Four reasons why this auto slowdown is different and the road ahead

The Indian automobile industry has failed to shake off the slowdown that has been plaguing it for months now. Auto sales across all segments continued the downtrend in June as manufacturers cut production to keep inventory in check amid weak retail sales and subdued consumer sentiment.

During the month, domestic sales across passenger vehicles (PVs), commercial vehicles (CVs) as well as two- and three-wheelers fell 12 per cent year-on-year, industry body Society of Indian Automobile Manufacturer (Siam) said. The combined sales of all automobiles fell to 1.9 million units in June against 2. 2 million units a year ago.

So, how does this slowdown then compare to the ones the automobile industry faced in the past? How swift will the recovery be? Edelweiss Securities, in its report dated July 10, has compared the current slowdown with the past 20 years' demand cycles and concluded that this time, it's different.


The difference can be seen on four counts, the report said. They are:


Domestic factors driven


Slowing income growth and Non-banking financial companies (NBFC) crisis are primary reasons for the current slowdown compared to earlier cycles which had been triggered by global events like Asian crisis, Dotcom bubble, global financial crisis, etc. 


The recent NBFC crisis had a twin effect on demand. It curtailed financing to new vehicles, and NBFC were financing customers who were not preferred for financing by banks. Hence, revival of lending by NBFC is critical for demand revival. 


Sharp regulatory cost pressure


Over FY19-21, vehicle prices are estimated to jump 13-30 per cent (1-2 per cent per annum over previous decade) due to safety, insurance and emission related compliance costs.  Come April 2020, India will upgrade to BS-VI from BS-IV emission standard Given that general price hike over the previous decade was 1-2 per cent per annum, a sharp increase in vehicle prices over FY19-21 can restrict the recovery.


Stiff competition from growing organised pre-owned vehicle market


Over the past five years, the size of pre-owned market has expanded significantly, with higher share of organised players. For instance, in passenger venhicle (PV), a significantly higher growth in pre-owned cars over the past two years is a reflection of rising consumer interest in this segment. This may impact new vehicle demand, especially in case of sharp price hikes. 


Significant margin pressure


The decline in gross and earnings before interest, depreciation, and ammoratization (EBITDA) margins in the current cycle is far higher compared to previous slowdowns with maximum impact on Bajaj Auto and Maruti Suzuki India Limited. In case of EIM, for the first time, decline in EBITDA margin is higher than in gross margin. This is due to increase in fixed cost on account of investment in product development capabilities and marketing in international geographies.


Hence, says the report, the recent slowdown is much sharper than the previous cycle on the margin front. 


"This seems to be a result of a combination of huge inventory reduction exercise as well genuine demand softness. These factors raise doubts on the industry’s ability to pass on the regulatory cost pressure without compromising on margin.," the report said.


What's the road ahead then?


"At the current juncture, we believe, volume recovery is unlikely to be as sharp as in the past, unless there is strong stimulus support. Also, Original Equipment Makers (OEMs) may be compelled to absorb some of the BSVI costs to revive volumes, especially in two-wheelers and passenger vehicles. In medium and heavy commercial vehicle (M&HCV), we believe the current slowdown is more due to the economic cycle rather than over-capacity in the system, as reflected in strong freight rates (compared to previous slowdown phases)," the report says.


About the impact of BSVI transition, the report says it's unlikely to majorly impact M&HCV demand as long as truck operators are able to pass on the costs. "We do not expect any major pre-buying and hence do not expect significant sales dip in FY21," it said.