Riding the Cycles: Risk, Resilience and India’s Auto Industry

The automobile industry is an important part of the Indian economy, the sector approximately contributes to 7.1% to the country’s GDP as compared to 2.8% in 1992-93. The sector accounts for 49% of India’s manufacturing GDP and provides direct and indirect employment to 19 million people, 4.7% of the country’s total exports are from the automobile industry.

Indian domestic vehicle sales in FY24 were 27.7 million units, 2W constitute the largest component with sales of 21.4 million units and contributing 77% of volumes. Passenger vehicle (PV) sales were 4.2 million units contributing 15% of volumes. The commercial vehicle (CV) and three-wheeler sales were 1.06 million and 0.99 million units.

Though the auto industry has been one of the bedrocks of growth of the Indian economy, being a discretionary purchase, its growth has been extremely cyclical. This has resulted in most funds avoiding the industry for most parts as the sector does not lend itself to structural margin expansion. In this piece we look at the sales of passenger vehicle sales over the last 15 years and look at understanding the cycles in the industry. Cycles are best understood by understanding the performance of the market leaders in the segment, in line with this we delve deeper into the performance of M&M and Maruti during the period in comparison with the Auto Index and the broader benchmarks.

Fig 1: Domestic PV Volumes over the last 15 years (Basis wholesale numbers)

Source: SIAM

Fig 1 shows the growth of the domestic volumes which have compounded at 6% over a 15Y period. However, this has seen periods of cyclicality in growth with the UV segment driving the growth in the current cycle. UV sales have compounded by 17% and constituted 60% of sales in FY24 as compared to 14% of volumes in FY10. We can also observe that UVs have overtaken passenger cars in FY22. Passenger cars constituted 37% of sales in FY24 as compared to 78% in FY10.

Fig 2: Domestic PV Volume YOY growth over the last 15 years

The above Figure (Fig 2) shows the growth of the PVs and its cyclicality. However, the consistency of growth has come from utility vehicles which has registered double digit volume growth in 9 of the 14 years, in addition the segment has degrown only once in FY14, volumes in this year saw a drop.

Fig 3: Export PV Volumes over the last 15 years

Source: SIAM

Exports have compounded at 3% over the last 15 years, however, the contribution of UVs to the overall growth has been increasing. The export volume of UV has compounded at 37% over a 15-year period (albeit a low base).

Fig 4: Export PV Volume YOY growth over the last 15 years

Passenger car segment has fared better on the export front as compared to domestic sales. Volume growth was positive in 7 years (50%) and volumes have compounded by 17% over the last three years for this segment.

Reviewing and Understanding Cycles

Broadly speaking, auto cycles have lasted 3 years (both defined as an upcycle or a downcycle). While, volumes in the domestic markets have compounded by 6% in the 15 year period, there have been periods where growth has come off – for instance the FY12-14 period saw negative and single digit growth, as we were coming off a period of strong growth of +20% in FY10 and FY11. Similarly, growth started tapering off from higher single digits in FY19 and the next couple of years were tough for the industry.

Table 1: Comparison of Maruti’s growth and realization vs the industry

P.S: The sections highlighted in red, have been downcycles for the industry vs the sections in black where the auto cycle was positive.

One of the reasons for us to pick Maruti was its ability to maintain market share across 15 years. Barring the period from 20-23 (where the volumes were driven by EV), Maruti continues to be the market leader and one of the best companies to navigate margins across cycles. In Table 1, we compare Maruti’s volumes, revenues, realizations, operating profits. In an upcycle, one would notice margins expand (volume expands) vs in a downcycle, the reverse tends to take shape.

Observations from the above table are as below

• Revenues have been impacted during downcycles with the exception of FY13. Volumes degrowth has been the primary reason for the drop in revenues
• The reason for Maruti to manage cycles well in the past has been their realization strength, thus holding onto prices across time.
• EBITDA growth in the FY12-14 period has been impacted only in FY12, the company’s EBITDA growth was strong in FY13 and FY14 in spite of the industry headwinds. Fall in operating profits in the FY19-21 period has been higher than the top line and has impacted margins
• Average margins in the FY12-14 and FY19-21 period stood at 10%, this is in comparison to average margins of 12% in the rest of the period
• Drawdowns have been severe in these two time periods with Maruti seeing an average drawdown of 30% in these two time periods. As can be seen, auto cycle drawdowns have been severe and hence the industry will always be cyclical. Understanding this is of essence to manage risk.

Table 2 : Market share of Maruti in the FY11-24 period is as below

Periods of headwinds have impacted market share of the company – for instance the market share dropped to 38% in FY12, however the company was able to gain back its market share. Maruti did not see a drastic fall in its market share in the FY19-21 period. Market share has seen a drop from FY21, this is on the back of the company’s underperformance in the UV segment, the company’s volume growth in this segment was below the industry growth rate leading to loss in market share. In FY24, we can observe the jump in UV market share, the UV segment of the company has grown by 75% while the industry growth in the year was 26%.

The definition of a cyclical industry comes from two aspects

1. They go through peaks and troughs in the form of cycles
2. The market leader continues to go through significant drawdowns too irrespective of the best execution.

In line with the above, one can observe the drawdowns of Maruti, M&M, Nifty Auto and Nifty 50 in the FY11-24 period. A strong cycle does not mean that drawdowns are minimized and this is extremely important to manage risk, when investing in auto.

Maruti’s average drawdown in the FY12-14 and FY19-21 period was 30%, this is including FY20 (COVID year), the average drawdowns for M&M are also similar. Headwinds in the industry do impact prices heavily even though the company is able to manage its costs and not take a large hit on margins.

Final Thoughts

We can observe from the above analysis that the headwinds lasted between FY12-14 followed by recovery in industry volumes in single digits in the FY15-18 period and then a drop in volumes in the FY19-21 period. The primary reasons for the slowdown in these cases were economic in nature like higher interest costs, inflation, higher fuel costs, liquidity crisis and/or result of policy announcements like transition from BS 4 to BS 6, introduction of various safety norms that led to increase in cost of vehicles and long-term third-party insurance cover mandated for 3 and 5 years.

Maruti, being the market leader, was able to hold on to prices in the FY12-14 and FY19-21 period as seen from no drop in realizations and limited impact on its operating margins. Margins were impacted in FY21 and FY22 and that was on the back of the following factors – COVID, shortage of semiconductors and the company’s falling share in the UV segment.

Understanding cycles in the past, has helped in investing in the auto industry and it being rewarding too as can be seen from the cycles below (FY15-18 being an upcycle and FY19-21 being a downcycle, partly affected by Covid). The last 3 years has been a strong upcycle for auto with the industry seeing both volume and realization growth.

Table 3: Auto returns (company wise) across cycles

In FY24 industry volumes grew by 8% after double digit growth in the previous two years, hence we are in the third year where we are witnessing healthy volume growth. The average industry volume growth in FY11-24 period is 6%.

Below is the point-to-point compounded returns of Maruti, M&M, Nifty Auto and Nifty 50 in the FY22-24 period.

As we enter the 4^th year of the auto cycle, there are a few trends that are visible on the ground. The passenger car segment has seen volume growth slowing down. Increased safety norms and higher insurance costs have led to an increase in the prices of these cars. Customers also have the option of buying used cars instead of purchasing entry level cars, which has affected the lower segment purchase.

Utility vehicles continue to do well, volumes in this segment have grown by 33% and 22% CAGR over the 3 and 5-year period. Wholesale Sales of M&M, which primarily has a UV portfolio, for the April-October 24 period was 3,14,714 units versus 2,58,622 units in the April-October 23 period. Maruti, who is gaining market share in the UV space, sold 4,14,309 UVs in the April-October 24 period versus 3,65,614 units in the April-October 23 period.

Some of the trends we are seeing on the ground are:

• Inventory levels with dealers as of August 2024 stood at 77,800 Cr and 70-75 days of inventory versus ideal range of 30-35 days
• Consumption – rural and urban. Rural demand is currently stronger than urban demand
• Approximately 70% of passenger cars in the country are purchased through finance, credit availability and competitive interest rates will impact demand

October sales month on month for all companies showed a healthy growth due to the festive season, this would have helped reduce the inventory levels in the industry and companies offering discounts to clear their stock cannot be ruled out.

It’s important to overlay past cycles, and risk-reward today points towards prudence in the sector over the next few years.

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