India Ratings Gives Negative Outlook On Auto Ancillaries For Financial Year 2020-21

With the lingering crisis in the auto sector, which has been going through the worst demand fall in two decades, the ancillary players are in for bad times in fiscal year ending 2021, says a report.

Rating agency India Ratings has accordingly placed a negative outlook on the sector as it expects flat-to-low single-digit growth in auto volumes next year, after falling in double digits so far this fiscal year. Auto sales have plunged 16 percent till January.

Continuing weak sales amid unfavourable macroeconomic factors, uncertain regulatory environment, limited credit availability along with the increased cost of ownership after Bharat Stage-VI implementation do not offer any great green shoots, it said in a report on Tuesday.

"We expect subdued vehicle sales in the first half of financial year ending 2021, after the BS-VI implementation, as consumers would take time to accept the revised pricing and a recovery only after the start of festive season," said the report.

While the BS-VI passenger vehicle prices are up over 10 percent, the same version of two-wheelers is up 10-15 percent.

An added worry for the ancillaries is the continuing correction in dealer level inventory, which has constrained demand, which according to the agency will lead to a high single-digit decline in revenue this year, before making a modest recovery in mid-single-digit in the fiscal year ending 2021.

"Demand is likely to receive an impetus from higher content per vehicle on the back of evolving regulatory norms and capabilities developed for BS-VI and electric vehicles, which could also be used to service other markets with similar regulatory requirements," says the report.

Margins of auto ancillaries may improve modestly in the fiscal year ending 2021 due to an improvement in operating leverage but will remain below the fiscal year ending 2019 levels. Downside risks can arise from pricing pressure from original equipment manufacturers, primarily in the first half, as they may not be able to fully pass on the price increases on account of BS-VI norms in a subdued demand scenario.

Most auto ancillaries entered the fiscal year ending 2020 after a period of elevated capex spending. With the demand falling, these companies have deferred non-essential capex.

Yet, the report expects their credit metrics to remain elevated in the fiscal year ending 2021, thanks to the deep deterioration in the fiscal year ending 2020. The capex cycle will resume once the demand conditions improve, likely in the fiscal year ending 2022.

Accordingly, the agency has a negative outlook on the sector, based on the expectations of a continued weaker-than-envisaged operating performance and credit metrics in the fiscal year ending 2021 amid a challenging economic environment.