Indian Automobile Sector 2.0: Evolution through Dieselization Author : Vatsal Sethi,Data Analyst,Value Research

Transcription

1 Indian Automobile Sector 2.0: Evolution through Dieselization Author : Vatsal Sethi,Data Analyst,Value Research The past few years have been very traumatic for the Indian Automobile Sector. Recognised worldover as the biggest emerging market and characterized by high growth, it was suddenly stopped in its tracks by an array of developments. Prolonged recession, weak global economy, a state of policy paralysis at home and loss of foreign investments were the root causes. The cumulative effect of these events led to an unexpected upheaval of the industry. Volatile fuel prices are one of the most important catalysts of this story. Yo-yoing global Brent crude oil prices had a direct impact on the domestic Petrol and Diesel prices. Further, government s intervention meant that these increses were never proportionately transferred to the end consumers. This took Petrol and Diesel farther and farther from each other on the price graph. Consumers initial dilemma and their subsequent affinity for Diesel went on to define the Indian Automobile Sector over the next few years. Like any good movie, the dieselization story of the Indian Automobile Sector too is filled with interesting characters, an oscillating plot and an open ending.

2 Volleying Fuel Prices To understand the drastic increase and price disparity between Petrol and Diesel prices, we first need to understand the pricing mechanism in India. The pricing mechanism can be likened to a pyramid. Because of our high dependence on imports (75-80%), foreign exchange rates make the foundation of the pyramid. The next several rungs are formed by numerous taxes like customs duty, central excise rates, VAT, highway cess and education cess. Finally on top comes the small margin accruing to Oil Manufacturing Companies. Forming the foundation and the most sizable rung of the pyramid, even the slightest of foreign exchange fluctuations have a cascading effect on the overall fuel prices. To illustrate, a 10% increase in Foreign Exchange rates have led to a 50% jump in Fuel prices over a 6 year period (see Table). Sources:

3 The violently swinging fuel prices in the past few years can be largely ascertained to the high elasticity between fuel prices and rupee-dollar valuations. Year Forex Diesel Petrol Price Gap (Prices are taken as Approximate values of Yearly Averages) Onslaught of the Global Economic Recession It took economic recession about a year s time to reach the Indian shores. Gripping consumers and manufacturers alike, it quickly tightened its noose around the economy. The consumers, struggling with high inflation, shrinking disposable incomes and high financing costs started becoming double minded about investing in new vehicles. Rising petrol prices also meant dearer fuel bills. Auto players on the other hand were facing one quarter after the other of sluggish growth. From enjoying a continuous growth of 17.2% over the last few years, the recession brought it down to roughly 7-8%. Manufacturers who had earlier invested heavily on the basis of past growth were now forced to hold high inventories and run plants on low production capacities. Adding fuel to the fire, rupee devaluation also accounted for rising input costs.

4 Year Passenger Vehicle (PV) Sales Source: Consumers and manufacturers alike were facing pressure on all fronts. Both were looking at alternatives to ease their problems. During the same period, the price gap between Petrol and Diesel began to inflate to abnormal levels. Source:

5 With Diesel becoming up to 50% cheaper than Petrol, customers saw savings in relative terms. Ignoring the high acquisition costs, majority of customers flocked towards diesel cars chasing fuel efficiency and low running costs. From being only sold half as much as their Petrol cousins in , they were now being sold in comparable numbers, even matching them in , a feat which was observed for the very first time in the Indian Automobile Sector. Manufacturers meanwhile scrambled to meet the seemingly unending demand as Diesel cars started comprising around 75-80% of total sales in models with both the options. Diesel Vehicles Sales in the Past Years Diesel Sales Total PV Diesel PV Petrol PV Year Percentage Sales Sales Sales Price Gap Ratio % : % : % : % : % (Percentage figures and Ratios are approximate and rounded off)

6 Caveats: No piece of data should be relied on its face value. It s only when we dig deep that we unravel the true picture. 1. There are around 510 Diesel Cars available for sale in India starting from Rs. 5 Lakh as compared to around 445 Petrol Cars available for sale in India starting from Rs. 2 Lakh. 2. Most SUVs, which have shown explosive growth in the recent years, are mostly diesel powered barring one or two. 3. Out of 1, 74, 997 cars sold in March 2014, cars have no Diesel variant available. (namely Alto, WagonR, i10, Santro, Omni, Celerio and Eon) 4. Out of 1, 74, 997 cars sold in March 2014, cars have no Petrol variant available. (namely Bolero, XUV 500 and Scorpio) 5. While observing the sales data by Body Type we see that in Hatchbacks, which command the lion s share of 51%, 12 of the 30 variants don t even have a Diesel option.

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8 Winds of Change The apparent shift towards diesel vehicles sent shockwaves throughout the industry and had most manufacturers caught by surprise. Years of dependence on Petrol had them classically conditioned to build capacities and expertise centered on Petrol vehicles. Hence, it took them some time to set sails and steer in a new direction. However, a distinction has to be made between passenger vehicle and utility vehicle manufacturers. Years of dependence on Petrol had conditioned them all to build product mix based around a family of petrol engines albeit a few options for diesel. Honda, for instance, was the worst placed strategically. Having a purely Petrol centric product line, it did not have even a single diesel product and consequently bled the most. On the other hand, Utility vehicle manufacturers like Tata and Mahindra, by the nature of their produce, had a healthy presence of diesel engines in their offerings. Strategically speaking, they were positioned right at the center of this shift and were the first ones to ride the wave. As soon as the realization came that this was not a one-time thing but a phenomenon which will stretch far longer, everyone rushed to the drawing boards and tinkered with the existing plans to include diesel engines in a significant manner. Maruti Suzuki Seen as a relatively late entrant in the diesel car space, the company has worked overtime to increase output through an alliance with Fiat. Beating the market trends, Maruti Suzuki has been able to expand volumes only because of explosive growth in its Diesel segment. Most of its diesel offerings like the Swift, Dzire, Ertiga and Ritz have lengthy waiting lists. MSIL s Diesel vehicle share increased to 58 percent from 48 percent in and to a high of 61% in Petrol vehicles consequently declined for consecutive years. Small car segment, its forte, too declined 13 percent.

9 Honda Having a Petrol-only product portfolio, shed tears of blood while others made hay in the sunshine. To claw its way back in the market, Honda bought out its Indian partner and produced its first ever diesel engine i-dtec in Now staying bullish on the back of strong horses like the Amaze and the City, Honda is in process of investing Rs crore in a new car assembly line, diesel engine plant and forging plant at its new manufacturing capacity at Tapukara, Rajasthan. It has also annexed Rs. 500 crore for a fresh R & D centre. Volkswagen Volkswagen India turned out to be the most far sighted and prepared manufacturer considering the sudden shift towards Diesel vehicles. While setting up shop in 2007, it decided to manufacture both petrol and diesel cars simultaneously. This enabled it to quickly churn out oilburners while other scrambled for them. Having a Diesel-Petrol sales ratio of 75:25, the situation has turned out pretty well for it. Same goes for Skoda, a Volkswagen group company, for whom it has been easy to manage the shift due to the synergies it derives from the parent company. Hyundai Although 60% of its i20 customers and 80% of its Verna customers prefer Diesel, it took the Korean major close to two years to set up a Diesel engine plant in India. Incurring additional costs on importing Diesel units from South Korea, in 2014, the company finally decided to pump in Rs.1600 crore for a Diesel engine factory in Chennai. Ford Riding on the wave of its DuraTorq engines, Ford was deriving only 30% sales from Petrol engines. Factoring in the export demand, the company took no time to add an extra annual capacity of specifically 80,000 diesel power units to its existing 2,60,000 units capacity.

10 The Great Diesel Gamble There s no denying the fact that diesel vehicles have had a stellar run in the market so far. Many believe that Diesel is the way to go. However, before engaging the top gear, we must pay attention to the cautionary signs coming on the way ahead. Monthly Diesel Price Increase Routine In January 2013, the cabinet had decided to raise diesel prices by 40-50paise/litre per month until losses on the fuel were completely wiped out. A total of Rs. 8/litre (approx) has been increased till now. If the government continues this price revision and the price gap starts hovering around Rs.10/litre, Diesel cars will become unviable for majority of buyers and they ll graciously switch back to Petrol ones. Diesel De-Regulation In November 2013, petroleum minister Veerappa Moily announced deregulation of Diesel by May Though not set in concrete due to nearing elections, if decision this goes through, diesel will become market-linked like Petrol and will rise/fall in relation to global crude oil prices. At present Diesel being under Government s control is relatively stable and largely immune from price shocks. Once it gets market linked, heavy fluctuations will lead to an unstable price and volatile price difference. This will aggravate confusions for the buyers and may tilt the balance back in the favor of Petrol vehicles. Additional Taxes on Diesel Vehicles The government is contemplating a proposal to levy an additional annual road tax up to Rs.50, 000 on SUVs. An even more abstract suggestion is doing the rounds in the Supreme Court asking it to impose an Environment Tax of 25 per cent (of the cost of the vehicle) on diesel vehicles to curb the growing levels of pollution in Delhi NCR. The problem is that both the proposals are considering only the Social Costs and not the Economic Benefits of diesel vehicles. In a nose-diving market, SUVs have been the only source of hope for the manufacturers and their stellar sales are a result of their comparable price to

11 sedans and hatchbacks. Increasing the acquisition costs will lead to considerable fall in their viability and consequent affordability. The Road to be Taken In the present market scenario, presence of Diesel vehicles in the product mix is a big plus. Thinking specifically in the short-term, Diesel vehicles has the potential of turning around balance sheets and bringing back companies from dead. From rolling in the deep a few years back to scorching the sales charts, Honda has come a long way on the back of its Amaze and City Sedans. Having a Diesel based Utility Vehicle-centered portfolio, Mahindra & Mahindra, known for tractors and farm equipments took 3 rd position in 2013 with over 11% of the passenger vehicle market under its feet. The market has numerous such success stories stemming from Diesel engine. But, owing to long product lifecycles, massive initial capital outlay, automobile industry is not the place to rely on short-term planning. Looking in retrospect, one is startled to discover that this mad rush for diesel vehicles was almost non-existent 5 years back and unthinkable in the beginning of the decade. In spite of all the caveats, when we consider the evolution curve of the market and the present operating environment, it is safe to say that this present craze for Diesel vehicles is here to stay. Dieselization is not a fad, rather a brand new phenomenon which will come to shape the industry in the coming years. The manufacturers, who have faith in the long-term feasibility of the industry and are not just here to survive but to win, must set up capacities for developing Small Capacity Diesel Engines.

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