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Raghuvir Srinivasan

There is a growing impression that the next wave of outsourcing from India will be in auto components. The truth is that there are few companies that measure up to the rigorous standards required for supplying to multinational majors.

HAS the Indian auto component industry arrived? Are auto component company stocks potential multi-baggers that will repeat the performance of IT stocks in the last few years? These are questions that follow the spate of positive stories in the media in recent months on the auto component industry.

There is a growing impression that the next wave of outsourcing from India will be in auto components and that the Indian component industry is poised to take a global leap. The export orders bagged by a couple of players and the proposed overseas acquisitions by Bharat Forge and Sundram Fasteners have added further credence to the opinion that the industry has arrived.

Riding on these positives, stocks of component manufacturers, such as Sundram Fasteners, Bharat Forge and Motor Industries Company (MICO), have appreciated rapidly in recent months. The stocks of many smaller companies, such as Motherson Sumi Systems, Premier Instruments and Subros, have joined the party.

It may be prudent to watch the industry closely before jumping to the conclusion that auto components is the next big story in the stock market. Granted, there are a number of positive factors to talk about, including the return of demand in the domestic market. Companies are operating either to capacity levels or very close to that. Indeed, a few have even announced expansion projects.

Divergence in industry

The crucial point though is that there is a significant divergence in the industry between the top-of-the-class performers and the rest. The danger that investors face now is that of inability to distinguish the top-drawer stocks from the others.

There are two categories of auto component stocks. One, those belonging to companies that have a solid domestic presence and are now striking out abroad. These are companies that are already significant exporters and which are now taking the next logical step of acquiring units abroad. This would include stocks of companies such as Bharat Forge and Sundram Fasteners.

Two, of those that are now reaping the resurgence in the domestic industry but do not have a significant export presence. These companies are typically low-profile and small- to medium-sized and their fortunes soar or sag in tune with the domestic automobile demand. This would include a galaxy of companies such as those from the Rane group, Sona Koyo Steering, Subros, Motherson Sumi, Premier Instruments, Denso India, India Nippon Electricals and Munjal Showa. Some of these are well-managed companies that are poised to enter the export market.

Between the two categories, the first would obviously enjoy premium discounting in the market.

This is already evident in the valuations of Bharat Forge and Sundram Fasteners, both of which have more than doubled in value in the last six months.

The second category should logically enjoy a lower valuation but the disturbing point is that they seem to be perceived in the same league as the first. Now, this is obviously due to all the hype that has been generated about the industry and the potential for outsourcing.

Way to go, yet

The truth is that there are very few companies that measure up to the rigorous standards required for supplying to multinational majors.

Indian companies are way behind in quality and adherence to delivery schedules, two of the most critical requirements looked for in suppliers by multinational majors. Besides, most Indian companies are way too small in size and have no experience whatsoever even in supplying to the replacement market abroad.

Vehicle manufacturers will hardly consider vendors who are small and unknown in the global markets, whatever cost advantage they may present them with. The multinational vehicle manufacturers have their own set of component suppliers with whom they have an established relationship and it would be very difficult to penetrate into this inner circle for Indian companies given their obvious inadequacies.

Even a Sundram Fasteners, which has established a reputation as a quality supplier in the global market, has been forced to use an indirect strategy to penetrate into the original equipment (OE) market abroad. Its impending acquisition of Dana Spicer's unit in the UK is a manifestation of this strategy.

Restricted competitiveness

Besides, the competitiveness of Indian companies in the global market is restricted to the relatively low-technology products such as castings, forgings, metal components and so on where production cost advantages have a significant influence.

It would be wrong to extend this logic to higher technology products such as engine management systems, emission control systems and high-end electrical components where multinationals such as Robert Bosch, Delphi and others dominate.

The outsourcing story, therefore, should not be overplayed. Yes, there will be some companies that will make it big in this game but they will, at best, be islands of excellence in the industry.

It would be dangerous to generalise this phenomenon across the industry and perilous to extend the logic into stock valuation. Investors would do well to spot these islands for investment and not to get carried away by the outsourcing story.

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