Rating Criteria for

Auto Ancillary Companies

The Indian auto ancillary industry is relatively small by global standards;
global auto ancillary companies have sales that are far in excess of those of their
peers in India. Nevertheless, the industry's size has increased substantially
during the last decade in line with the growth in the production of automobiles
in India. There have also been significant improvements in production quality
in order to meet the requirements of the increasingly quality-conscious Indian
consumer.
Since its inception, CRISIL has assigned credit ratings to the debt instruments of
several leading players in the auto ancillary industry. The industry continues to
face pricing pressures and cyclical demand conditions from its customers in the
original equipment manufacturer (OEM) market. The replacement or after
market (AM), is more stable than the OEM market; however, auto ancillary
companies face challenges in the AM segment too, in the form of competition
from the unorganised sector and the OEMs, themselves. Increases in the prices
of commodities such as steel, aluminium and copper have also impacted the
auto ancillary players. These factors have resulted in a secular decline in
operating margins over the last few years; some companies have been able to
partly offset this trend by a growth in business volumes. CRISIL's ratings on
automotive suppliers take all these factors into account; they reflect the
company's exposure to these industry challenges.
The broader criteria of manufacturing companies do apply to entities in the
auto ancillary industry; however, this article details the industry-specific
factors impacting market position and operating efficiency of players.
BUSINESS RISK ANALYSIS
Market position

CRITERIA - Corporate Sector

Customer base
A diversified customer base is a strong risk-mitigating factor that can reduce
the adverse effects of a cyclical or structural change in demand conditions in a
vehicle segment (cars, commercial vehicles, tractors, etc.) or downturn in the
fortunes of an OEM.
A diversified customer base also strengthens a company's bargaining position
in negotiating supply contracts with OEMs. Companies that have diversified
their revenues across a large base of customers carry higher ratings than their
less diversified counterparts. Diversity may however, be less of an issue for
companies with an especially strong market position, particularly if their
products address high-growth areas.

Presence in the AM and export markets

Presence in the AM and export markets is another
factor that adds stability to a company's revenue
streams and consequently, its operational cash
flows. This is on account of the relatively stable
demand profile in the AM segment, and its low
correlation with changes in the domestic OEM offtake. Moreover, the AM segment is relatively
more profitable and less exposed to pricing
pressures than the OEM segment. Export
revenues also add diversity and stability to a
company's overall revenue streams; this is
because revenues from exports are de-linked from
the fortunes of the domestic automobile industry.
Market share
An auto ancillary's business share in the OEM and
AM segments reflects strongly on the company's
market position in the product range. A strong
market position, in turn, is a good indicator of the
company's ability to withstand pricing pressures
from OEMs and a determinant of its pricing
flexibility in the AM segment. It also reflects the
strength of the company's relationship with
OEMs, and therefore, its ability to procure new
orders from existing and new OEMs. A strong
market share, normally translates into large
business volumes; this gives the company the
benefits of economies of scale, enabling it to offer
competitive prices in both the domestic and export
markets.
Operating efficiency
Cost structure
In an industry that is constantly looking at cost
reduction avenues, a company's material costs
constitute a strong focus area; operational
efficiency therefore translates into ability to
sustain market position in a competitive
environment. Operational efficiency is measured
in terms of labour productivity, capacity
utilisation, cost structure etc., which influence the
overall costs of production. Companies with
strong operational efficiencies and consequently,
cost-effective production practices, attract the
attention of cost-focused OEMs. Moreover, an
operationally efficient company is in a better
position to withstand pricing pressures from

OEMs in a scenario of secular decline in

component prices. Operational efficiency is a key
determinant of credit quality and is adequately
reflected in the ratings assigned to companies in
the industry.
Technology
The technology gap in automobiles between India
and the developed world has been gradually
narrowing. India's auto ancillary suppliers have
been compelled to adjust faster than their
counterparts in the developed world in supplying
products with the appropriate technology to
automobile OEMs. Companies with strong inhouse component development teams or quick
access to technology from collaborators or
technology partners would be in a better position
to procure orders from OEMs and ensure survival
in a competitive market. Technology partners
have greatly influenced OEM decisions in
finalising auto ancillary vendors, especially when
the former are suppliers to the concerned OEMs'
international operations, making validation
easier. Consequently, companies with access to
component technology, including that from
overseas partners, stand to benefit.
Product complexity
The degree of product complexity determines the
importance of an auto ancillary company in the
overall supply-chain, and consequently,
influences its credit profile. Product complexity
may be measured by the extent of research and
development efforts, product validation,
precision in shape forming and machining
operations, component assembly, etc. A high
degree of product complexity limits the
downward risks of price erosion due to the auto
ancillary's importance in the supply chain. It also
discourages new entrants, thus ensuring stability
in market position for companies. The diesel fuel
injection system is a good example of a product
characterized by a high degree of design and
manufacturing complexity, which has ensured
limited competition, and superior pricing power
for its manufacturers in India and the world over.

FINANCIAL RISK ANALYSIS

CONCLUSION

For the analysis of the financial risk of an auto

ancillary company, CRISIL follows the standard
criteria used for all manufacturing companies.
This criterion is presented in detail in our
publications ' Rating Criteria for Manufacturing
Companies' and 'CRISIL's Approach to Financial
Ratios'.

Thus, in CRISIL's opinion, the key success factors

for the auto ancillary sector include:

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Diversified customer base

Presence in AM and export markets
Cost control measures
Access to technology and
Degree of product complexity