The Hindu Business Line : Riding out the bumpy phase

The fortunes of the auto component industry are closely knit with those of the automobile industry. And in the last few months, both sectors have witnessed a reversal in fortunes. On the domestic front, sales of medium and heavy commercial vehicles and two-wheelers have been hit hard due to rising interest rates. This slowdown has spilled over to the auto component makers as well.

On the export front, component makers have again been on the losing side due to an unprecedented appreciation in the value of the rupee. Besides, increasing costs of raw materials such as steel and aluminium have also exerted pressure on their margins.

Rising interest rates and input costs have, in recent quarters, led to a sedate performance from the major component manufacturers. Faced with this three-pronged challenge, auto component manufacturers are re-working their strategies to tackle the slowdown.

Diversification of product portfolio

Take the case of companies such as Munjal Showa and Omax Autos, auto component makers that supply predominantly to the two-wheeler companies. Given their high reliance on credit-funded purchases, two-wheeler sales have been among the worst hit by the slowdown, registering a negative growth of 8.52 per cent during April-August 2007 over April- August 2006. For an 8 per cent increase in sales year-on-year, net profits of Munjal Showa, a supplier of shock absorbers, struts and gas springs, have dropped 20 per cent in the June 07 quarter. To avoid such impact arising from concentration on one segment of the industry, companies are taking steps to diversify their product offerings outside the two-wheeler segment.

For instance, Omax Autos, which derives 85 per cent of its revenues from the two-wheeler segment, is setting up a new unit for manufacturing chassis for the light, medium and heavy commercial vehicles to be supplied to Tata Motors.

Wheels India too is planning to expand capacity of wheels for tractors and small trucks. As the ‘hub and spoke’ model (under which large vehicles are used to carry cargo between cities and small vehicles are used for movement within the city) gains ground in India, the demand for smaller trucks is expected to increase further translating into higher revenues for the company.

Besides, increasing supplies to the tractor industry would help further de-risk the revenue stream as the growth in the tractors segment tends to be unrelated to that in other vehicle segments such as passenger cars, CVs or two-wheelers. The company is also foraying into manufacturing wheels for earthmoving vehicles. With the construction and infrastructure industry in a boom phase, this move could help sales and earnings remain resilient to any slowdown in vehicle sales.

Focus on value addition

While some companies are adopting diversification into new segments to cushion the effect of a slowdown, others such as Sona Koyo Steering are resorting to a superior product mix to tackle the margin pressures.

A superior product mix helps companies earn higher realisations without resorting to price increases. Original equipment manufacturers (OEMs), keen on cutting costs, are not in a position to grantany price increases to the component makers even if the latter cite higher input costs.

Sona Koyo Steering, a key supplier to Maruti Suzuki, introduced a high-value column-type electronic power steering (EPS) in 2006-07, which helped its top line grow by 72 per cent over the previous year. The company is expected to have the first-mover advantage when the demand for the column type EPS increases over the next few years.

Similarly, companies engaged in the forgings business are moving into producing value-added machined forging components, rather than raw forgings, in a bid to upgrade their product mix.

Exports, inorganic growth finds favour

Exports of components to overseas markets also provide players with a cushion against any slowdown in domestic automobile sales. Global automobile OEMs, under pressure to reduce costs, look increasingly towards low-cost manufacturing locations such as India to outsource components manufacturing. Several leading players have taken measures to step up their overseas sales. For example, the export market for aluminium-based components (due to its lighter weight and consequent advantages of fuel efficiency) is fast growing. Targeting this huge export opportunity, Sundram Clayton has demerged its brakes business into a wholly-owned subsidiary named Wabco-TVS (India) Ltd to focus more attention on its aluminium die casting business. Companies such as Sundram Fasteners, Amtek Auto and Bharat Forge have, in the past few years, acquired companies that have facilities closer to global OEMs in Europe and America. This has helped them gain ready access to a diverse customer base consisting of big automobile OEMs such as Volkswagen, BMW, Daimler Chrysler, Audi, Scania and Volvo, to name a few.

These companies adopt a ‘dual-shore manufacturing model’ under which offshore locations are used as a technical hub with emphasis on product design, development and manufacture of high-value critical components; Indian facilities are used in high-volume production due to their cost advantage. For the companies, this model brings in two benefits — optimisation of costs, a larger product portfolio and geographic diversification across locations.

Capacity expansions

To keep pace with the new alliances and ventures, whether it is the Mahindra-Nissan-Renault alliance or the Tata small car project, component makers are following the OEMs while locating their own plants. This facilitates JIT (Just in Time) supplies to customers and will lead to savings in transportation costs. Rico Auto, Lucas TVS and Sona Koyo Steerings are setting up plants in Singur to supply to the Tata small car unit there. As Tata Motors commissions its production for pick-up trucks in Thailand, Lumax Industries plans to set up a manufacturing facility in Thailand. Lucas TVS is also mulling a plant in Thailand to gain access to global players operating in the Thai market.

However, the export route to diversification is not a risk-free one. India’s strength in exports has traditionally been in low-technology products such as forgings, castings, and plastics. The array of overseas acquisitions made so far has no doubt, given the companies access to world-class clientele and their technology. But there is room for further improvement in terms of quality and best practices. Besides, the acquisitions, having been made in highly developed markets such as Europe and the US, are taking their time to pay off.

A second concern is the continued appreciation of the rupee. As more and more companies emerge as Tier I suppliers to OEMs, they enter into long-term contracts, necessitating gradual reduction in prices and less flexibility for renegotiation in case of a currency fluctuation.

A third would be the competition from China and Thailand and other low-cost hubs in Asia.

What’s in store?

There are two views on the recent sluggishness in vehicle sales. One is that the slowdown is attributable to a mere postponement of purchases due to the sharp spike in interest rates over the past year. If this is true, as interest rates begin to flatten, and possibly drift downwards, a resumption of earlier growth trends appears possible.

However, the alternative view is that the slowdown could be a leading indicator of a broader economic trend (the blip in recent industrial production numbers too seemed to suggest this). If so, the slowdown could well get prolonged into a cyclical downturn. Investors in auto component stocks may have to adopt a ‘wait and watch’ mode for the next few months to see how things unfold on the domestic front.

Currently, companies catering largely to the CV and two-wheeler segments seem to have borne the brunt of the slowdown, the exception being those serving the passenger car makers. Stocks of component companies that are diversified across product segments seem a good bet in present market conditions.

Looking beyond auto

Faced with vulnerability to cyclical downturns in the auto industry, companies such as MICO, and Motherson Sumi Systems and Bharat Forge, have followed the strategy of looking beyond the automobile sector in a bid to diversify their client base. This is a strategy perfected by MICO which is present in the power tools business apart from auto components.MICO has diversified into producing power tools, security systems and packaging machinery, which find industrial applications.

Motherson Sumi, through its polymers business, caters to white goods and electronic goods manufacturers such as Whirlpool, LG and Samsung.

It has also entered into a joint venture with Badla of Germany to manufacture components and assemblies for mobile phone manufacturers in India.

The company earns around 14 per cent of its their revenues from the non-auto components business.

Bharat Forge has moved into forging and machining of high-value parts required for the oil and gas, energy, aerospace and heavy engineering sectors. Non-auto components business currently contributes around 17 per cent to their revenues.

These moves help these respective auto component companies ensure that their revenue and earnings streams are not entirely hitched to the performance of the automobile sector.

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