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Disclaimer: This is a broad industry article and not a commentary on any individual security. The intent here is to simplify and explain the working of a particular industry. This post is not a recommendation to buy/hold/sell any security. It is for informational purposes only. Investors should seek the advice of their independent financial advisor prior to making any investment decision based on this article or for any necessary explanation of its contents. The data used in this article is from publically available sources and we are not responsible for any discrepancy in the same.
After two detailed pieces on the credit card space, we move our sight to a sector that has been beaten up both in India & across the globe and will continue to see headwinds in the years to come: Automobiles. In that background, we thought it would be helpful to develop a deep understanding of the broad sector as well as individual niches so that if the market does present an opportunity, we have all our homework done, and can act fast and decisively. We start with one of the less glamorous parts of analyzing any industry (eating our frogs), the regulatory changes & government schemes. There are 6 major changes here - 1. Emission regulations: The switch from BS-IV to BS-VI 2. Electrification regulations: Faster adoption and manufacturing of electrical (& hybrids) 3. Commercial vehicle load regulations: Axle load regulations. 4. Efficiency regulations: Corporate average fuel efficiency norms. 5. Braking regulations Anti-lock braking system and advanced braking system guidelines 6. Insurance regulations In this piece, we will cover 1,3, & 4 leaving the rest for our next piece.
Let us dive into each of these to understand what they are and the potential implications of the same on the auto space.
BS-VI: As the threats of climate change become grow darker by the day, the need for environmental protection and emission control becomes even more important. It is in that context that the BS-VI regulations come in, which through a combination of better-refined fuel and a newer engine & exhaust systems aims to reduce particulate emissions from vehicles. Starting April 2020, all vehicles sold in India will be BS-VI compliant. BS-IV vehicles sold prior to the date will face no challenges and will be allowed to run unimpeded for their entire working life.
On the fuel front, BS-IV vehicles can run without issues on BS-VI fuel. BS-VI vehicles however are expected to run into issues if forced to run on BS-IV fuel, given the stress on exhaust systems. (We stop the discussion on fuel, for now, leaving a deep-dive on this for a later date.)
On the Auto side, this would require changes on both the exhaust and engine side. The exhaust will see the addition of advanced sensors & supply and dosing modules. The engine will see the improvement in plunger, injector, and cooler module to combust optimally, and monitor and process exhausts to meet requirements. There would also be additional liquids like "Adblue" required that help convert nitrogen compounds into nitrogen and water.
For the consumer, there are three main factors that matter: the fixed cost (of purchase), the performance, and the variable cost (mileage and maintenance). Let’s try to look at these one at a time.
The price is expected to go up for both petrol and diesel variants, with a mid-single-digit rise expected in petrol PVs and a mid-teens rise expected in the price of diesel variants. Diesel vehicles become more expensive due to the higher investments needed to move those engines to BS-VI. On the commercial vehicle side, firms would be much more concerned about the mileage the vehicles would have and not so much of the upfront cost since a majority of CVs in India are bought on loans, which makes the impact substantially less severe.
On the performance front, BS VI vehicles are expected to take a hit for similar engine displacement, although it wouldn’t be significant. Manufacturers can also make amends to the engine capacity to bring it at par with the older cars.
Which brings us to the variable cost front. On maintenance, BS-VI is definitely expected to be cheaper. One major input, AdBlue, which is used to breakdown Nox and is currently quite expensive but is expected to come down as volumes increase and technology mainstreams. On the mileage front commentary till now has been mixed, with four wheeler variants reporting minor decrease in mileage, two wheeler variants reporting an increase in mileage, and commercial vehicles expected to have the strongest increase.
The low cost of borrowing in current environments and lower variable cost benefits for CVs, could see a sharp uptick in commercial vehicle sales once the new regulations kick in. This will be welcome relief to a sector reeling against the additional stress of axle load regulations (discussed below) other than other demand and liquidity related issues plaguing the broader auto space. NBFCs providing financing to CVs could also see good business.
Axle load regulations - Next we look at commercial vehicle load regulations which were implemented in July 2018, around a year ahead of elections. Changed for the first time since 1983, Axle load regulations increased the permitted load on commercial vehicles by 20%-25%, with a tolerance of upto 5%. The move allowed more weight to be carried in a single journey, reducing logistics costs by around 16%-18%, but also consequently hurting the demand for trucks. (For a space that sees an 8% increase in tonnage a year, the axle load regulations effectively absorbed almost three years worth of demand.)
One rationale for the move is said to be the higher cost of raw materials for the government's infra-projects and affordable housing projects (which needed to be accelerated ahead of the election year), which were exacerbated by the overloading norms became stricter. Another reason could also be to reduce the friction of doing business in the country by reducing the logistics cost across the board, resulting in either better margins for the industry or better prices for the end customer. The axle norms bring India’s GVW (Gross Vehicle Weight) in line with most developed countries.
As discussed above, while this was a broad positive for the economy as a whole, there are select pockets that got hit disproportionately. The first of these is commercial vehicles. In line with expectations, CV volumes dropped sharply following the move. In many ways the sector is still reeling from the impact of the norms. The improvement that the BS VI regulations bring in, will offset the damage done here to a certain extent. The other major player that the move hurts is small fleet operators who lost the 'competitive edge' they had due to their ability to overload (larger operators ideally would refrain from flouting norms).
Fuel Efficiency+ Pollution control regulations- This brings us to the last piece for today’s post Efficiency norms - CAFE or the Corporate average fuel efficiency norms. These norms came into force since 2017, and have an additional kicker in 2022. The norms are aimed at reducing fuel consumption by improving fuel efficiency, thus reducing the harmful impact on the environment. For India, it also provides an additional benefit of reducing our oil import bill, something that has been an issue for the country for the longest time now.
The norms take the average of all vehicles sold by the auto player across fuel types and checks the weighted average by sales volumes. These are to be such that the Co2 emissions per km are less than 130gm till 2022, and below 113 gms thereafter. Over the long term, the intent here is to bring this in line with developed countries. (Expected by 2025).
Other than the move towards more fuel efficiency, the move is also expected to lead to a soft push towards electric vehicles. If the government so chooses, it can tighten the CAFE norms thereby increasing the pressure on auto players to transition to EV faster, presenting a very interesting lever in the hands of the government. While there were certainly talks around this, the current pain the Auto sector is in, and the huge amount of people who rely on it for employment could drive them to defer the decision.
That's it from us for this week. If you enjoyed reading our posts, please do share them on social media platforms and Whatsapp groups you are a part of! Will mean a lot to us, and your friends and colleagues will be a bit better off for it! We will be covering the other regulations and policies in one of our upcoming long-form posts soon.
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