A Short Slide

THE AUTOMOBILE SECTOR, HIT HARD BY DEMONETISATION AND BS-IV RULING IN 2016/17, MAY SEE SHORT-TERM VOLATILITY DUE TO GST.

The automobile sector, hit hard by demonetisation and BS-IV ruling in 2016/17, may see short-term volatility due to GST

In the April-June quarter of the current financial year (FY2017/18), the automotive sector in India was expected to bleed for two key reasons. First, a drop in prices was on the cards post the launch of the Goods and Services Tax ( GST) on July 1 and buyers decided to stay away from the market till it happened. Second, auto dealers could not avail of input tax credit on stocks existing before July and, hence, companies were offering huge discounts, resulting in margin pressure. Short-term demand issues persisted. As per data from the Society of Indian Automobile Manufacturers ( SIAM), sales across the overall commercial vehicles segment declined by 9.1 per cent in the June quarter compared to the year-ago period while threewheeler sales stumbled by 24.75 per cent. However, sales in the passenger vehicle segment grew by 4.38 per cent during the quarter.

In some respects, the SIAM figures for the June quarter followed the broad trends of the previous financial year ( FY2016/ 17). At the time the sector struggled against some major drawbacks – demonetisation in November last year and the Supreme Court’s ban on selling Bharat Stage III ( BS III) vehicles beyond March 31, 2017, as the country tightened its emission norms. The effect of GST, a standardised tax system, should be temporary, experts say, but nobody knows just how big or lasting it will be.

A Painful Past

Till the time of going to press, auto companies had not filed their first quarter results for 2017/18, but a performance analysis of the 13 listed companies that broadly cover the key segments, including commercial vehicles, passenger vehicles, two-wheelers and three-wheelers, affirm their continued plight. Overall, this basket of companies saw an 8.4 per cent decline in net profit year on year in the March quarter of 2016/17, the sharpest fall since March 2013. Net sales during the period saw a year-on-year growth of 6.8 per cent on a standalone basis.

A closer look at the data reveals that Tata Motors, which had posted losses over the last three quarters in 2016/17 on a standalone basis, had a bearing on the combined bottom line of the commercial vehicle industry, which also reported net losses in the March quarter. During that quarter, Tata Motors’ commercial vehicle segment saw muted demand due to weak replacement growth and subdued freight demand. If we remove Tata Motors from the bunch, the aggregate looks different, but the outcome remains the same. Operating profits of these companies, exTata Motors, have been declining for the last two quarters of 2016/17 and growth went into negative territory for the first time in the past 12 quarters. Net profit margins declined around two percentage points in 2016/17.

Commenting on the scenario, Rohan Korde, a research analyst with Prabhudas Lilladher, says, “The third quarter performance [2016/17] of the auto sector was adversely

impacted by demonetisation, which hampered retail demand initially. The fourth quarter performance was affected due to the discounts given to sell BS-III vehicle inventory and the ancillary cost/provision related to the conversion of BS-III vehicles to BS-IV- compliant models.”

In the first two quarters of 2016/17, the auto industry saw an average growth of 11 per cent in overall sales. “The second half witnessed improved consumer sentiments post the seventh Pay Commission’s recommendations, normal monsoon after two successive years of deficit rainfall, lower financing costs, affordable fuel prices and healthy replacement demand due to diesel car ban. The industry was about to pick up speed when demonetisation was announced on November 8. This led to negative growth in the auto industry during December 2016,” says Darshini Kansara, a research analyst with CARE Ratings.

For the full fiscal of 2016/17, these companies witnessed a single-digit growth of 4.3 per cent in net sales compared to 13.5 per cent growth in 2015/16. The bottom line was squeezed by 4.2 per cent in 2016/17 as against 7.2 per cent in 2015/16. Operating margins also came down around two percentage points over the last three fiscals.

But the so-called ‘shrink’ does not worry the likes of Sugato Sen, Deputy Director General at SIAM. “Most of the segments would grow in 2017/18 once the market settles down,” he notes.

Left in the Lurch

While demonetisation hit auto sales, the apex court’s ban on the sale of BS-III vehicles after March left the industry with a huge inventory. Due to the Supreme Court’s ruling, automakers had two choices: they could either push sales in the next two days (the notification came on March 29) or export their stock.

As per CARE Ratings estimates, the industry had an unsold BS-III vehicles inventory of around 8.24 lakh units worth about Rs 14,000 crore as on March 29, 2017. Two-wheelers accounted for the lion’s share of unsold stock (6.71 lakh units), followed by commercial vehicles (96,700 units), three-wheelers (40,000 units) and passenger vehicles (around 16,198 units).

“Considering the average per-day sales for 2016/17 (April 2016-February 2017), the new inventory comes down to 6.84 lakh units in case sales were enhanced by two additional days’ volume of sales (March 30 and 31). It would reduce the inventory to zero for the passenger vehicle stock. However, the cost of the unsold inventory of commercial vehicles, as well as two- and three-wheelers, would be around `12,500 crore as on April 1, 2017,” says Kansara of CARE Ratings.

According to CARE Research, for manufacturers or dealers, the cost of working capital (taken at 10 per cent) is calculated to be `1,250 crore per annum. If the players export the remaining stock, it will take about 10

months to clear the commercial vehicle stock and about three months to clear the two- and three-wheelers stock (considering the category-wise monthly average export sales in 2016/17). Therefore, the additional cost of holding the inventory post the ban would be about `105 crore a month. The normal holding period of stock is about one month and, hence, the additional holding of stock would mean around `800-1,000 crore as interest cost, assuming all this stock would be exported in some time. There is another catch. With the BS- IV norms coming into effect, the cost of production and, therefore, prices are expected to go up, which could impact overall demand.

Segments Falter

The two-wheeler (79 per cent market share) and the three-wheeler segments were the worst hit during the March quarter. Net sales were down by 4.3 per cent, and growth in operating profits plunged to a 20-quarter low. Operating expenses, as a per cent of net sales, inched up 60 basis points over the last four quarters of 2016/17. On a standalone basis, Hero MotoCorp, the largest company in this segment, saw its revenue decline 0.3 per cent year on year during the March quarter while Bajaj Auto’s revenue fell by 3.7 per cent. In contrast, the revenue of Eicher Motors (the fourth biggest) increased by 38 per cent, backed by some robust growth in Royal Enfield sales.

“The fourth quarter [of 2016/17] came against the backdrop of demonetisation, and the two-wheeler segment is one of the most cash-dependent products. The financing part is quite low, sometimes as low as 30 per cent. So Q4FY17, from a demand perspective, had an adverse impact,” says Nishant Vass, AVP, Equity Research, and Research Analyst, Autos, at ICICI Securities. At the same time, commodity prices were going up, putting pressure on margins. “There was also a one-time impact of BS-III ruling, which led to a massive clearance on the last day or so from the inventory remaining with the dealers. The companies took a one-time impact on their profit-and-loss accounts for compensat- ing the dealers,” he adds.

In sync with the overall trend, the commercial vehicle segment saw a decline of 28.8 per cent in operating profits in the March quarter as raw-material expenses increased by 9 per cent, outpacing sales growth. As mentioned before, Tata Motors hugely impacted the profitability of the segment. The company had an unsold BS-III inventory of 15,000 units worth `4,000 crore, and plans to export a part of it. Even if we exclude Tata Motors, the profits of this segment fell by 12.2 per cent and 7.1 per cent, respectively, in the last two quarters of 2016/17.

Passenger vehicles fared better with 13 per cent rise in net sales and profit growth of 17 per cent. Maruti Suzuki registered a significant growth of 35.6 per cent in net sales and 50.6 per cent growth in net profits year on year on a standalone basis. Most of the passenger vehicle makers have shifted to producing BS-IV- compliant models since the past two-three quarters,

says Kansara.

Recovery Ahead?

All is not doom and gloom in the auto segment. For one, the industry has welcomed the compliance requirements to be followed and is working accordingly. Vass of ICICI Securities thinks consumers have come back, but obviously, uncertainty [regarding pricing and taxation] will not help. However, BS-III ban was a policy decision that caught everybody unawares, and it had an impact.

“Because of GST, vehicle prices will come down by 3-4 per cent, and the price benefits will be passed on to consumers, which will push demand,” says Abhishek Jain, senior analyst with HDFC Securities.

Some of these are already happening on the ground. For instance, most automakers have ensured price cuts in sync with the new tax regime. Ex-showroom prices of Maruti Suzuki models have come down by up to 3 per cent while Hero MotoCorp is offering price reductions on mass-selling models ranging from `400 to `1,800. With prices coming down and technology being revved up – BS-IV compliance and leapfrogging to BS-VI by April 2020 are proof enough – the momentum is building, although slowly. ~

Additional inputs by Chanchal Pal Chauhan