Fiscal year 2003-04 had turned out to be a watershed year for the Indian passenger car industry. Led by some strong macroeconomic factors, the domestic car sales witnessed a strong 29% jump in volumes YoY.
Let us throw some light on some of the changes that have taken place in the industry off late and how would they help putting the industry on a higher growth pedestal.
While the growth in FY04 could be attributed to a host of factors, some cyclical and some structural, we believe that owing to some encouraging steps taken by the government and other agencies in recent times, the industry might well be headed towards a higher growth trajectory.
Low penetration levels: Despite growing at a strong CAGR of 11% over the past five years, the penetration levels in India is still low as compared to other developing nations.
In fact, even countries like Pakistan and Sri Lanka have higher penetration than India. This in itself gives us an idea of the growth potential of the industry in the country.
Excise cut benefits: Taking into view the role of the auto industry and the manufacturing sector in general towards employment generation and economic growth, the government has over the past few years brought down the excise duties on cars to a significant extent.
This has played a very important role in improving the fortunes of the industry, as lower prices has led to a strong growth in demand. However, still a lot needs to be done on this front.
According to the industry estimates, total tax on a car still amounts to 54% of its basic price at the factory premises. Thus, any further reduction in taxes can go a long way towards boosting the demand for cars in the country.
Low interest regime: Favorable interest rates prevailing in the country have also enabled the demand to grow at a fast clip. Infact, today almost 80% of the cars sold in the country are financed.
With more and more banks jumping into the fray and trying to outdo each other in order to grab a pie of the lucrative auto financing market, interest rates are likely to remain competitive (though with an upward bias).
Infrastructure improvement:Having realised the importance of top class road infrastructure, the government has taken various initiatives to improve the road infrastructure through various initiatives.
While the NHDP will be focusing on building better quality highways, other initiatives will address the rural road development. Apart from aiding the economic growth, better road quality would also help in propelling the demand for passenger cars in the country.
Thus having looked at some of the key reasons behind the robust growth in the passenger car industry, we believe that the industry is in a position to top the CAGR of 11% of the last five years and grow at even faster clip over a similar period in the future. There might be some occasional blips. But on a point-to-point basis, the growth is likely to be attractive.
However, the key aspects an investor to keep in mind is what kind of profitability a car manufacturer is likely to make over the long-term, especially when competition is intensifying.
Global carmakers margins at the operating level have peaked at around 7% to 8% levels (Honda and Nissan being the classic case). This when compared to the Indian players are significantly lower. The risks therefore, are two-fold:
The imperative to launch new models will not recede. For every new launch, the cost at the operating level is likely to increase without a commensurate rise in profits. So, margins will be squeezed.
More importantly, investment in assets will increase to comply with new safety and environmental regulations. Incrementally therefore, return ratios could suffer at the margin.
While there is a strong case for investing in passenger car manufacturers, if an investor keeps these factors in mind, the chances of going wrong can be reduced.
Equitymaster.com is one of India's premier finance portals. The web site offers a user-friendly portfolio tracker, a weekly buy/sell recommendation service and research reports on India's top companies.