Operating margins of auto ancillaries to remain under pressure in H2 FY2022 impacted by commodity inflation; Omicron wave adds to industry woes: ICRA

Demand for auto components stems from domestic OEM, replacement and exports. Most domestic OE sub segments are expected to register healthy volume growth in FY2022, albeit on a low base of the last fiscal. Pass through of commodity prices will also inflate revenues by 4-5%. However, certain segments like 2W and buses will be impacted by the Omicron wave. We expect delayed recovery in the 2W segment because of affordability and dampened sentiments. Also, demand for buses is expected to be impacted during the upcoming school season for the third year in a row. Supply-chain issues could prolong further as well. Easing of Covid 2.0 related lockdown restrictions and improvement in personal mobility, healthy freight movement and pent-up demand arising from deferment of purchases last year, supported replacement sales for auto components in Q2 and Q3 FY2022. While there could be some impact on mobility because of the ongoing covid wave, freight movement and deferment of fresh vehicle purchases will result in healthy replacement demand in Q4 FY2022.

Notwithstanding the potential Omicron impact, we expect an 8-10% growth in domestic aftermarket demand for FY2022. Exports remain a bright spot in the Indian auto component story. We expect a 20%+ growth in exports for FY2022. Indian auto component suppliers have reported a healthy improvement in sales volumes to Europe in YTD FY2022 and have a strong order book for the next few months, partly aided by the China+1 strategy. Q3 FY2022, has however, been relatively dull because of supply-chain issues. ICRA believes that the export order book for Indian auto component suppliers would have been even better if not for the chip shortages. As for exports to the USA, Class 8 truck order book is expected to soften as OEMs get cautious, even as demand remains strong. It is expected to bounce back over the next few months. Relatively high infections and prolonged lockdowns in India’s key export markets like Europe and USA remains a downside risk.

Says Ms. Vinutaa, Assistant Vice President and Sector Head, ICRA Limited, “ICRA expects a robust 15-17% revenue growth in FY2022 for the Indian auto component industry, driven by domestic OEM, replacement, export volumes and pass-through of commodity prices. The healthy volume growth would, however, come on a low base of FY2021. The growth forecast for FY2022 has been revised downward by 200 bps to 15-17% from the earlier estimates due to the ongoing Omicron wave, delayed recovery in semi-conductors and muted 2W/bus demand. There could be a downward bias to our estimates in case of prolonged lockdowns or significant demand slowdown because of the Omicron wave.”

Revenues of ICRA’s sample of 48 auto component suppliers registered a healthy growth of 17.8% YoY in Q2 FY2022, supported by recovery across most domestic OE segments (except 2W), aftermarkets and exports. We expect revenues in Q3 and Q4 FY2022 to remain relatively muted on YoY basis, with supply chain issues lasting longer than previously expected. There could be a downward bias to our estimates in case of prolonged lockdowns. Commodity price and other input costs like freight have witnessed sharp increase in the last 3-4 quarters, and auto ancillaries have not been able to pass through entirely, resulting in significant decline in gross margins. The operating margins shrunk by 240 bps to 10.6% in Q2 FY2022. Given the anticipation of elevated commodity prices in H2 FY2022 as well, the gross margins of auto ancillaries will be lower on YoY basis in FY2022. OPM of auto ancillaries (ex-tyres) will contract by 75-125 bps due to commodity price impact in FY2022 and will remain lower than the normal levels of 11-12%. Operating margin of tyre companies will also moderate in FY2022 from record highs in FY2021.

Despite lower operating profits, the overall interest cover remains comfortable for most entities at over 10x. The liquidity position also remains comfortable currently across tier-I and tier-II players. Auto ancillaries continue to stock relatively higher inventory levels to ensure seamless operations, given the supply chain issues and elevated commodity prices. The coverage indicators for the sector are expected to remain comfortable going forward as well, aided by healthy accruals and modest debt-funding. Majority of ICRA rated auto ancillaries continue to be in the investment grade category, reflecting a healthy credit profile. However, maintaining adequate liquidity is critical.

ICRA’s interaction with auto ancillaries indicates that most of them are re-evaluating investment plans, in the backdrop of the recently announced PLI scheme. Given that most tier-I suppliers are eligible, the capex intensity is likely to increase going forward. At present, the incremental announced investments are primarily towards capability development i.e. new product additions and committed platforms, unlike the investments towards capacity expansion witnessed in the past.

“Over the long term, premiumization of vehicles and focus on localisation will translate into relatively stronger growth for auto component suppliers. We expect a 5-year CAGR of 8-10% for the industry. While operating margins are likely to be impacted in FY2022 because of cost pressures, FY2023 margins will benefit from improved operating leverage benefits and increasing premiumization of vehicles, apart from normalization of supply chain issues and commodity pressures.” added Ms. Vinutaa.