ICRA Rating Feature

INDIAN PASSENGER VEHICLE INDUSTRY: GROWTH MOMENTUM TO

CONTINUE

Contacts:
Anjan Ghosh
aghosh@icraindia.com +91-22-3047 0006

SUMMARY
With expected sales of ~2.5 million passenger vehicles in FY11e, Indias passenger vehicle market ranks as worlds seventh largest; larger than markets like United Kingdom, France and Spain by volume India has been one of the few markets globally to buck the recessionary trend and record a strong 25.6% volume growth in FY10. The growth momentum continues to be on track with first eleven months of FY11 registering a growth of 29.8% over the corresponding period in the previous year Strong economic growth, rising disposable income levels, favorable demographics, easy financing environment and relatively low car penetration have been the prominent growth drivers for the industry While at the one end, the growing domestic market is attracting foreign OEMs, on the other, established players are positioning themselves as strong contenders to offer low-cost car manufacturing capabilities to the world So far, most foreign car makers, barring Hyundai have focused on the sedan and premium segment cars, shying away from the highly competitive small-car segment; with these players now launching small-cars that too designed keeping in mind specifically the Indian consumer, the small-car segment, which has so far been dominated by three players commanding over 80% of the volumes is likely to see increase in competitive intensity Some of the newly launched models have had good initial response and have been aggressively priced, indicating new entrants strategy to grab market share while sacrificing profitability Large established incumbents in the Indian passenger vehicle market derive strength from their low-cost manufacturing capabilities (especially in the small-car segment), strong brand recognition and wide distribution & servicing reach, something which can be difficult to replicate We believe, while the incumbents will have these competitive advantage over newer entrants, these are likely to diminish in the long-run as new players with global experience gain brand recognition and expand their network and product offerings Superior small-car portfolio, a wide distribution and service network and competitive pricing on the back of locally sourced auto components are going to be the key factors in determining the success of a foreign OEM in the Indian market

Subrata Ray
subrata@icraindia.com +91-22-30470027

Shamsher Dewan
shamsherd@icraindia.com +91-124-4545328

March 2011

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ICRA Rating Feature

Indian Passenger Vehicle Industry: An ICRA Perspective

While competitive pressures are likely to intensify, we believe that strong GDP growth, rising disposable income levels, easy availability of finance and more particularly Indian consumers aspiration to own cars, especially given the state of public transport, would ensure that the industry will experience strong growth in the foreseeable future We estimate the Indian passenger vehicle industry will reach ~4.85 million in annual sales by FY16, representing a growth of 10.8% CAGR over the next five years Notwithstanding the strong long-term outlook, the industry faces certain near term challenges in form of rising commodity prices, interest rates, tightening liquidity scenario and increased competitive intensity We believe that rising labour costs is also likely to see cost increases across the supplier network, though it is likely to be mitigated by greater scale economies and higher degree of automation Within the lower priced segment (mini/compact), the price band is widening, with higher priced but better value products achieving higher volumes than some of the lower priced models. The price range may widen further depending on the success of the Nano segment

Strong growth drivers augur favourable prospects for the Indian passenger vehicle market The domestic passenger vehicles industry has been on a relatively steady growth phase over most of the last decade and has registered a 10 years CAGR of 10.3% during the period. It has been one of the few markets worldwide which saw growing passenger car sales during the liquidity crisis and recessionary phase witnessed during FY09. Buoyant economic growth, rising disposable income levels, favourable demographics, strong growth from tier II/III cities and rural India, together with improving availability of vehicle financing at competitive interest rates have been the key factors fuelling growth in the Indian passenger vehicle market. Among the emerging markets, India continues to have one the lowest car density, estimated at 13 cars per 1,000 people compared to other markets such as China (45), Brazil (160), and Indonesia (42). The growth has also been supported by OEM led initiatives like whole host of new model offerings from both from existing companies as well as new entrants in the market. Furthermore, in India, the car prices have remained relatively flat over the years (adjusted for the decline in duties) compared to steadily rising per capita income levels.
In addition to the strong domestic demand, the OEMs have also been positioning themselves as competitive small-car makers, benefitting from Indias technological capabilities in the manufacturing small-cars, scale economies and a well-established component supplier base. Over the past 10 years, export of vehicles have grown at a CAGR of 31.7% to achieve volumes of 0.45 million units in FY10. ICRA expects overall growth momentum to be sustained driven by strong domestic demand and increased thrust on exports.
Trend in Domestic Passenger Vehicle Volumes
2.5
2.0 30% 32% 49% 18%

1.5 1.0
0.4 0.3
0.5

1.1

0.7

0.7

FY 95

FY 96

FY 97

0.5

FY 98

0.5

FY 99

FY 00

FY 01

FY 02

0.7

0.7

0.5

FY 03

0.9

FY 04

FY 05

1.1

FY 06

FY 07

1.4

1.5

2%

-5%

-6% -2%

5%

FY 08

1.6

8%

FY 09

Domestic Passenger Vehicles (in Millions)

Growth (%)

Source: SIAM, ICRAs estimates

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1.9

28%

21% 12% 0%

FY 11M 10 FY11

2.3

26%

30%

60% 50% 40% 30% 20% 10% 0% -10% -20%

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Growth drivers in place to support demand

Passenger Vehicle Sales and GDP Growth
2,500 2,000 1,500 1,000 500
-

8.5% 7.5% 6.4% 5.8% 4.4% 3.8%

9.7% 9.2% 9.5%

12.0%

Current Estimate Germany U.K. USA Japan South Korea Russia Brazil Turkey China India

7.4% 10.0% 6.7% 8.0%

1,380

1,550

1,553

1,950

6.0%

734

707

675

1,062

902

1,143

4.0% 2.0%
0.0%

Indian PV Sales (in '000s)

Real GDP Growth Rate (%)

Passenger vehicle density (per 1,000 persons) 500 463 1,200 445 246 188 158 85 45 13

FY00

FY01

691

FY 03

FY 05

FY 06

FY 07

FY 08

FY 09

4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 -

Trend in India's per capita GDP

19.0%

FY 10

FY 02

FY 04

Trend in average borrowing rates

17.0% 15.0%
3,270 3,499

2,072

2,308

2,573

2,878

3,051

13.0%

1,574

1,667

1,731

1,888

11.0%
9.0% 7.0%

2010e

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10

GDP per capita, PPP (in US$)

Source: Indian Planning Commission, World Bank, IRF, SIAM, Industry, ICRAs estimates

Steady economic growth and favourable demographic profile Barring marginal blips during the last couple of years, the Indian economy has moved into higher growth (8.5%+) trajectory which is likely to be sustained over the medium term. In addition to steady economic growth, the passenger vehicle industry is also benefitting from Indias favourable demographic profile, which is reflected by its very young population (50% of population under the age of 25), steadily improving dependency ratio, growing urbanization and trend towards smaller, nuclear families. These trends in turn results in higher savings and increased ability to purchase vehicles, as well as explaining the preference for smaller-cars. In addition to favourable demographic profile, rising per capita GDP levels is also resulting in improvement in vehicle affordability in India, which is estimated to amongst the lowest when compared to other major automotive market. In India, the per capita GDP has almost doubled to US$ 3,270 between 2000 and 2009, while car prices (adjusting for the decline in duties) have remained almost at the same level as they were five years back, thereby increasing flexibility to own cars. Relatively low-penetration levels In terms of current market size (estimated at ~2.5 million units in FY11e), the Indian passenger vehicle market is relatively small compared to other emerging auto markets like China, South Korea and Brazil. Despite strong growth witnessed for a nearly a decade, penetration of cars in India continues to remain the lowest (refer to table above) among emerging markets. As growth in passenger vehicle has been more secular in nature, supported by both major cities and tier II/III cities, we expect that car penetration levels would continue to improve mirroring the

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trend witnessed by some of the other markets, particularly China, which witnessed 5x increase in car density between 2002 and 2009. Availability of finance at competitive rates With over 65-70% of cars being financed in India, availability of financing options at competitive rates has also been one of factors driving growth. In India, the vehicle financing penetration has been steadily rising over the years, facilitated by competition amongst banking and NBFC participants. In comparison to China, where vehicle penetration rates are much lower (~10-15%), India scores in terms of higher vehicle financing availability, which combined with increasing disposable income levels provides an ideal platform for strong growth going forward. Barring few instance of rise in interest rates, vehicle financing cost has declined over a longer period of time supported by favourable interest rate regime and relatively healthy performance of the asset class amongst various consumer finance categories. This has also encouraged lengthening of tenure of financing and LTVs, further facilitating consumer flexibility. Favourable demand scenario from smaller towns and rural areas In addition to demand from urban areas, smaller towns and rural India have been incrementally driving demand for passenger vehicles in India. For instance, the share of sales from top-10 cities has fallen to 40-45% from 60%-65% over the last five-to-six years. Maruti Suzuki, also for instance now generates nearly 19% of its sales from non-urban areas compared to just 4-5% about five years back. This has largely been prompted by rising disposable income levels in smaller towns and rural areas, improving road connectivity and higher no. of earning members in the family. Industry estimates suggest that approximately 60% of the rural economy now depends on non-agricultural income such as trading, remittances from cities, employment in the manufacturing sector etc. That apart, substantial increase in crop prices, which has been moving up over the past three years, has also resulted in higher disposable income. Additionally, the increase in land prices across the country, and the implementation of the sixth pay commission has collectively helped in supporting the growth in the rural and semi-urban cities/tier III cities. The OEMs have also helped expand demand by targeting these markets with greater financing availability and better service & distribution reach.

India is likely to emerge as a small-car production hub In addition to strong domestic demand, India is well on its path of becoming a global production hub for small-cars. In 2009, it surpassed Japan to become the largest small-car market in the world, accounting for the sale of around 900,000 small-cars, as compared to 700,000 sold in Japan. India is also now the second-largest exporter of small cars, behind only Japan. In FY10, India shipped out nearly 450,000 vehicles, registering a CAGR (%) of 26% between FY06-10. Exports now form a considerable part of the Indian industry, accounting for 18.6% of the total PVs sold in FY10, compared to 7.3% in FY02, with small cars comprising over 90% of total passenger car exports in FY10.
Chart 3: Trend in export volumes, reflecting increasing share of small-cars
500,000 450,000 400,000 350,000 300,000 250,000 200,000 150,000 100,000 50,000 -

73% 56%
33%

78%

79%

78%

86%

90%

94%

94%

92%

100%

80%
60%

40% 20% 0%

FY 02

FY 03

FY 04

FY 05

FY 06

FY 07

FY 08

FY 09

Total Exports

Small Car Exports

FY 10 YTD FY YTD FY 10 11 % of small car exports

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Indian Passenger Vehicle Industry: An ICRA Perspective

The growth in export volumes was particularly strong in FY09 and FY10, benefitting from the demand arising largely from scrappage schemes offered by most European nations. While the export growth in the current year has the affected by higher base effect and repeal of scrappage scheme, the long-term prospects continue to remain strong. While Hyundai Motors and Maruti Suzuki are leading exporter accounting for over 90% of export volumes, other global players who have recently marked presence in India are pursuing opportunities set-up India as their manufacturing hub. Nissan is expected to start exporting Micra to Europe. India has become the largest export hub for Hyundai (outside Korea) with over 40% of its small car production catering to export demand from India.
Chart 4: Trend in export volumes Chart 5: OEM-wise market share in exports segment
Others, 0.7% M&M, 0.7% Tata Motors, 1.5% Maruti Suzuki, 33.1%

500,000 400,000
300,000

54% 6% 13% 10%

33%

200,000 100,000
-

60% 50% 40% 30% 20% 10% 0%

FY 06

FY 07

FY 08

FY 09

FY 10

Passenger Vehicles

Growth Y-o-Y (%)

Hyundai, 64.0%

Source: SIAM, ICRAs estimates

What it takes to become a global automotive production hub? In addition to low-cost manufacturing capabilities, other factors that determine a Attractive domestic market Political & Business & proximity to other countrys competitiveness in emerging as a Environment markets global production hub include an attractive domestic market, its governments favourable in becoming a trade policies, presence of an established and auto hub technologically-advanced component supplier base, an efficient supply chain and movement in exchange rates. In terms of cost Technological capabilities Low production cost & in a particular class of competitiveness, India has built up the scale efficient supply chain vehicles and significant competencies and cost advantages in the production of small cars. It benefits from lower development and labour costs, and improving auto component manufacturing base. However, poor infrastructure, resulting in higher logistics costs and changes in international duty agreements (i.e. FTA between Korea and EU) with competing manufacturing locations remain a significant factor in determining export potential from India. However, increased focus on fuel efficiency and international demand moving towards small-cars also augurs well for India. The industry is also witnessing a trend towards alliances or platform sharing in the exports segment.
Considering the auto makers quest for lower production cost, we expect India to compete increasingly with countries across markets that offer lower production costs and benefit from favourable government policies. Some of examples of nations that are likely to compete with India are Thailand and Indonesia (for exports to Asian markets), Czech Republic, Slovakia and Poland (for European markets) and Mexico (for North American markets).

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Interestingly, China which has emerged as the worlds largest automotive markets in the last decade is yet to establish itself as a global production hub, something that Japan achieved during the 1970s and South Korea in 1990s when these markets witnessed an upsurge in automotive production. In contrast to India, ownership restrictions in China make its less attractive for foreign OEMs to develop it as an export base though Chinas robust domestic market has attracted a large number of joint ventures and contributes to ~50% of domestic capacity. However several local Chinese manufacturers are now fast acquiring global scale and skill levels and have aspirations to establish strong presence in the developed markets.

Competition set to rise in the small car segment; higher priced small-cars gaining traction The strong growth reported by the industry and critical mass that achieved by the domestic market has attracted most of the global OEMs to the Indian market. Most global OEMs targeting India now have strong local strategies, India specific platforms/models, and view to establish India as one of their sourcing hubs. In terms of product launches in India, OEMs are now developing models specifically to meet Indian consumers preferences and market conditions compared to the past, where most global majors have chosen models from their existing platforms. Toyotas Etios and Hondas Brio (to be launched) are some of models that have been developed clearly keeping the Indian consumer in mind. Over the past two years, nearly 50% of the capacity addition has been by international OEMs. Barring Hyundai, foreign OEMs such as Toyota, Honda, Ford and General Motors have so far been present largely in the mid and upper end segment cars while shying away from the highly competitive small-car segment. However, recognizing the significance of entry level in India, now almost of all the OEMs including the recent entrants such as Volkswagen and Nissan are focusing on tapping the high volume small car segment in India.
The number of new model launches has increased substantially, particularly in the higher priced/premium end of the segment. Being the largest segment by volumes, the small-car segment has witnessed the highest numbers i.e. 11 new launches in the last three years (of which five were launched in 2010) with major ones being Ritz, A-Star, Zen Estilo (from Maruti Suzuki), i10, i20 (from Hyundai), Indica Vista (from Tata Motors), Ford Figo, Chevrolet Beat, Polo (from VW) and Etios (from Toyota). In the near term, Honda is also expected to enter the small-car segment (with launch of Brio) and Toyota is expected to launch the hatchback version of Etios.
Chart 6: Small car offerings in Indian market
40 35 30 25 20 15 10 5 -

Table 1: Planned launches in the small car segment Impending launches in the small car segment Honda Brio Toyota Etios (Hatchback) Hyundai New small car Maruti Suzuki - Swift Refresh General Motors - (through SAIC JV) Renault Nissan Bajaj Renault Small car Expected in 2011 2011 2011 2011 2012 2012 2012

FY 07 FY 08 FY 09 FY 10 FY 11 FY 12e FY 13e
Number of Small Car Offerings

Source: ICRA Research

The new models viz. Fords Figo, VWs Polo, and GMs Beat have made some inroads in the market with good initial response, while other players such as Nissan and Toyota with their recent launches are in the ramp-up phase. More importantly, the new models have been priced at fairly aggressive price points and as new entrants ramp-up their volumes and other players enter the market, we expect that the
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14

17

23

26

31

35

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small car segment is likely to see some fragmentation with incumbent players likely to face competitive pressures. Further, General Motors plans to introduce cars from its Chinese JV with SAIC also marks the beginning of a new trend, which could result in more Chinese players enter the Indian market in the long-run. Apart from SAIC (along with GM), BYD, Chery International, JAC and Brilliance Auto are some of the other Chinese auto-makers that have announced plans of exploring opportunities of entering the Indian market.

Small car portfolio and extensive marketing & servicing network key to succeed in India Typically during the initial launch phase, new models gain market share owing to heightened 100.0% interest among buyers but we expect that 80.0% 95.5% 94.5% 91.9% sizeable market share gain for new entrants 86.0% 60.0% will only be in the long-run as these players go through a phase of establishing recognition for 40.0% 14.0% their brand, expanding their distribution and 8.1% 5.5% 20.0% 4.5% service network. We believe that a wide 0.0% product portfolio, competitive pricing, FY 08 FY 09 FY 10 11M FY11 expectation of high fuel efficiencies, presence Top 3 Players Other Players of diesel versions and modern designing have been some of the factors that have helped players to compete successfully in this segment. The market share of the new players in this segment has been steadily increasing; in the current year, barring the top three players, the share of other players now stands at 14.0%.
Everyones eyeing a pie of the Indian market some announcements by OEMs Volkswagen Aims at achieving 10% market share in India General Motors Aims at scripting its success in China with Shanghai group in the Indian markets Has plans to introduce some of its already established models from its Chinese JV Renault Plans to launch five models between 2011-13 Nissan Plans to expand its offering to nine models by 2012; aims to capture 10% of the market Targeting India a global hub for outsourcing small cars as well auto components Toyota Plans to double its sales volume by next year with the launch of its small car Etios

Supported by efforts to increase localisation Interestingly most of the international OEMs, barring the established ones have had volatile earnings profile in India. Low economies of scale, high import content and exposure to foreign currency fluctuation have been the key factors affecting profitability. Now, with most OEMs targeting the highly competitive small-car segment, thrust on localisation of key components forms an integral part of international OEMs strategy to compete on cost. More particularly in the small car segment, where competitive pressures are relatively higher compared to other segments. Typically, localization levels are low (during the launch phase) and increases gradually over the years with pick-up in volumes. While localisation appears to be a straightforward route in achieving cost competitiveness, it is only meaningful at large volumes, involving large investments in capacity building. M&M-Renault JV in contrast had adopted a low investment (higher import dependence) strategy with its initial launch, enabling it to test the market response with limited investments. Besides cost advantage arising from
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lower duties and logistics costs, localization also helps in reducing fluctuation arising on account of currency volatilities. In terms of technological positioning, although the Indian auto component manufacturers may lack design know-how in certain product categories, their overall capability in manufacturing auto components, with consistent quality and reliability is now well acknowledged by global OEMs and component manufacturers alike. This is evident from the trend of increased localisation levels in most new models. Additionally, most auto global players are setting up capacities to locally develop and manufacture engines & transmissions in India with vendor development forming a key part of their strategy. Some of the international auto suppliers by virtue of their established vendor relationship with international OEMs have also set-up JVs with local players, benefitting the domestic auto suppliers with new technologies/platforms. Some of the OEMs have also set up their R&D centres in India, which are at present confined to providing basic localisation of imported components and research services.

New small car entrants also have aggressive dealership expansion plans Most of the new small car Table 2: Dealership addition plans by various OEMs entrants have aggressive plans to Cities Existing Dealer Network Expansion expand dealerships in coming Company covered Network Plans Maruti Suzuki 805 869 N.A years. However, we believe that Hyundai 290 300 320 incumbents wide distribution Tata Motors 250 N.A and service network will act as General Motors 210 250 their competitive advantage for Honda 71 120 150 (by 2012) some time to come as attracting Toyota N.A 117 150 (by 2012) new dealers for new players will Ford 100 159 N.A not be easy. Typically, a dealer Volkswagen 56 67 N.A generates 60-70% of its income Nissan 23 23 N.A from car servicing and spares and Source: company releases, media articles, ICRA Research with current vehicle population in favour of the top three players, OEMs will have to structure their sales commissions appropriately to attract investments by dealers.
Chart 8: Trend in Capacity Utilisation Demand Supply Scenario: managing constraints at suppliers end and finding 73% 50.0 76% enough skilled labour gaining priority 74% 45.0 72% 40.0 70% over anything else 72% 35.0 63% 30.0 In line with the strong growth witnessed by the 25.0 68% industry and strong prospects, capacity creation 20.0 15.0 64% has been at the core of each OEMs strategy for 10.0 5.0 the Indian market. In fact at this stage, OEMs 60% have been more concerned about managing FY09 FY10 FY11e FY12e FY13e production levels amid bottlenecks at suppliers Installed Capacity (in Lacs) Utilisation (%) end and labour shortages. Given the capacity Source: ICRA Estimates expansion plans, we expect capacity addition in excess of 50% between FY09-13e. Between FY09-11e over 50% of the incremental capacities have been added by international OEMs who have entered the Indian market over the last 2-3 years. Although manufacturing capacities are fairly flexible, majority of the capacity creation has been keeping in mind opportunities in the small car segment and exports market. In the medium-to-long run, although strong domestic demand and export potential is likely to keep capacity utilization over ~70%, we expect

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increasing competitive intensity to restrict the pricing power with OEMs and subsequently put pressure on their profitability indicators particularly in the current inflationary scenario.

Trends in JVs/ collaborations Globally, the automobile industry is going through a phase of consolidation and collaboration, triggered by stagnating demand, industry-wide overcapacity, increasing commoditization/ reducing pricing power and rising cost of implementing safety features and emission norms. As more global players enter the Indian market, the impact of this trend of partnership would be increasingly visible in this market too. Some of the active alliances in India include Fiat-TML (manufacturing JV and distribution sharing arrangement); Renault-Nissan (proposed facility share); SAIC-GM (Indian operation under JV, to bring products from SAIC stable), VW-Suzuki (likely collaboration in small car), Renault-Bajaj (small car). The number and scope of such alliances are expected to increase going forward as OEMs aim to rationalise their investments and maximise reach through alliances spanning technology, manufacturing and distribution.
Unlike the Chinese automotive market, where leading passenger vehicle players are mostly Joint Ventures (JVs) between global OEMs and local players due to ownership constraints, in the Indian context most of the JVs in the passenger vehicle space have not been able to make meaningful presence in the Indian market. These JV entities have either parted ways or restructured their product portfolio and business plans to meet Indian consumers preferences. In contrast however most of the Global OEMs now have a direct presence in India. In addition to contract manufacturing, the industry is also witnessing other collaborative arrangements such as sharing engines/platforms and distribution and service network. For instance, Fiats diesel engines are being used in some of Maruti Suzukis and Tata Motors cars. Similarly, Tata Motors manages the service and distribution facilities for Fiat in India. Furthermore, developments at global level, such as acquisition by Volkswagens of 20% stake in Suzuki reflect some further potential collaborative arrangements given Volkswagens increasing focus and Suzukis strong presence in the Indian market. We expect such alliances to gain momentum driven largely by the need to access technology (as we move towards developing hybrid vehicles) and distribution and service network. However, at the same time, consolidation in the form of entire companies being acquired as has been seen globally is unlikely.

GST roll-out to benefit the industry with reduced outgo

In addition to the fundamental factors driving demand, the likely Under GST roll-out of Goods and Services Tax 400,000 (GST) would create one time spurt in passenger car volumes as the average duties would come 64,000 down substantially (refer to table). At present, the effective Tax Component in the final prices 104,900 64,000 tax rates (including excise duty, Tax as a % of Final Price 21% 14% CST, and VAT) applicable on Source: ICRAs estimates passenger vehicles range between 21-38% depending on the size of the car. With implementation of GST, we expect OEMs to pass on the benefit of lower taxes at least some extent to induce higher volumes.
Table 3: Impact of implementation of GST on vehicle prices Under VAT Assuming Average Car Price at OEM 400,000 Add: Excise Duty @ 10% 40,000 Add: Central Sales Tax @ 2% 8,800 Add: VAT @ 12.5% 56,100 Add: Expected GST @ 16% -

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Utility Vehicles Segment: New model launches likely to pick-up With volumes of 275,556 units in FY10, the Utility Vehicles (UVs) accounted for little over 13% of the total market with growth averaging around 9% over the past five years. In India, the UV segment is primarily dominated by SUVs priced in the Rs. 7-11 lacs range. In line with the passenger car segment, top three players in the UV segment account for over 85% of the market, of which two are domestic players. A sizeable part of the UV market also caters to the people mover segment, which has also been one of the key growth drivers striving on demand from the growing IT/ITES sector. In this segment, the industry is witnessing an increasing preference towards smaller MUVs such as Maruti Suzukis Eeco for intra-city movement. More players are expected to launch models in this segment with major ones being Tata Motors (Venture) and GM (through its collaboration with SAIC).
Table 4: M&M dominates the market with presence in the mass segment
M&M Toyota Tata Motors Others FY 06 43.2% 18.9% 19.5% 18.4% FY 07 40.8% 19.8% 21.8% 17.7% FY 08 42.4% 19.7% 20.3% 17.7% FY 09 47.1% 17.0% 18.5% 17.4% FY 10 55.2% 19.7% 13.0% 12.1% YTD FY10 55.8% 19.6% 12.9% 11.7% YTD FY11 52.6% 20.3% 13.4% 13.7%

Source: SIAM Data; * Till February 2011

With the acquisition of Land Rover (by Tata Motors) and Ssangyong (by M&M), we expect Indian OEMs to consolidate their position in the UV segment with launches in the premium segment, leveraging on the platforms and technological expertise of the acquired entities. While Land Rover would largely cater to high-end segment, given the product profile, synergies with M&Ms existing models, Ssangyong is likely to compete in the upper-end segment, which is currently dominated by GMs (Capitva), Fords (Endeavour) and Hondas (CR-V). Both Tata Motors and M&M have expressed intentions not just to launch models from the foreign acquisitions in the domestic market but also pursue opportunities to locally assembly the vehicles. Similar to the passenger car segment, the premium SUV segment has also been of interest to the international OEMs with nine players entering the premium segment over the past six years.

Competitive pressures and cost-based headwinds to restrict profitability indicators The profitability indicators of passenger cars OEMs is influenced by a confluence of factors with predominant ones being fluctuation in input material prices, manpower costs, competitive intensity in the underlying market impacting the ability to pass on cost increases, and volatilities in foreign exchange. For OEMs in India, in addition to fluctuation in key commodity prices, fluctuation in foreign exchange movement has also impacted profitability indicators of OEMs as almost all the players have some import content and some of them significant export dependence. In India, leading OEMs derive cost competitiveness from their economies of scale and relatively high localisation content backed by efficient supply chain system. The profitability of OEMs without a meaningful presence in the entry level segment has been particularly volatile due to poor scale economies. In this context, some of the foreign players have had volatile earnings profile in their Indian operations driven largely by foreign exchange exposure, large one-time costs (related to platform development, marketing/launch expense) not being spread over large volumes and high import content. Now, with most OEMs targeting the highly competitive small-car segment, thrust on localisation of key components forms an integral part of international OEMs strategy to compete on cost.

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Chart 9: Trend in prices of key material prices and profitability indicators of OEMs

Trend in Key Commodities - Steel & Aluminium

3,500

Trend in Domestic Rubber Prices

50,000 21,000 18,000 45,000 15,000 40,000 12,000 9,000 35,000 6,000 30,000 3,000
Apr-07 Apr-08 Apr-09 Apr-10 Oct-07 Oct-08 Oct-09 Oct-10 Jul-07 Jul-08 Jul-09 Jan-08 Jan-09 Jan-10 Jul-10

3,000 2,500 2,000 1,500 1,000

May-07 May-08 May-09 May-10 Sep-07 Sep-08 Sep-09 Sep-10 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11

LME Prices of Aluminium (Average)

HR+CR Average Prices

Rubber Prices (Rs./Quintal)

Trend in RMC/OI (%)

85.0%
80.0%

Trend in OPBDIT Margins (%)

21.0% 18.0% 15.0% 12.0% 9.0% 6.0% 3.0% 0.0%

75.0%
70.0% 65.0%

60.0% Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 FY09 FY09 FY09 FY09 FY10 FY10 FY10 FY10 FY11 FY11 FY11
Maruti Suzuki Tata Motors M&M

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 FY09 FY09 FY09 FY09 FY10 FY10 FY10 FY10 FY11 FY11 FY11
Maruti Suzuki Tata Motors M&M

Source: Industry analysis services, company releases

Given the commodity-based headwinds being witnessed at present, rising labour cost (which results in cost increases across the supplier network) and limited flexibility to raise prices owing to increasing competitive pressures, we expect the profitability indicators of OEMs to remain under pressure. Although the impact of some these cost-based headwinds could be mitigated by greater economies of scale and higher degree of automation.

Outlook The passenger vehicle market size in India is now comparable to some of the developed economies of the world and ranks seventh globally. The presence of global players, introduction of global platforms/technologies and stricter emission norms indicate that the market is gradually attaining maturity. A buoyant economic growth, growing middle class population, rising disposable income levels, relatively low penetration of cars and adequate availability of financing are likely to provide an ideal backdrop for a sustained long term demand growth for the sector. However, with increasing interest from foreign players, competitive intensity is likely to become a key challenge for OEMs. With most major markets facing excess capacity and demand saturation, the Indian market is likely to remain a key destination for global majors over the medium term. With most of the international players eyeing the small car market, we expect the competitive intensity to increase in this segment resulting in greater fragmentation of market share, especially over the long-term. Apart from pricing pressure that is likely to increase with competition, the rising quality expectations and tightening regulatory norms on emission and safety are likely to push up cost pressures on OEMs. We estimate the Indian passenger vehicle industry will reach 4.86 million in annual sales by FY16, representing a growth of 10.8% CAGR over the next five years.
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Indian Passenger Vehicle Industry: An ICRA Perspective

With global demand shifting to smaller cars, global players are likely focus on strategies of producing cars of the same platforms in low-cost countries like India, Thailand and Mexico. In terms of cost competitiveness, India has built up the scale and significant competencies and cost advantages in the production of small cars. It benefits from lower development and labour costs, and improving auto component manufacturing base. Maruti Suzuki and Hyundai have already establish meaningful presence in exports out of India, and now many other global players including Renault-Nissan, VW, Ford have either adopted strategy or are in the process of exploring opportunities to develop India as part of their global manufacturing hub. Interestingly, China despite being known for its low-cost manufacturing capabilities and large automotive market supported by presence of international players is yet to establish a meaningful presence in exporting cars, though the situation may change over the medium term, especially considering rising capabilities and aspirations of its large local players. With most of the global players targeting the most competitive, small car segment, increasing localization remains critical for OEMs to establish profitable business given the competitive intensity in the small car segment. As a result, most OEMs are focused on increasing localization content to reduce costs and thereby compete with market leaders. Additionally, auto ancillaries will have to ramp-up their capital investment as OEMs continue to develop new platforms and increase their localization contents. Besides localisation of components, key challenges facing new entrants would be establishing a strong service/ distribution network, which has become increasingly prohibitive due to rising real estate costs in many markets. Going forward sharing and co-operation on distribution network and service facilities could play a significant role in rationalising cost structures. In terms of product launch, while most global majors are likely to choose from their existing portfolio for launch in India, key to success would be the ability to incorporate changes necessary to meet Indian preferences and market conditions.

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Annexure I: Industry Composition Passenger cars and utility vehicles are the main segments of the Indian passenger vehicle industry with the former accounting for 78% of total volumes. India has primarily been a small-car market, mainly due to the high demand for a cost-effective mode of transportation. Within the passenger car segment, small cars comprising A1 and A2 segment account for almost 80% of total volumes.
Passenger Car Volumes: Segment-wise concentration
100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%

16%

17%

20%

19%

82%

82%

21%

21%

18%

20%

18%

77%

77%

77%

FY 02

FY 03

FY 04

FY 05

75%

FY 06

75%

FY 07

FY 08

FY 09

77%

FY 10

78%

A4-A6: Executive, Premium, Luxury

A3 Segment: Mid-Size

A1-A2 Segment: Small Car

YTD FY 11

Source: SIAM, ICRAs estimates; YTD till February 2011

Unlike some of the other emerging markets where market shares are more fragmented, the Indian passenger vehicle industry has been dominated by three major players Maruti Suzuki, Hyundai Motors and Tata Motors, which collectively accounted for over 80% of total volumes in FY 2010. These players with their strong product portfolio, particularly in the small car segment, extensive distribution and servicing reach and strong brand franchise (created over several years) have maintained their market position for years together. However, as the Indian market has attracted several international OEMs, this trend is likely to undergo a change especially as most of the OEMs are now targeting the small car segment, the largest segment by volumes. Most OEMs are launching models keeping the Indian consumer in mind. In fact, most of the models being launched in India are either being launched for the first time in the world, or simultaneously in some other markets. Despite concentrated market share, the industry has been highly competitive, especially in the small car segment where incumbent players by virtue of their large volumes, facilitating economies of scale and established vendor base have competitively priced their models.

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18%

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Annexure II: Industry Statistics

Table 5: Trend in market share of leading OEMs in the domestic passenger vehicle market OEMs Maruti Suzuki Hyundai Motors Tata Motors M&M General Motors Ford Toyota Motors Honda Motors FY 02 50.4% 13.0% 13.2% 6.6% 1.3% 2.2% 3.7% 1.6% FY 03 46.7% 14.6% 14.7% 7.4% 1.2% 2.2% 4.3% 1.9% FY 04 46.7% 14.4% 15.5% 7.6% 2.0% 2.4% 4.7% 2.4% FY 05 45.9% 13.4% 16.9% 7.5% 2.7% 2.6% 4.1% 3.5% FY 06 46.1% 13.9% 16.5% 7.4% 2.7% 2.5% 4.1% 3.7% FY 07 46.1% 14.1% 16.4% 6.5% 2.8% 3.0% 3.7% 4.4% FY 08 45.9% 14.0% 14.7% 8.4% 4.3% 2.2% 3.6% 4.1% FY 09 46.5% 15.7% 14.9% 7.7% 4.0% 1.8% 3.0% 3.4% FY 10 44.7% 16.2% 14.7% 8.0% 4.5% 1.9% 3.3% 3.2% YTD* FY 11 44.9% 14.4% 14.0% 7.2% 4.3% 3.9% 3.1% 2.5%

Source: SIAM, ICRAs estimates; Note: Passenger vehicle volumes includes UVs and MPVs; * Till February 2011 Table 6: Trend in market share of leading OEMs in the export segment OEMs Hyundai Motors Maruti Suzuki Nissan Ford Tata Motors FY 02 10.2% 23.0% 57.2% 8.7% FY 03 12.4% 44.8% 38.3% 3.7% FY 04 32.6% 39.6% 18.6% 8.6% FY 05 49.3% 29.4% 13.6% 6.6% FY 06 58.1% 19.8% 9.2% 11.4% FY 07 58.2% 19.8% 11.6% 9.1% FY 08 66.1% 24.3% 1.1% 6.8% FY 09 75.5% 20.9% 0.2% 2.1% FY 10 64.0% 33.1% 0.3% 1.5% YTD *FY 11 52.0% 31.5% 10.4% 2.6% 1.9%

Source: SIAM, ICRAs estimates; * Till February 2011 Table 7: Trend in segment-wise growth Segment-wise FY 03 YoY growth (%) A1 + A2 Segment - Small 5.5% A3 Segment - Mid 10.1% A4 Segment - Executive 133.0% A5 Segment - Premium -7.1% A6 Segment - Luxury 14.5% Passenger car 6.4% Utility vehicles 9.0%

FY 04 21.3% 50.8% 553.2% 29.5% 35.2% 28.6% 28.8%

FY 05 14.1% 26.4% 78.9% 8.7% 61.5% 17.8% 20.5%

FY 06 8.1% 5.8% 7.3% 7.4% -41.3% 7.6% 10.3%

FY 07 25.7% 5.7% 49.0% -3.5% 361.5% 22.0% 13.3%

FY 08 11.6% 14.6% 2.9% 2.8% 105.2% 11.8% 11.3%

FY 09 0.7% 7.1% -20.3% 45.8% 26.8% 1.4% -8.0%

FY 10 27.4% 14.2% 37.8% 26.7% 15.7% 25.1% 20.9%

YTD* FY 11 30.2% 33.3% 14.3% 38.3% 37.6% 30.3% 19.7%

Source: SIAM, ICRAs estimates; * Till February 2011 Table 8: Trend in composition of domestic passenger car market Composition A1+A2 Segment - Small A3 Segment - Mid A4 Segment - Executive A5 Segment - Premium A6 Segment - Luxury FY 02 82% 16% 0% 1% 0% FY 03 82% 17% 0% 1% 0% FY 04 77% 20% 2% 1% 0% FY 05 75% 21% 3% 1% 0% FY 06 75% 21% 3% 1% 0% FY 07 77% 18% 4% 1% 0% FY 08 77% 19% 4% 1% 0% FY 09 77% 20% 3% 1% 0% FY 10 78% 18% 3% 1% 0% YTD* FY 11 78% 18% 3% 1% 0%

Source: SIAM, ICRAs estimates; * Till February 2011

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