Digging Deeper | Crisis in the Indian auto industry?

Rima M. | Supriya Jambunathan

Even as reports about the worst 2 month slump in sales of passenger vehicles (PVs) in India and a rising industry inventory hit the headlines, and even as we learnt that Tata Motors Ltd (TML) had nearly doubled its consolidated net loss in the June quarter, news came on July 26 that the company had rebounded after hitting a fresh 9-year low on weak Q1 show. It was reported that the shares of Tata Motors rebounded nearly 3 percent intraday on July 26 after a disappointing show in June quarter (Q1). But that does not negate the falling knife analogy that observers have used to describe the state of the company, and by extension, the Indian automobile industry.

On this edition of Digging Deeper, we will try to understand just what has gone amiss in the big picture and why.

Downward slide

Tata Motors, on July 25, posted a huge loss of Rs 3,698 crore in June quarter, dented by a disappointing performance by Jaguar Land Rover (JLR).

A Moneycontrol piece reported that JLR suffered a pre-tax loss of 395 million pound, compared to 264 million pound loss in the corresponding period of the last fiscal, on quarterly revenues that declined 2.8 percent Year over Year (YoY) to 5.1 billion pound due to weaker market conditions. Additional plant shutdown time and delays in WLTP (Worldwide Harmonised Light Vehicle Test Procedure) certification, resulting from Brexit contingency planning, also contributed to the lower sales and profits, JLR said.

As the piece says, it was a worse-than-expected loss at bottomline level as consolidated loss was estimated at Rs 2,127 crore and JLR loss at 236 million pound for the quarter ended June 2019, according to a poll conducted by CNBC-TV18.

Several brokerages now have a sell call on the stock because, as was pointed out before, Tata Motors reported its worst pre-exceptional loss-before tax in a decade.

Amit Panday of Mint added that Tata Motor's commercial vehicle (CV) and passenger vehicle (PV) businesses put together reflected a bigger decline in segment-specific revenues when compared with that of JLR. He explained, "The CV and PV businesses posted Q1FY20 revenue of Rs 14,309 crore, declining from Rs 17,290 crore a year earlier. In comparison, JLR’s Q1FY20 revenue fell to Rs 45,661 crore from Q1FY19 revenue of Rs 48,215 crore. This shows that the British carmaker has been able to narrow the losses it has been accumulating for some time, as a result of continued cost-cutting steps such as savings from employee exits, material costs, lower capex, and tightening of working capital needs."

So the issue is broader than just the travails of one brand or segment. But let us focus for a bit on Tata Motors.

A slump in market demand

One of the reasons why Q1FY20 was the worst in terms of market demand is because the demand environment in the China market, the single-biggest for JLR had reported a sharp drop of 34% y-o-y in sales in FY19. But things are becoming stable now, said P.B. Balaji, chief financial officer, Tata Motors to Mint. He also added that the first quarter saw stress in liquidity and financing for CVs and PVs. However, this should ease out now.

We quote Balaji, "We have been correcting inventory, working on dealer profitability and focusing on retail growth on the back of new product launches. All these fundamental interventions made by us is resulting in turning the China business stable."

But solutions cannot be simplistic as the problem with Tata Motors is rooted in multiple fault lines.

P.B. Balaji, chief financial officer, Tata Motors, however, insists that the company's Turnaround 2.0 strategy is bearing fruit because besides tightly controlling the inventory, it has also simplified the supply chain to focus on retail over wholesale.

Balaji has told Mint that he expects the current liquidity squeeze in India to improve in the coming quarters on the back of government intervention. You will recall that the government in the 2019 budget has provided credit guarantee to state-run banks to buy high quality loans from non-banking financial companies.

Litany of woes

An ET report has however used the term "deep pain" while describing Tata Motors’ standalone loss after tax for the June quarter which came in at Rs 97 crore. The piece attributed this to dismal sales in Q1 FY20 as wholesale (including exports) fell 22.7 per cent to 1,36,705 units.

The piece also referred to the stoic outlook of the company which anticipates that both commercial vehicles (CV) and passenger vehicles (PV) businesses will continue to strengthen efforts for competitive, consistent and cash accretive growth through focus on retail growth, customised financing solutions, market activations, new product launches, rigorous cost reduction and inventory management to mitigate BS-VI transition risk.

Guenter Butschek, CEO and MD of Tata Motors, was cited by ET and we quote, "The continued slowdown across the auto industry due to weak consumer sentiment, liquidity stress and the impact of axle load effect particularly in medium/heavy duty, impacted overall demand,” but he also added that  with Budget announcement and upcoming festive season, the company expects some tailwinds for the remaining FY20.

Cost-cutting measures

ET has also reported that Jaguar Land Rover continued to benefit from the ongoing impact of its 2.5 billion pounds profit and cash improvement programme, which delivered a further 100 million pounds of cost-savings and 300 million pounds reduction to previously planned investment in the quarter, taking the total savings to date to 1.7 billion pounds.

The piece added, "While free cash flow was negative 719 million pounds after 795 million pounds of investment spending in the quarter, this represented a 954 million pounds improvement year-on-year. This improvement reflects 756 million pounds of favourable working capital."

As was mentioned before, the company's outlook remains optimistic that Jaguar Land Rover's financial results will improve over the balance of the year and it continues to target a 3-4 per cent EBIT margin for the full year with continued investment resulting in negative but improving cash flows.

Ralf Speth, JLR Chief Executive was cited by ET and we quote, "Jaguar Land Rover is in a period of major transformation. We are simplifying our business, delivering on our product strategy and adapting to the tough market environment."

However Tata Motors is not an isolated case study and the auto industry has experienced a significant slow down over all.

The bleak big picture

Pritish Raj in Financial Express has reported how car sales slump has hurt dealers and over 200 showrooms have shut down.

We quote, "According to estimates drawn up by Federation of Automobile Dealers Association (Fada), around 200 dealer showrooms of passenger vehicles have downed shutters in the last one year, leading to job losses of around 25,000 people.

Typically, a big dealer has around 12-15 showrooms while a small dealer will have under five. Typically one upper-sized showroom which sells around 700 vehicles a month employs around 150 people, while smaller showrooms selling 200-250 vehicles a month employ around 60 people.Though none of the PV manufacturers shared any numbers relating to closure of their dealership, industry executives said with bank funding drying up, closure of some of them was inevitable."

The piece explains how a dealership business runs. "Once a company appoints a dealer, the latter pays for the wholesale despatches every month to the manufacturer. Typically, if a dealer can sell 300 vehicles a month, it stocks 500 or more vehicles.

The manufacturer does not provide any credit to the dealer for taking the despatches and the capital for taking the vehicles from manufacturers is through bank or NBFC financing. These are short-term credit of around 180 days and so far sales are good the system works fine. What has happened with a prolonged slowdown being witnessed now is that banks and NBFCs have stopped funding vehicle purchases by dealers as sales are not happening as per expectations and they are not able to repay the loans."

The piece cites FADA president Ashish Kale who says that the shutdowns have been mostly in the metro cities with Mumbai and Delhi accounting for the higher share. He says that the rate of closure has been higher than the previous years as banks have become cautious on the inventory funding and since stocks were the only collateral with the banks, poor sales have made the banks ask for more security.

SBI chairman Rajnish Kumar, however, told Financial Express that the bank has not yet cut down on financing for auto dealers but will deal with the stress in the sector.

The piece also cites industry sources who say that some of the big manufacturers try to help some of the weak dealers by asking bigger ones to takeover them. This usually works well for bigger manufacturers and hence the number of their dealers shutting shop is lower than those of smaller manufacturers.

The piece does not discount the possibility that some of the dealers who have shuttered showrooms are the ones who borrowed heavily to create infrastructure in anticipation of a future demand and sales but have got stuck. Fada director, international affairs, Nikunj Sanghi told FE that inventory correction is the only way the situation can improve. Sanghi aded that if the vehicles are not selling and the loan is not repaid in time, the loan becomes more unsecured. Majority of the dealers are still sitting on a very high inventory.

The piece attributes the slump in PV sales in the second half of FY19, to the hike in insurance premium, increase in vehicle prices owing to safety features coupled with cash crunch in the system, following defaults by financial companies such as IL&FS and DHFL. Since the manufacturers did not control pushing stocks last year, a higher than normal inventory at dealers has increased their working capital.

Warning bells

According to Reuters, India's auto parts makers have warned of 1 million job cuts if this slowdown continues. The slump has already prompted automakers to cut production and automakers and parts makers to cut jobs.

Moneycontrol cited Reuters in an earlier piece to inform that India's auto parts industry could be forced to slash a fifth of its 5 million or so workforce if the slowdown in vehicle sales continues. This fear was underscored by Ram Venkataramani, president of the Automotive Component Manufacturers Association of India (ACMA).

To repeat, India's auto industry is in the middle of one of its worst slumps. Passenger vehicle sales fell 18.4 percent in the first quarter, and monthly passenger vehicle sales in June fell by the biggest margin in 18 years.

The drop in production "has led to a crisis like situation in the auto component sector," said the ACMA president in a statement on July 24.

According to Reuters, the slump in the auto sector, which accounts for nearly half of India's manufacturing output, has been a major factor behind the slide in economic growth to a five-year low earlier this year.

Venkataramani said investments in the auto sector have been frozen due to a lack of government clarity on its electric vehicles (EVs) policy. He said a government plan to speed up the rollout of EVs would raise India's import bill and damage prospects for auto components manufacturers.

Venkataramani also called for a cut in the goods and services tax for the vehicles and auto component sector.

A crisis in the making

Pankaj Doval, writing for The Times of India, has cited a top official from the industry association as well as company officials, to report that nearly 10 lakh jobs have been shaved off from the auto component industry, following a prolonged and painful slowdown that has seen the demand for cars, commercial vehicles (CVs), and two-wheelers slip to historic lows.

The piece points out once again that the component players are the backbone of the domestic automobile industry and contribute nearly 2.3% to the country’s GDP.

Vinnie Mehta, director-general of Automotive Component Manufacturers Association (ACMA) told TOI, “It is a crisis, and we have been under intense pressure over the past one year, which has resulted in significant production cuts at factories. Our estimates show that job losses are between 8 lakh and 10 lakh, and are across key automobile manufacturing locations such as the Haryana belt, Pune region, Chennai, Nashik, Uttarakhand, and Jamshedpur.”

Mehta also told TOI that the impact has been “unprecedented” and is being felt across the spectrum of the auto component industry and added and we quote again, "I have never seen such a scenario when a top supplier such as Bosch completely shuts down its factories for as many as five straight days. This is scary."

Speaking to TOI about the nature of job losses, he said a majority of them are contractual staff hired by companies for routine production work and many of them are working at the shop floor or engaged in logistics and other allied/support activities at factories.

Speaking about the size of the component industry, ACMA said in 2018-19, that nearly Rs 4 lakh crore worth of parts were made in India, of which components worth roughly Rs 2.3 lakh crore were sold to auto makers, while exports amounted to Rs 1lakh crore. After-market sales accounted for around Rs 67,500 crore.

The industry, says TOI, is also calling it a “never-seen-before crisis”, considering that the slump is coming at a time when they have made heavy investments for migration to new BS6 norms.

Industry players have told the paper that a faster shift to electrical mobility will not give them much time to recover investments made towards upgrading to new emission and safety standards. Also, there is a need to grasp the complexities related to the new clean mobility systems, which will require technology upgradation as well as new investments.

Ashok Taneja, MD & CEO of Shriram Pistons & Rings told ToI, "Almost every company in the industry is right-sizing, while putting a freeze on new hiring, except when they are moving to a new location. The focus has shifted from business to working towards remaining viable.” As the piece says, companies are adjusting and moderating production in line with sales realities and directing investments towards automation and robotisation to drive in quality and right-size manpower.”

The industry demand that GST on components should  be brought down to 18% to drive in affordability is the one issue that will gather momentum in the time to come. How the government and the industry synergise to get over a rather imposing economic road bump will define the immediate future of the auto industry in India.