Sustainability vs profitability: Auto firms walking a tightrope

Amid a steep increase in input costs, auto firms will have to walk the tightrope and strike the right balance between demand sustainability and profitability.

While a price increase in the first month of the calendar year is a yearly phenomenon, what makes the current year different is the quantum of jump that prices of key commodities, including steel, rubber, rhodium and platinum have seen.

It comes at a time when sales have just started turning the corner after a protracted slowdown and recovery in some segments still remains patchy. Passing on the full cost increase, therefore, may not be prudent as it may dissuade buyers, who have just started opening up their wallets, said analysts and auto company officials.

The complexity of finding the right balance has made India’s top three passenger vehicle makers Maruti Suzuki India, Hyundai Motors India and Tata Motors delay the decision. But most other firms, including Mahindra and Mahindra and Kia Motors, have already taken a call on this. The three are likely to announce it in the coming weeks.

“Manufacturers have to walk a fine line of volume and profitability as we all have just recovered from a bad phase,” said Shashank Srivastava, executive director – sales and marketing – Maruti Suzuki India. Maruti will be announcing a price hike in the coming weeks. Last month, the company launched a price protection scheme for those booking cars till January 10. “A lot of models got sold out as people wanted to beat the impending price hike. The scheme was to ensure that we don’t let down our buyers,” said Srivastava.

Hyundai Motor India is also contemplating a price hike, which it will announce in a couple of weeks, said Tarun Garg, director sales, marketing and service. “Our effort will always be to keep the increase to the minimal. But it’s inevitable as one hasn’t seen this kind of hike in input costs in the recent past,” said Garg.

Maruti’s Srivastava said the increase in input prices is primarily being fuelled by strong inflationary trend seen in rhodium prices. It has shot up to $16,000 per oz from $2,000 per oz in a span of seven to eight months.

Demand for the precious metal has shot up since various countries switched to stricter emission norms. The catalytic converter is one of the key aggregates for Bharat Stage VI and Euro norms. The demand has outstripped supply, causing the prices to harden, added Srivastava.

Prices of key raw materials in international markets, a reference point for domestic prices, have seen sharp year-on-year (YOY) jump since the last eight months. Japan rubber prices soared 85 per cent YOY, while prices of China HR steel (per tonne) and LME aluminium have increased 34.6 per cent and 32.2 per cent, respectively. Even precious metal prices are up. Rhodium (dollar per oz) is up 63.3 per cent and palladium (dollar per oz) is up 5.3 per cent, according to Bloomberg data.

Mitul Shah, head of research at Reliance Securities, expects the sales recovery for auto firms to continue despite price hikes. The recovery, however, will come at the cost of margins. “Price hikes taken by most companies are around 1-2 per cent. This is not sufficient to cover commodity cost escalation, while it would provide some cushion to margin impact. We believe that auto makers would take price hike in a phased manner to pass on the full cost impact. This would restore their margins over the next 1-2 quarters,” he said.

In line with global prices, domestic prices also surged. Prices for October contracts for steel had seen an upward revision of 10-12 per cent, but between October and January, the difference between spot and contract prices is about ~17,000 and ~18,000 a tonne.

Normally, an average of sixmonths is taken as a reference point for contract prices and a steeper increase is likely when contracts are revised.

"Global steel prices in December 2020 were the highest in the last 7-8 years. This was driven by a robust recovery of demand in China coupled with soaring iron ore prices," said Isha Chaudhary, director at CRISIL Research. Spot domestic prices, however, are at a discount of 6-8 per cent to global landed steel prices.

“Requirements of auto companies are under six-monthly contracts. The new contract is effective from October after which there has been a huge rally in steel prices globally,” said Ranjan Dhar, chief marketing officer, Acelormittal Nippon Steel India. A steel producer pointed out that 100 per cent of auto requirements are covered under contracts. The list of vendors is provided by automakers.

Basic raw materials (metallic) for automobiles majorly consist of steel, pig iron and aluminium. Hetal Gandhi, director, CRISIL Research, said, “Although raw material cost accounts for 75 per cent of total operational cost, basic raw material cost comprises 15-25 per cent of raw material cost.” This is because the amount of value addition done on the basic metal inputs is high, added Gandhi.