Pressure on credit quality of diversified auto component suppliers expected to abate: CreditAlert

25 Sep 2009 , 07:16 PM

CRISIL keeps all its outstanding credit ratings under continuous surveillance. The surveillance process ensures ongoing monitoring of all sectors, and involves frequent interactions with issuers to understand trends and track actual performance against projections. CRISIL also has detailed periodic meetings with issuers to get a closer understanding of their business and financial position and strategy. Building on the strength of this surveillance process, CRISIL has introduced CreditAlerts, providing investors and the market with more insights into today’s dynamic business environment. Each of CRISIL’s CreditAlerts will highlight sharp trends and key developments in a specific sector, and the likely implications of these trends on the credit quality of companies in that sector. In recent months, the domestic demand for automobiles – especially two-wheelers, passenger cars (including utility vehicles [UVs]), and light commercial vehicles (LCVs) – has witnessed a return to healthy growth. CRISIL believes that this growth has positive demand implications for autocomponent suppliers because of their business linkages with the automobile sector.

The demand for two-wheelers and passenger cars (including UVs) increased by 15% and 21%, respectively, in the first five months of 2009-10, compared with the corresponding period of 2008-09 (refers to financial year, April 1 to March 31). The demand for LCVs increased by about 11% during the first five months of 2009-10 over the corresponding period of the previous year. This contrasts with the near stagnant or negative demand growth for these segments during 2008-09. Better availability of finance, lower cost of finance on decline in interest rates, more income in the pockets of a large section of consumers following the implementation of the Sixth Pay Commission recommendation, and increased rural penetration, have supported this demand growth. CRISIL expects this growth trend, if sustained, to help improve the utilization rates for most suppliers in the current year.

In addition to a better domestic demand outlook, many auto-component suppliers are also expected to benefit from the decline in input prices. Besides, most component suppliers have also exhausted their high-cost inventory, which had mounted due to a slowdown in off-take in the second half of 2008-09. Furthermore, auto-component suppliers have also implemented several cost reduction measures and are exhibiting greater caution in undertaking capital expenditure programmes. These trends will help auto-component suppliers to offset the severe pressure they faced on their business and financial profiles in the past 12 months (refer CRISIL’s article “Weakening demand dents automotive component suppliers’ creditworthiness” dated January 2009), and may even enable them to improve profitability, control debt, and prevent further deterioration in their capital structure.

Going forward, CRISIL expects easing of the ongoing pressure on the credit profiles of component suppliers, especially those that maintain a healthy balance sheet, participate primarily in the growing domestic segments (two-wheelers, passengers cars and UVs, and LCVs), and are diversified with a reasonable presence in the after-market, where demand continues to be stable. Should some of these trends sustain, these can set the stage for a potential improvement in the credit quality of these suppliers over the medium term. Conversely, entities with a weak capital structure, narrow product profile, and having a greater reliance on the medium and heavy commercial vehicle (M&HCV) segment or export markets, where demand remains weak, are unlikely to see a significant relief in their credit quality over the near term.

CRISIL currently has ratings outstanding on 83 auto-component suppliers. CRISIL is carrying out a comprehensive assessment of the sustainability and impact of the above trends on the credit profile of its auto-component supplier portfolio. Any rating or outlook change as a result of this assessment will be announced in due course.