Excess capacity starts to worry Indian car makers

Indian auto makers sold 3.22 million passenger vehicles in 2014-15 out of their annual capacity of 4.96 million, which is 65% of their overall capacity.

The head of India’s automobile lobby group is a worried man.

In several interactions with reporters over the past one year, Vikram Kirloskar, president of the Society of Indian Automobile Manufacturers (Siam), has flagged concerns on the country’s auto makers building new factories and adding production lines. The problem, he says, is that a prolonged economic slowdown has reduced demand, keeping a lot of the existing capacity idle. Yet, that has not stopped the companies from expanding capacity, hoping the market will pick up soon.

On 10 July, Kirloskar, who is also vice-chairman of Toyota Kirloskar Motor Pvt. Ltd, rang the alarm bell.

“There is a lot of excess capacity across the board,” Kirloskar said at a press conference to release the industry’s June quarter sales numbers.

“Sales are down. We are not even close to our peak levels of 2012-13. Any significant investment in capacity creation will take time as it becomes very difficult to make profits,” Kirloskar said.

The first signs of overcapacity showed up soon.

On 29 July, a mere 20 days after Kirloskar raised his concerns, the world’s third largest auto maker, General Motors Co. (GM), said it will shut of one of its two factories in India, as it looks to consolidate its operations in the country. What it did not say is that GM India posted its biggest annual loss of Rs.3,847 crore in fiscal year 2014. Its accumulated losses have expanded to Rs.6,552 crore, which is roughly what it costs to set up a car factory in India.

In this context, Kirloskar’s statement has a larger narrative. Have the auto makers bitten off more than they can chew?

According to Siam data, Indian auto makers sold 3.22 million passenger vehicles in 2014-15 in the domestic and export markets, out of their annual capacity of 4.96 million, which is 65% of their overall capacity. However, this percentage worsens if one takes out Maruti Suzuki India Ltd, Hyundai Motor India Ltd and Honda Cars India Ltd, all of which utilize at least 80% of their capacity. Exports accounted for 19% of the total passenger vehicles sold. Despite the low utilization, there is massive capacity expansion under way at Maruti, Honda and Mahindra and Mahindra Ltd. Once that happens in the next two-three years (see chart), the total installed capacity will reach 6.9 million units: a situation worrying enough for Kirloskar.

According to forecasts from leading consultants such as EY, PricewaterhouseCoopers (PwC), KPMG and IHS Automotive, the Indian passenger vehicle market will see 4.44-5.3 million sales annually by 2020. That still leaves around two million in excess capacity, which the auto makers will look to utilize via exports. But experts believe that will be a mammoth task.

For that matter, even the outlook for the domestic market is bleak. India’s passenger vehicle market expanded from 2.5 million units in 2010-11 to just 2.6 million at the end of 2014-15, and given the state of the economy, achieving five million in sales annually by 2020 will be a Herculean task.

After GM India, other auto makers, too, may have to take extreme steps, sooner or later.

Zeroing in on any particular company may be premature, but the reported financial health of some auto makers is worrisome.

Ford India Pvt. Ltd’s accumulated loss is more than Rs.2,000 crore even as it plans to invest $1 billion in Gujarat for a new vehicle assembly facility. Only three passenger vehicle companies—Maruti, Hyundai and Mahindra—are profitable.

“Quite a few guys have excess capacity today,” said Abdul Majeed, national automotive leader at PwC, a management consulting firm. “If they do not get their act together, they will have problems. If a company does not operate at 65% of its production capacity, it will incur huge losses as fixed costs and depreciation will continue to rise.”

Majeed said that while Japanese and South Korean manufacturers have made deep inroads into the Indian market, the Europeans and Americans have not been able to do so.

“Time may be running out for them,” Majeed said.

Overcapacity is a global phenomenon and it may have just started to show up in India. China will have about 11.4 million vehicles’ worth of idle capacity by 2017, more than double that of European auto makers, according to data from JSC and Deloitte Consulting. From 2005 to 2006, long before GM and Chrysler filed for bankruptcy and appealed for federal aid, US auto makers had excess capacity. They also had high fixed costs, including leases on factories and labour contracts that prevented them from laying off workers when demand dwindled.

The scenario is unlikely to be repeated in India, said Deepesh Rathore, co-founder and director, Emerging Markets Automotive Advisors, a Gurgaon-based consulting firm.

“GM is a different case. Their products could not match up to the expectations of Indian consumers,” Rathore said. “In my opinion, others are smarter and you cannot ignore the fact that only 17 out of 1,000 Indians own a car.”

Despite entering the Indian market in 1994, GM’s sales crossed 100,000 units only in 2010 and 2011, and dropped thereafter to 55,000 last year. It has an installed capacity of 282,000 units, which it will scale down to 220,000 after its consolidation.

However, to increase vehicle penetration, India will have to focus on rapid economic growth, according to Majeed. According to him, reaching sales of five million units by 2020 will be difficult if the economy does not pick up fast.

“We will not reach five million by 2020 if our GDP (gross domestic product) does not grow in the range of 7.5-8%,” Majeed said. “And I am talking about the old method of GDP calculation here, not the new one.”

India revised its method to calculate GDP growth in January. According to the new method, which has been questioned by many economists, the economy is expected to grow at 8% in the current financial year.

Analysts expect India to become the world’s third largest passenger vehicle market after China and the US by 2020.

Excess capacity has prompted Western car makers in India such as Ford and Volkswagen to boost exports and benefit from India’s low labour costs and economies of scale, apart from working to increase domestic sales.

But can exports compensate for the domestic slump and help auto makers utilize the idle capacity?

According to Pradeep Saxena, executive director, TNS Automotive, an auto consultant, it will not. “I am surprised that the industry has just 65% capacity utilization at present. Why has not anybody spoken about it?” Saxena said. “Exports won’t compensate that much as even the global markets are not doing great.”

That, coupled with local currency fluctuations and political unrest in countries where Indian firms export may affect exports further, said Majeed.

But, the industry is working very hard, said Kirloskar.

“You got to trust us for that.”

There is no official forecast for car exports from India.