3 big announcements in 3 days: What’s causing all the buzz in auto-ancillary sector?

Auto ancillary companies have been busy in the last few days.

On February 17, Minda Corp announced that it was buying a 15.7 percent stake in Pricol Limited. On February 18, Lumax Auto Technologies signed a deal to buy a majority stake in IAC India. Then, on February 19, Samvardhana Motherson announced a pact to acquire the Germany-based cockpit-module maker SAS.

What is driving these acquisitions?

According to these industry experts, the companies are bulking up to face disruptive trends such as electrification and premiumisation, they are moving up the value chain to survive, and they see reasonably priced, good companies to buy.

The first reason is simple—the future is here and it can be captured in what is called the LACE effect.

About two years ago, in March 2021, Elara Capital brought out a report and explained LACE as an acronym for the four trends that would disrupt the auto-ancillary market.

Elara Capital’s Jay Kale said the recent buying seemed to align with the four trends. Kale is a senior vice president, equity analyst (auto and auto ancillaries) at the brokerage.

In LACE, L stands for light-weighting. That is, according to the analysts, stricter emission norms would require automakers to make lighter vehicles.

A stands for active safety. Safety features in the car can be passive, such as airbags that are activated after a collision. Or they can be active features, such as the electronic stability programmes, which can stop the vehicle from skidding.

C in LACE stands for connected vehicle technologies, to enable vehicles to communicate with and respond better to their surroundings. For example, a vehicle can connect to the surrounding infrastructure, such as traffic lights, and let the driver know when to slow down or speed up.

E is for electrification of mobility and that by far has been the most disruptive. It is changing the demands from the crucial export market and has lopped off a large portion of the parts that a vehicle has.

In Elara’s report from two years ago, the analysts had said that nearly 19 percent of auto-ancillary exports from India were made up of engine parts. The report warned that this significant share would be at risk if the global transition to electric vehicles (EVs) takes off.

If we look at Samvardhana Motherson’s SAS buy, we can see that it gives the Indian ancillary company a deeper exposure to the EV market. The target company, which is a German cockpit-module maker, has electric vehicles making up 50 percent of its order book.

HDFC Securities’ institutional research analyst Aniket Mhatre said that auto ancillaries that have had an internal combustion engine or ICE focus will now ensure that they have an EV focus as well.

Besides these future trends, there are other drives for this buying spree. Mhatre said that PLIs or production-linked incentive schemes could also be behind this. He said that a lot of localisation is taking place in auto-component manufacturing. Assembly lines will now need to be set up for a lot of components that were imported earlier, and that will open up opportunities for auto ancillary companies.

When the scheme was announced, the companies were grappling with various challenges, such as fall in demand and semiconductor shortages. Now that those troubles have passed, the companies are planning for incremental growth opportunities.

Also, he said, a lot of MNCs are looking to make India a sourcing destination, which is driving demand for auto-ancillary vendors, which in turn is leading to these acquisitions.

Premiumise or die

Varun Baxi, research analyst for the auto sector at brokerage Nirmal Bang, said that the auto ancillaries have to premiumise and that will go beyond the electrification trend.

“A significant portion of revenues, or around 15 percent of the revenues, for Indian ancillary companies comes from exports. Therefore, the companies have to keep pace (with the changes in the global market),” he said.

Baxi cited the example of Unitech Machines, which lost clients in the lighting vertical to competitors such as Lumax Auto because they lagged in the premiumisation journey.

Also, auto ancillaries need product diversification for their next leg of growth. “It has become very difficult for a single-product (vertical), single-customer, single-geography ancillary to survive,” said Baxi.

Basically, companies can power their growth by increasing their client list, their geographical reach or their product portfolio. Since the number of major clients now is limited and the export market gives only low- to mid-single-digit growth, the next spurt of growth has to come from their product line.

“You either increase the kit value of the product or increase the number of products,” said Baxi, adding that this is powering premiumisation and the acquisitions.

For example, Samvardhana Motherson’s acquisition of SAS will give the Indian company an entry into cockpit design and assembly. According to analysts, Motherson was making only parts of the cockpit and now they will make the entire module.

Himanshu Singh, research analyst (auto) at Prabhudas Lilladher, also pointed to better margins that come from this acquisition. For example, SAS did around 11.5 percent EBITDA (earnings before interest, taxes, depreciation and amortization) margin in CY22, while Samvardhana Motherson in their modules and polymer products had a margin of 6.3 percent in FY22.

Similarly, Minda’s Pricol stake buy can be seen as the company trying to expand its presence in the instrument cluster segment. Pricol is a market leader in this product category, particularly in two-wheelers.

“The instrument cluster is a new product line for Minda. Last year, they had made 10 percent of their revenues from this (product line) but a year or two ago it had zero percent share in the company’s revenues. Now they are looking to increase exposure in this category,” said Prabhudas Lilladher’s Singh.

With EV adoption, the market has also shrunk for auto ancillaries. “With EVs, 25-30 percent of their market, both in terms of the number of products and in terms of the kit value, is gone. The engine (ICE) has the maximum number of parts and that entire thing has gone. The engines are getting replaced by the electric powertrain, which is electronics heavy,” said Baxi.

The market is also becoming increasingly competitive. As Baxi put it, “This is more of a winner-takes-all market.”

“While this is true for both the replacement market and the OEM market, it is a more pressing reality for the OEM market. That is also a big reason that is driving the consolidation,” he added.

According to Baxi, the pandemic was a strain for many companies across the world. These are essentially good companies, which are technologically advanced, and have now become available at an attractive price. Indian auto ancillaries that have a strong balance sheet and good track record are swooping in to make the best of this opportunity.

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