Auto Sector Outlook Remains Stable to Negative - India Ratings

Mumbai, January 16, 2014: India Ratings & Research (Ind-Ra) has maintained a stable to negative outlook on the automobile sector for FY15. The financial profile of most industry players is strong despite all segments displaying a yoy decline in sales volumes during April-December 2013. The agency revised the auto sector outlook in July 2013 to stable to negative  from stable.   
Ind-Ra believes the low leverage (net adjusted debt/EBITDA) of most auto original equipment manufacturers (OEMs) provides them the financial flexibility to sustain the on-going economic downturn. However, OEMs with limited product and geographic diversification could face further credit profile weakening.
The agency expects the commercial vehicle (CV) segment to post a 6%-9% yoy decline in domestic volumes in FY15.  Most truck fleet operators are likely to defer investments in new vehicles at least till 1HFY15. This is because of a decline in their operating margins as road freight rate increases have not kept pace with upward revisions in diesel prices. Given the low base of FY14 as well as the likely improvement in the industrial activity in 2HFY15, Ind-Ra believes a high single digit positive growth rate will be possible in 2HFY15. This is reflected in the upper limit of the range of the expected sector growth rate.     
According to Ind-Ra’s base case, volume growth in passenger vehicles (PVs; including cars, utility vehicles (UVs) and multipurpose vehicles (MPVs)) will decline 3%-8% yoy in FY15. Segment underperformance would continue on the back of reduced affordability due to the rising cost of ownership and shrinking discretionary spending power of the average consumer. However, robust agricultural output translating into meaningful rural demand as well as exports is likely to cushion industry volumes. PV exports, in particular, partially offset the significant decline in domestic volumes in FY13.  Exports ranged from 17%-20% of the PV industry sales volumes in the past five years.   
Ind-Ra believes UVs, which displayed 51% yoy growth in domestic volumes in FY13, will register a 2%-4% yoy decline in FY15 (base case) following an expected 4.6% yoy decline in FY14.  The increase in excise duty to 30% announced in March 2013 from 27% earlier (for vehicles longer than 4m) together with higher diesel prices has sharply impacted the demand, particularly in the entry segment which accounts for most volumes. Ind-Ra’s volume growth expectation factors in product launches in this segment, without which the decline would have been even steeper.   
In an optimistic scenario, where political certainty post the 2014 general elections results in a significant revival of economic activity, growth rates in the CV and PV segments could improve to around 1%-4% and 2%-4%, respectively.   
Ind-Ra estimates a capacity addition of 1.6 million units and 0.2 million units over FY14-FY15 in the PV and CV segments, respectively. This is likely to result in capacity use falling to 45%-47% in FY15 for PVs from the FY14 estimated of around 54%. While for CVs, the capacity use would decline to 35%-37% in FY15 from the FY14 estimated of around 40%. Ind-Ra expects underuse of capacities to result in under-absorption of fixed costs and consequently margin pressures for OEMs.
WHAT CAN CHANGE THE OUTLOOK
Positive Outlook Unlikely: Given the structural issues of overcapacity and intensifying competition, Ind-Ra does not envisage the outlook being revised to positive even in the event of a modest volume revival. However, curtailment or postponement of planned capacity addition coupled with sales volumes at levels observed in FY11-FY12 could positively impact the credit profile of the sector and result in a stable outlook.
Prolonged Weak Demand: Increased political uncertainty in the event of a fractured mandate in general elections leading to continuation of the on-going muted economic activity could depress CV and PV volumes even further. Additionally, any external shock pressuring the rupee and a subsequent spurt in interest rate could impact the overall economic activity moderately. This could affect the volumes as well as the credit profiles of corporates in the sector. These factors could lead to a negative outlook.   
(Source: Manager – Corporate Communications and Investor Relations, India Ratings & Research -A Fitch Group Company.)

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