Auto sector momentum may slow as stimulus packages vanish

The auto industry, which has been showing signs of a revival in the past few months thanks to the general economic recovery, availability of easier financing and the government’s stimulus package, may face a bumpy ride in the next few months.

The end of the “scrappage” scheme in Europe in December, the change in emission norms in April 2010, and the likely roll-back of the excise-duty cuts announced as part of the stimulus package are significant obstacles in the way.

The scrappage scheme — launched in April 2008, under which someone trading his old car for a new one gets a sizeable discount on the new vehicle — has played a key role in the revival of India’s exports in recent months.

It has been particularly helpful for auto majors like Maruti Suzuki and Hyundai, which earned a sizeable chunk of revenues from European markets. Jamshed Dadabhoy, analyst with Citigroup, said Maruti is potentially at risk, given that it will export around 100,000 units of the A-Star in FY10 to European markets. “In its 2QFY10 results conference call, the company management had noted that the FY11 exports outlook remains difficult to predict, given a) exports to the EU were buoyed by fiscal incentives (mostly end Dec 09), and b) non European market sales have yet to recover meaningfully,” the analyst said.

“Maruti exports to 18 EU nations - which will account for 90% of A Star exports in FY10. FY11 export estimates are pared to 150,000 units from 170,000 earlier,” Dadabhoy added. Similarly, Europe accounts for 70% of Hyundai’s exports. The company exports i10 and i20 to seven European countries.

To tackle the problem, both companies have started exploring non-EU markets.
A Maruti spokesperson said the company has started to export to non-EU markets in the last 2-3 months. “Export of A-star also started to non-European markets and neighbouring countries like Bhutan and Nepal in this phase. Prominent non European markets for A star are Algeria, Angola, Saudi Arabia, UAE, Morocco, Libya and New Zealand. The numbers are, however, very small.”

Hyundai is also looking at south-east Asian countries and Australia. “At this point the non-EU markets are very small. In Australia we have managed to sell around 20,000 units,” said a Hyundai spokesperson.

The introduction of Bharat Stage IV (BS4) emission norms in 11 cities from April 2010 is another concern area for auto companies. The norms will need a change in fuel and engine technology to meet the stricter emission standards, which will in turn push up costs.

Dadabhoy said the impact of a change in emission norms is probably the most benign over a longer-term basis. “But in the year when the standard changes, emission norms result in significant volatility in sales over a 2-3 quarter period — acceleration in sales before the norms kick-in (the pre-buy), followed by a period of soft sales as the trade absorbs the impact of higher-cost vehicles”.

“Oil refineries’ inability to supply the appropriate grade of fuel typically results in the implementation being delayed by 3-6 months. This, in turn, results in vehicle shortages, especially if vendors have stopped supplying critical engine parts for the older emission norm vehicles,” he added.

Dadabhoy noted that the impact is most pronounced for commercial vehicles (especially the heavy trucks), and is lower for light trucks and passenger cars. Tata Motors, the largest commercial vehicle manufacturer in the country, expects some pre-buying demand. “But we do not see any impact on the overall FY2010-11, given the growth impetus in the economy. Tata Motors does not comment on pricing. The company will take appropriate decisions, depending upon emerging factors,” a Tata Motors spokesperson said.

The company also stated that there will be no issues with respect to availability of spare parts. Pawan Goenka, president (automotive) of Mahindra and Mahindra, which has already launched a BS 4 compliant Scorpio and is set to roll out medium and heavy commercial vehicles from its joint venture with International Trucks Ltd, said prices of its vehicles will be more representative of the market once the emission norms become applicable.

The BS 4 Scorpio costs about Rs 10000-20000 more than the latest “refreshed” model (priced at Rs 7-9.5 lakh). The auto industry is also hoping that the excise duty benefit (reduction from 12% to 8% for vehicles below 1500cc) that it received from the government in January this year would not be rolled back. Moreover, they are wary of a rise in input costs as steel and rubber prices increase.

Most players have cut prices by 3-4% to pass on the impact of lower duties and costs. Margins in 1HFY10 have been boosted (by 300-350 bps, according to Citibank estimates) owing to the benefits of lower input costs. “In FY11, we think there is a fairly high probability that margins will be impacted by the twin effects of a) higher input costs, and b) higher excise duties,” Citi’s Dadabhoy said.

Companies intend to pass on the impact of higher costs on to the customer. “Beyond a reasonable level if we cannot take the burden of the cost it will be passed on to the end consumer,” Goenka said.