To start with the post and to build some context, let's start with the story. In 1928, an American boxer who went by the name of James J Braddock pulled off a major upset by beating Tuffy Griffiths. He got an instant fame but down the years owing to injuries in his right hand, suffered losses. With his family in poverty, he was resorted to menial jobs during great depression where he worked with his left hand. Eventually his left hand became so strong that he returned to boxing only to pull off another major upset by beating Tommy Loughran.
This story is also on the similar context where auto sector pulled of Tuffy Griffiths moment post 2008 sub prime mortgage crisis where it grew phenomenally.
Let's have a look at NIFTY auto index from the period May 2018 to present.
Source: Link
Now straight away jumping to Great Depression era of James J Braddock in auto sector, we observe that there has been a fall of ~40% in the index. For the folks concerned about the definition, NIFTY auto index is designed to track the behavior and performance of automobile sector which includes each and every sector in the full value chain. For eg. manufacturers of automobiles, commercial vehicles, auto ancillary players, Tyre manufacturers etc. Which brings us to the next question what is afflicting auto sector in India and what is the way ahead?
One thing from the graph is pretty much evident that the decline started in Sep 18 which coincides with the NBFC slump. To understand how auto sector got impacted due to NBFC crisis, we need to delve deeper into the crisis.
NBFC typically lends money for a longer period, say a housing loan of 25 years. They tend to make money by borrowing it at a cheaper rates through different institutions by issuing commercial papers. The problem lies in the repayment period for NBFC's which typically ranges from 6 months to 1 year. While they are lending for longer duration, they are borrowing the money for short duration and once payment is due, they issue a new set of commercial papers, raise the money and pay their older dues.
This scenario changed all of the sudden with DHFL and IL&FS crisis when they failed to pay their lenders. The government had to step in and the mutual fund houses which already had a lot of exposure to NBFC's, had to cut their exposure. This led to what in classical parlance, is known as Asset Liability Mismatch
NBFC's play a major role in the auto sector both on supply side as well as demand side. From demand side perspective, they were unable to provide the loans to consumers. From supply side, they were unable to finance showroom dealers to meet their working capital requirements.
The other reason for the slump is the slowing economy and hence decrease in demand. This decrease in demand has led to inventory pileups for OEM's. This problem is clearly evident where the dealers have trimmed their inventory levels to 21 days (Source~ Link).
To make matters worse, the VC money poured into on demand cab aggregators and pre-owned car distributors have also made the matter worse (Source: Link). New age startups are solving the problems which consumers used to face while making the decision of buying pre-owned cars.
The other reason for the slump is the slowing economy and hence decrease in demand. This decrease in demand has led to inventory pileups for OEM's. This problem is clearly evident where the dealers have trimmed their inventory levels to 21 days (Source~ Link).
To make matters worse, the VC money poured into on demand cab aggregators and pre-owned car distributors have also made the matter worse (Source: Link). New age startups are solving the problems which consumers used to face while making the decision of buying pre-owned cars.
The upcoming BS-6 norms and the government's push towards electrification is sure to raise the prices of the vehicles which can further dent the demand.
Given the existing scenario, the government can play a significant role to arrest the auto slowdown. Primary among them is easing credit, providing economic stimulus to kick start the economy, rolling out the policies one step at a time when the entire ecosystem is ready. The most common lament from the auto industry is that the industry itself is not ready for EV rollout. It requires a lot of investments from OEM's, ancillaries and after market service providers. The government should rollout these policies once the industry is ready as a whole, to take on electrification push. Also the GST rate cuts by government would help the industry stimulate
the demand. The current GST rate of IC engine powered vehicles vary from
~28% and can go as high as ~50%. (Source:Link)
Lastly, the question arises about the path to recovery of beaten down stocks and go towards the path of beating Tommy Loughran. The bluechip stocks of the likes of Motherson Sumi have fallen by ~50% in the past one year as is evident from the chart:
Source (Link)
The electrification of automobiles is sure to happen. The players which are resistant to changes today, can find their existence in peril once electrification comes in. The players who are embracing the changes and making themselves prepared for it, can reward their shareholders with the better return. A case in point: Motherson Sumi is the supplier for 6 out of 10 EV commercial vehicle makers.
Government interventions along with the sector's embrace to the future would largely result in creating a winning combination for the sector in a longer run.
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