Steady rise in metal prices is a big risk for the automotive industry

The steady rise in metal prices is set to raise raw material costs for automakers and reverse the gains in margins accrued to the industry in the past few years from benign commodity and energy prices.

The pressure on the industry’s operating margins was already visible during 9MFY21. Analysts expect more pain for automakers since prices of steel and non-ferrous metals, such as copper, aluminium, and zinc, have increased further in three months.

Hot-rolled coil prices in China — that acts as the global benchmark for steel prices — are up 28 per cent since the beginning of the current calendar year; they are up 116 per cent in the past 12 months. As a result, steel producers, including Tata Steel and JSW Steel, have raised their prices in recent weeks.

The London Metal Exchange (LME) — that tracks the prices of non-ferrous metals — is up 14 per cent year-to-date and has rallied 66 per cent in the past 12 months.

“The steady rise in metal prices is a big risk for the automotive industry. It has the option to increase the product prices to a similar extent, but it will impact their volumes and revenue,” says G Chokkalingam, founder and MD of Equinomics Research & Advisory.

He says the exact impact on a company’s revenue and profit will depend upon the price elasticity of demand and market structure. But higher raw material cost has often translated into lower margins for the industry.

It shows in the profit and loss account of listed automakers. Historically, there is strong correlation between automakers’ raw material cost (as per cent of net sales) and international steel prices and LMEX prices. Expenses on raw material were equivalent to 72.7 per cent of automakers’ net sales in the first nine months of FY21, up from 68.4 per cent in FY20 and two-decade low of 67.1 per cent in FY18.

The Business Standard analysis is based on the profit and loss accounts of top five listed automotive manufacturers — Maruti Suzuki, Bajaj Auto, Hero MotoCorp, Ashok Leyland, and Eicher Motors. All numbers are on a standalone basis and exclude subsidiaries and joint ventures.

Car and two-wheeler makers have tried to pass on the higher raw material cost by raising their product prices, but historically higher raw material cost has most often resulted in lower operating margin for the industry.

For example, auto companies’ core operating margins (excluding exceptional income) was down to a 20-year low of 7.6 per cent of net sales during the April-December 2020 period.

Analysts at Motilal Oswal Securities, for example, expect automakers to report a quarter-on-quarter decline in net profits in the fourth quarter (Q4) of FY21, despite steady volumes and revenue.

Metal companies, on the other hand, are expected to report the highest-ever quarterly profits in Q4FY21.

The impact is already visible in the stock price and market capitalisation (m-cap) of automakers. The BSE Auto Index — that tracks the m-cap of listed auto companies — has begun to underperform the broader market. The Auto Index is down nearly 12 per cent from its 52-week high, against 5 per cent decline in BSE Sensex from the highs.

The Street expects the industry to remain a laggard, with most analysts either neutral or underweight on auto stocks.