also resulted in higher disposable income. Additionally, the increase in land prices across the country, and the implementation of the sixth pay commission has collectively helped in supporting the growth in the rural and semi-urban cities/tier III cities. The OEMs have also helped expand demand by targeting these markets with greater financing availability and better service & distribution reach.

India is likely to emerge as a small-car production hub

In addition to strong domestic demand, India is well on its path of becoming a global production hub for small-cars. In 2009, it surpassed Japan to become the largest small-car market in the world, accounting for the sale of around 900,000 small-cars, as compared to 700,000 sold in Japan. India is also now the second-largest exporter of small cars, behind only Japan. In FY10, India shipped out nearly 450,000 vehicles, registering a CAGR of 26% between FY06-10. Exports now form a considerable part of the Indian industry, accounting for 18.6% of the total PVs sold in FY10, compared to 7.3% in FY02, with small cars comprising over 90% of total passenger car exports in FY10.

 
The growth in export volumes was particularly strong in FY09 and FY10, benefitting from the demand arising largely from scrappage schemes offered by most European nations. While the export growth in the current year has been affected by higher base effect and repeal of scrappage scheme, the long-term prospects continue to remain strong. While Hyundai Motors and Maruti Suzuki are leading exporter accounting for over 90% of export volumes, other global players who have recently marked presence in India are pursuing opportunities to make India as their manufacturing hub. Nissan is expected to start exporting Micra to Europe. India has become the largest export hub for Hyundai (outside Korea) with over 40% of its small car production catering to export demand from India.

 
 
What it takes to become a global automotive production hub?

In addition to low-cost manufacturing capabilities, other factors that determine a country's competitiveness in emerging as a global production hub include an attractive domestic market, its government's favourable trade policies, presence of an established and technologically-advanced component supplier base, an efficient supply chain and movement in exchange rates. 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. However, poor infrastructure, resulting in higher logistics costs and changes in international duty agreements (i.e. FTAbetween Korea and EU) with competing manufacturing locations remain a significant factor in determining export potential from India. However, increased focus on fuel efficiency and international demand moving towards small-cars also augurs well for India. The industry is also witnessing a trend towards alliances or platform sharing in the exports segment.

 
Considering the auto makers quest for lower production cost, we expect India to compete increasingly with countries across markets that offer lower production costs and benefit from favourable government policies. Some of examples of nations that are likely to compete with India are Thailand and Indonesia (for exports to Asian markets), Czech Republic, Slovakia and Poland (for European markets), and Mexico (for North American markets).

Interestingly, China which has emerged as the world's largest automotive markets in the last decade is yet to establish itself as a global production hub, something that Japan achieved during the 1970s and South Korea in 1990s when these markets witnessed an upsurge in automotive production. In contrast to India, ownership restrictions in China make its less attractive for foreign OEMs to develop it as an export base - though China's robust domestic market has attracted a large number of joint ventures and contributes to ~50% of domestic capacity. However, several local Chinese manufacturers are now fast acquiring global scale and skill levels and have aspirations to establish strong presence in the developed markets.

Competition set to rise in the small car segment; higher priced small-cars gaining traction

The strong growth reported by the industry and critical mass that achieved by the domestic market has attracted most of the global OEMs to the Indian market. Most global OEMs targeting India now have strong local strategies, India specific platforms/models, and view to establish India as one of their sourcing hubs. In terms of product launches in India, OEMs are now developing models specifically to meet Indian consumer's preferences and market conditions compared to the past, where most global majors have chosen models from their existing platforms. Toyota's Etios and Honda's Brio (to be launched) are some of models that have been developed clearly keeping the Indian consumer in mind. Over the past two years, nearly 50% of the capacity addition has been by international OEMs. Barring Hyundai, foreign OEMs such as Toyota, Honda, Ford and General Motors have so far been present largely in the mid and upper end segment cars while shying away from the highly competitive small-car segment. However, recognizing the significance of entry level in India, now almost of all the OEMs including the recent entrants such as Volkswagen and Nissan are focusing on tapping the high volume small car segment in India.

The number of new model launches has increased substantially, particularly, in the higher priced/premium end of the segment. Being the largest segment by volumes, the small-car segment has witnessed the highest numbers i.e. 11 new launches in the last three years (of which five were launched in 2010) with major ones being Ritz, A-Star, Zen Estilo (from Maruti Suzuki), HO, 120 (from Hyundai), Indica Vista (from Tata Motors), Ford Figo, Chevrolet Beat, Polo (from VW) and Etios (from Toyota). In the near term, Honda is also expected to enter the small-car segment (with launch of Brio) and Toyota is expected to launch the hatchback version of Etios.

 
The new models viz. Ford's Figo, VW's Polo, and GM's Beat have made some inroads in the market with good initial response, while other players such as Nissan and Toyota with their recent launches are in the ramp-up phase. More importantly, the new models have been priced at fairly aggressive price points and as new entrants ramp up their volumes and other players enter the market, we expect that the small car segment is likely to see some fragmentation with incumbent players likely to face competitive pressures. Further, General Motors' plans to introduce cars from its Chinese JV with SAIC also marks the beginning of a new trend, which could result in more Chinese players enter the Indian market in the long run. Apart from SAIC (along with GM), BYD, Chery International, JAC, and Brilliance Auto are some of the other Chinese automakers that have announced plan of exploring opportunities of entering the Indian market.

Small car portfolio and extensive marketing & servicing network key to succeed in India

Typically during the initial launch phase, new models gain market share owing to heightened interest among buyers but we expect that sizeable market share gain for new entrants will only be in the long-run as these players go through a phase of establishing recognition for their brand, expanding their distribution and service network. We believe that a wide product portfolio, competitive pricing, expectation of high fuel efficiencies, presence of diesel versions and modern designing have been some of the factors that have helped players to compete successfully in this segment. The market share of the new players in this segment has been steadily increasing; in the current year, barring the top three players, the share of other players now stands at 14.0%.

 
 
Supported by efforts to increase localisation...

Interestingly most of the international OEMs, barring the established ones have had volatile earnings profile in India. Low economies of scale, high import content and exposure to foreign currency fluctuation have been the key factors affecting profitability. 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. More particularly in the small car segment, where competitive pressures are relatively higher compared to other segments. Typically, localisation levels are low (during the launch phase) and increase gradually over the years with pick-up in volumes. While localisation appears to be a straightforward route in achieving cost competitiveness, it is only meaningful at large volumes, involving large investments in capacity building. M&M-Renault JV in contrast had adopted a low investment (higher import dependence) strategy with its initial launch, enabling it to test the market response with limited investments. Besides cost advantage arising from lower duties and logistics costs, localisation also helps in reducing fluctuation arising on account of currency volatilities.

In terms of technological positioning, although the Indian auto component manufacturers may lack design know-how in certain product categories, their overall capability in manufacturing auto components, with consistent quality and reliability is now well acknowledged by global OEMs and component manufacturers alike. This is evident from the trend of increased localisation levels in most new models. Additionally, most auto global players are setting up capacities to locally develop and manufacture engines & transmissions in India with vendor development forming a key part of their strategy. Some of the international auto suppliers by virtue of their established vendor relationship with international OEMs have also set-up JVs with local players, benefiting the domestic auto suppliers with new technologies/platforms. Some of the OEMs have also set up their R&D centres in India, which are at present confined to providing basic localisation of imported components and research services.

New small car entrants also have aggressive dealership expansion plans

 
Most of the new small car entrants have aggressive plans to expand dealerships in coming years. However, we believe that incumbents' wide distribution and service network will act as their competitive advantage for some time to come as attracting new dealers for new players will not be easy. Typically, a dealer generates 60-70% of its income from car servicing and spares and with current vehicle population in favour of the top three players, OEMs will have to structure their sales commissions appropriately to attract investments by dealers.

(To be continued in the next issue)