Auto Ancillary Stocks

Key points from Dr.Vajay Malik blog.

• Cyclical Business Performance: The auto ancillary sector is cyclical, meaning that periods of increasing sales and profit margins are typically followed by periods of decline. The source cites Jamna Auto Industries Ltd and India Nippon Electricals Ltd as examples of companies that have experienced this cyclicality.
• Low Bargaining Power: Auto ancillary companies have very little bargaining power with both their customers (OEMs) and their suppliers (large metal producers). OEMs often have multiple suppliers for each component, giving them leverage to demand lower prices. In addition, auto ancillary companies must compete with imports from other countries, such as China. The source uses India Nippon Electricals Ltd to illustrate the pricing pressure and challenges in recouping increased production costs from customers.
• Impact on Working Capital: The low bargaining power of auto ancillary companies also affects their working capital management. OEMs often adopt a “just-in-time” approach, requiring suppliers to deliver products just before they are needed, leading to increased inventory holding costs for the ancillary companies.
• OEM Preference for Large Suppliers: OEMs prefer to work with large suppliers who can provide a wide range of products. This creates a situation where “big becomes bigger” in the auto ancillary sector. Larger suppliers have better bargaining power with OEMs and can achieve economies of scale. Minda Industries Ltd, a large Indian auto component manufacturer, is presented as a case study of a company benefiting from its size and diverse product offerings.
• Importance of Technology and R&D: Auto ancillary companies must continuously invest in technology and research and development to stay competitive. This is particularly crucial as OEMs often include price reduction clauses in their contracts, requiring suppliers to find ways to reduce costs over time. Companies that fail to keep up with technological advancements risk losing market share. Gandhi Special Tubes Ltd is cited as an example of a company that faced challenges due to its inability to upgrade its technology to meet new emission standards.
• Technical Tie-ups and Acquisitions: Indian auto ancillary companies often engage in technical tie-ups with global players to gain access to new technologies. This is partly because Indian companies tend to spend less on R&D compared to their counterparts in developed countries. These tie-ups can also help Indian companies gain business from global OEMs operating in India. The source discusses the experience of Minda Industries Ltd, highlighting both the benefits and limitations of technical tie-ups. Acquisitions are another strategy used by auto ancillary companies to gain access to technology, expand product lines, and enter new markets.
• Challenges of Acquisitions: The acquisition-led growth strategy often results in complex corporate structures with multiple subsidiaries, associates, and joint ventures. This can make it difficult for investors to assess the true financial performance of a company, as consolidated financials may not always provide a complete picture. The source points to the case of Minda Industries Ltd, where consolidated financials did not capture the full turnover of the group. Additionally, the lack of transparency in reporting investments in various entities can hinder investors’ ability to evaluate investment decisions made by the company.
• Aftermarket/Replacement Market: The aftermarket segment, which involves selling replacement parts, is generally considered more profitable and less cyclical than supplying to OEMs. However, building a significant presence in this market is challenging due to factors like intense competition from the unorganized sector, price-sensitive buyers, and the need for large investments in distribution and marketing. Despite its focus on the aftermarket segment for over a decade, Jamna Auto Industries Ltd struggled to achieve meaningful scale in this area, illustrating the difficulties involved.