The Hindu Business Line : Two imperatives for automakers

Defend the business, and manage the evolving scenario. These are the two key areas that Indian automotive companies have to focus on, says Mr Rakesh Batra, Partner and National Leader - Automotive Practice, Ernst & Young. "This situation is without precedent and requires an immediate response to ensure survival," he observers.

The global automotive sector is experiencing a significant downturn. Rapidly declining demand, frozen credit markets and depressed market confidence are forcing all automotive companies to rethink their business strategies and operational tactics, Mr Batra mentions.

"In India, the adverse impact is quickly becoming evident with companies reporting sharp decline in October and November sales leading to burgeoning inventories and production cutbacks."

The first of the two key focus areas, that is, defending the business, involves taking immediate actions to reduce break-even, when operating at current reduced sales volumes for the customer segments, explains Mr Batra, during the course of a recent email interaction with Business Line. "This can be achieved by reducing fixed and variable costs, reducing working capital and ensuring sufficient liquidity by securing additional sources of finance."

On the second, `manage the evolving scenario,' his counsel is that companies need to take actions in the next 6-12 months to prepare for the medium term (next 1-3 years). "This should include scenarios of a prolonged downturn and an economic revival and cover actions to stay afloat by selling underperforming assets and reducing prices to ensure positive contribution margins."

Excerpts from the interview:

Where do the real advantages or areas of cost reduction lie in the automotive sector today?

Raw material cost is the largest component of total costs for an auto vehicle or component manufacturer, accounting for 70-85 per cent of the net sales. Therefore, most players concentrate on reducing input costs to improve their operating margins.

Today we are in a deflationary environment with respect to commodity and raw material costs, but some of this cost reduction will be offset by lower volumes.

Beyond material costs, companies need to: improve the efficiency and effectiveness of their advertising spend; improve `order to delivery' process to be more flexible and agile to changing market conditions; and reduce new product development costs and cycle time through greater internal and external integration. These will create sustainable cost reductions that deliver competitive advantage.

Do auto companies have headroom to sell cars at heavy discounts or maybe even agree to limited period loss in order to clear inventory?

The industry is currently saddled with heavy inventories with the sudden and large decline in sales in November which will have an impact on profitability. Two other factors are also affecting margins - Cenvat duty cut of 4 per cent in the recent stimulus package which is estimated to cost the industry Rs 500-1000 crore on the unsold inventory, and the model year change.

If dealers are not able to liquidate their stocks before the month-end, they will have to carry them over to the next month, and this will call for higher discounts.

Besides, dealers and auto companies are also facing severe liquidity and working capital problems and all of these factors are likely to drive heavy discounting this month.

There should be headroom to absorb these discounts since commodity and other input prices are declining. The reduction in excise duty of 4 per cent should also translate into a reduction of the final effective duties on the automotive sector by 16 per cent (for medium and luxury cars) to 30 per cent (for small cars).

Assuming that the selling price ex-factory is maintained, the price reduction due to such Cenvat duty reduction alone should be 3-4 per cent. Many manufacturers are also planning price increases effective January 2009 as announced in recent reports.

Would demand be stimulated substantially if interest rates are lowered?

Low-cost financing was a key driver of the growth in auto sales over the last 2-3 years. Earlier, for a Rs 3-lakh car, a customer could get a loan up to Rs 3.20 lakh, which would cover the cost of insurance, registration and road tax.

Now banks want the customers to invest 50 per cent of the total cost as upfront payment.

Besides, financiers have become cautious with respect to deviations on underwriting standards, and tight credit screening measures have been adopted to ensure better asset quality.

Vehicle repossession rules are also becoming a barrier. As all vehicle-financing is against assets (car, two-wheeler, etc.) and if repossession rules are unworkable, then non-banking finance companies and banks remain reluctant to finance vehicles.

Customers are also not willing to lock up so much of their own funds, given the uncertainty with the economy and jobs outlook.

So while lower interest rates will certainly help and are definitely needed to stimulate demand, it may not be a sufficient condition on its own.

Your views on how the Indian automotive market compares with the global market.

The conditions and crisis being witnessed in the global automotive markets, including India, are quite similar and without precedent.

Analysis of the November 2008 sales reflects a widespread and systemic collapse of car sales around the globe, affecting both the mature and emerging markets alike, and is estimated to be in excess of 20 per cent globally.

The US, Japanese and Western European markets, the `triad' of automotive mature markets, witnessed falls of 36 per cent, 18 per cent, and 25 per cent, respectively, which have accelerated from previous months. More significantly, they have been joined by a remarkable and systemic collapse in car sales in other key regional markets around the world.

Brazil fell 26 per cent, South Korea slumped 22 per cent, South Africa and Australia fell by 28 per cent and 22 per cent, respectively, according to IHS Global Insight. This compares with declines of 14.4 per cent in October and 17.9 per cent in November in the Indian market.

What is the outlook for the next few months?

Though auto companies have passed on the reduction in Cenvat to consumers, interest rates, access to financing and reasonable underwriting standards continue to be barriers to increased car sales.

Overall consumer sentiment and confidence are also low with the uncertainty over jobs, global economic meltdown and auto industry crisis. Till these barriers are addressed and consumer confidence improves, we are likely to see continued pressure on new vehicle sales into the first quarter of 2009.

As a result, FY09 may be flat with respect to FY08, owing to growth of 10.1 per cent in the first half. However there are many other potential issues that could surface in the next 1-2 months stemming from the slowdown in sales domestically, vulnerability of suppliers and dealers due to working capital issues, and potential bankruptcy of GM and Chrysler if bailout is not approved.

The industry is currently saddled with heavy inventories with the sudden and large decline in sales in November which will have an impact on profitability.

D. MURALI

(Portrait by R. Rajesh)

AccountSpeak.blogspot.com

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