Fitch Ratings India Private Limited

Fitch Ratings India Private Limited

Indian Automotive Secor

Auto and Auto Components Outlook 2008 Conference Call

January 30, 2008

Moderator:Good evening, Ladies and Gentlemen. I am Amit, the moderator, for this conference. We welcome you to the teleconference on Auto and Auto Components Outlook 2008 of Fitch Ratings. We now handover to Ms. Priyamvada Balaji and Mr. Sailesh Agrawal for the overview on the sector. After they finish, please feel free to ask query or questions that you may have. Thank you and over to you, ma’am.

Priyamvada Balaji:Yeah, hi, good afternoon everyone and welcome to the conference call on the Indian Automotives sector held by Fitch Ratings. I am Priya, and today, I will be discussing FitchRatings 2008 outlook for the domestic auto sector, primarily focusing on passenger cars and commercial vehicles or CVs. I will then handover the presentation to my colleague Shailesh who will walk you through our outlook for the auto ancillary sector.

Just to give you a broad overview, the Indian auto sector has had one of its longest and strongest growth cycles over the last four years with car demand growing at a CAGR of around 18% for the period per annum while CV demand has grown even faster at 26% per annum, although the past nine months of course have shown a kind of slowing down of growth rates, and this slowdown has been even more stark in the case of commercial vehicles. Now, when discussing the automotive sector, it is important to keep in mind the inherent cyclicality of demand, specifically after 3-4 years of good growth, the market tends to kind of slow down a bit for a year or two and then recover subsequently, so it has been an ongoing feature of the market for the last 10-15 years, and it is probably likely to remain so going forward as well. It is an inherent nature of the industry. While the drivers and dynamics of cars and CVs are a bit different, there are some common themes, which we expect over the coming calendar. I will discuss them as we go along.

First our growth forecast: We expect the current scenario of growth to continue over at least the next 6-8 months of this calendar, and then we will anticipate a recovery in growth rate, probably towards the end of this calendar like somewhere around Q3, Q4, and this of course is partly due to the fact that the base effect of 07 would have been lower, so growth rates will start looking higher. For the car market, we expect a year’s growth, i.e., the financial year’s growth to be around 10% on an overall basis, but we expect it to gradually pickup as and when the newer models are launched, so it will start slower and then slowly pickup as the year goes on. We haven’t really factored the impact of cost of the Nano into these forecasts, and we believe that the introduction of this car will majorly change the industry dynamics. We think that this will effectively ease into the second-hand car market as well as to an extent bridge the gap between the lowest end car currently prevailing and the midsize executive two-wheeler segment. It is a very broad gap and this acts as a really nice bridge between the two costs, so this is similar to what the _____0252 is actually with the LCV and 3-wheeler goods carrier market. As far as the growth rates of the CV segment are concerned, we expect a more muted kind of a growth forecast for this sector going forward, and this reflects the more inherent cyclicality as compared to the passenger car market. It is important to bear in mind that growth across the CV sector has not been uniform and while the LCV market has shown reasonably comfortable positive growth, the _____ 03:17market has shown quite a decline over the last few months and even December numbers have continued to show a decline. So this is something which we expect to continue going forward, i.e., the LCV market will continue to kind of outperform as far as growth is concerned at least over the short term.

In terms of export, they have been supporting domestic demand to a certain extent but risks do remain on account of our negative outlook for the US auto sector. We would like to reiterate, however, our positive long-term views for the sector for both passenger car and commercial vehicles because of the strong underlying fundamentals. I won’t go into them into too much detail because it is something we are all familiar with. The underlying strong economic growth, the strong GDP growth, IIP growth as a result as well as a strong _____ 0405 demographic shift which we expect to take place. Now the second thing which we expect, with the change in the market structure in terms of what kind of products India wants, first stop, if we look at the car market, we can see that slowly there has been a shift from the mini segment to the compact segment, i.e., your B, B+ kind of categories which will primarily compromise your hatchback, and this shift we expect to continue over the next year and as well as over the medium term. We expect the maximum number of new launches to come in this segment, and if you look at the next 10 launches planned for the coming year, most of them are going to be in the C+, B- kind of segment. We expect this trend to continue for the car market. Another factor is because of the price differential between petrol and diesel. Diesel cars are becoming a lot more popular, and we expect this trend as well to continue. For the CV market, the shift has been substantial because we have seen a clear hub-and-spoke kind of a network coming up in the logistic sector. We talked about it in our last outlook, and here we are actually seeing with the kind of road developments taking place. Logistic players are actually accelerating their hub-and-spoke kind of networking if you will, so they are actually investing in large trucks for the long-haul distances and the smaller LCVs for the last-mile delivery, so we are seeing actually the MCV started getting a bit squeezed as far as the market is concerned. This we expect to again to continue over the next short and medium term. Now as far as CAPEX cycle goes, so Fitch Ratings has really not invested in CAPEXuntil last year so as a result of which you saw the assets were increasing quite substantially reaching its peak somewhere around FY06-07. You also saw capacity utilization being one of the highest level in the region of 77% to 80% across the sector on average. Now, this kind of underlying the need of additional CAPEX and sure enough most of the OEMs have a now substantial CAPEX plan. We expect on an overall basis, the CV capacity in India to double over the next 2-3 years and so also for the passenger car capacity. In addition, OEMs are also investing quite substantially in new model development to kind of upgrade their products right now, which are right now reaching the end of their life cycle, so new product development is going to be quite a substantial investment for most OEMs. In addition, you are also going to have to see investments in new emission norms because the new Bharath emission norms are expected to come up in 2010. The first thing which we expect is the competitive attempts which will increase quite substantially across both the CV and the car market. If you look at the CV market, it is historically been virtually a 2-player market with Ashok Leyland and Tata Motors pretty much dominating the entire industry. Now, however, given the kind of growth forecast which people are predicting on the long term, many international players are really actively targeting India in a much more focused manner than they did earlier on, so you see players like Volvo, I-Tech, and Mann announcing quite aggressive investment plans for Indiaas independently or through joint ventures. As a result, the CV market we think is likely to get more fragmented, although this impact is only going to happen over the longer term. Immediately, there is no major new capacity coming up per se from any major other player. So we expect the current majority focus of Tata Motors and Ashok Leyland to continue. In the CV market, we look at the 2 main segments which are your B segments and your C segments. The B segment is much less fragmented. There are 3 main players: Maruti, Hyundai, and Tata Motors, and these pretty much dominate that market. The C segment, however, will bear all the new entrants, the international guys who came in late 90s and early 2000, they all started launching products there so that you see is the market share being a lot more fragmented. Even the kind of product launches we are anticipating from existing as well as the incumbents, we expect the B segment will also start getting fragmented increasingly, although this is a longer-term trend rather than an immediate term trend. In terms of inorganic growth, the companies in India are definitely looking at inorganic growth opportunities. We expect this trend to continue both in terms of small acquisitions to beef up technical and design capabilities as well as to certain extent acquisition to kind of make an entry into international market and all new segments. Now what does this all mean for industry financial profiles? What we expect is the industry competition level increasing. We expect this combined with a kind of slowing down of demand, which we are forecasting, to result in margin pressures over the short and medium terms. We expect that they will be starting off with softer discounts and this will have a clear impact on margin. The slower volume growth as well which will result in slightly muted growth or flat growth in your basic cash flows. In addition, with the kind of strong CAPEX, we expect companies to continue to report free cash flow negative numbers in case of short and medium term until the new capacities start generating money. As a result of which some of you may as we actually see are looking to raise debt for this kind of 2-year timeframe. As a result of which we are going to see some kind of increase in leverage. It is important to note, however, that most of the players have actually wisely used the kind of strong cash generation over this last positive cycle so today they are financially stronger and better positioned to handle any kind of a slowdown and demand as they compare to 2000 or as even compared to a 1997. Actually the industry is financially much stronger and so we actually derive a lot more comfort from that. In conclusion, what I would like to say is that our long-term view for the segment remains very, very positive. We are very positive as far as financial profile as well are concerned we think that in the short-term while there will be some kind of a slight deterioration; we think they will start recovering in the longer term once the new capacities start generating cash. As a result for our 2008 outlook for the sector, we have a stable-to-a negative bias kind of an outlook. That is probably my view as far as the cars and the commercial vehicle markets are concerned. I will now handover the discussion to Shailesh who will walk you through our auto components outlook. Shailesh?

Shailesh Agrawal:Good evening everybody. This is Shailesh. I will discuss the auto component sector. Our outlook for the auto component sector for the year 2008 is stable to negative. The primary reason for the bearish outlook is the recent slowdown in the domestic automobile market. The potential global slowdown in the world economy coupled with the weakening of dollar is likely to accentuate this trouble. The domestic demand of auto components will be driven by the automobile demand, which Priyamvada has already discussed in detail. While a weak dollar is certainly hitting the exports to the US, it is the potential global recession, which we feel is more disturbing and will potentially hit the entire export market. On the _____11:52 side, the Indian auto ancillaries are moving up the value chain and from being just manufacturers based on the OEMs, designs, and joints, they are now more of core developers of auto components. The relatively lower labor cost and design as well as manufacturing will definitely help competitiveness of the Indian manufacturer. The other positive could be the acquisition of customers through relationships developed through the Indian venture of large transnational OEMs. Some of the under performing or small manufacturers may also be acquired by their Indian counterparts. They can be used as marketing window as well as source of new technology and quality accessions with the OEMs, so these 2 qualities could help the competitiveness of the Indian manufacturers, but the weak dollar will certainly hit the exports. Now, the sluggish growth and margin pressures at OEMs level in the domestic market will certainly not allow any price increase for auto component. There may be, I mean, some increase in terms of passing on of the raw material price increase but as such we don’t expect any increase in prices because the OEMs as such will be under pressure #1, and they have a much higher bargaining power compared to their supplier. Now, there is the general inflation and that will also put the margins under pressure. Weak dollar is already putting pressure on margins of the exporter. Now on the CAPEX side, despite lower margins, the auto components will hardly have any option not to invest in the CAPEX, and they will have to undergo substantial CAPEX. This will be required to launch the new models and capacity expansions of the OEMs’ technology upgradation. CAPEX will also be required to align the product range with the market as the market may expect turbulence. There can be new launches, the retirement of the existing model, some of the existing manufacturers OEM may not be performing well, and then their vendors may have to change some equipments and some technologies to serve another OEMs, so kittled together the CAPEX and margin pressures will put pressure on the credit profile. The credit profiles of individual manufacturer will be linked to the performance of the OEMs. Some of the Indian component manufacturers are very much concentrated on a single OEM, so in case the OEMs they are serving is not performing well, these companies will definitely have trouble, so a diversified auto component manufacturer will definitely have better standing than a manufacturer which is more concentrated on a single OEM. Some of the component manufacturers may look for another sector, I mean, which use the similar product like railways or defense, and such diversification will help, I mean, mitigate any market risk that they may have. Overall, what we feel is that the proclaimed profiles will be under pressure, and I will also reiterate that this is the short-term outlook for the year. The long-term outlook for the auto components sector is certainly good because we believe that economic fundamentals are strong, and if the economy does well, then the autos and auto components both will do well. This is in short from my side. Will you like to add something, Priyamvada?

Priyamvada Balaji:No I think am fine Shailesh. We can have the floor open for questions. Amit?

Moderator:Thank you very much, sir. We will now begin the Q&A interactive session. Participants who wish to ask questions, please press *1 on your telephone keypad. On pressing *1, participants will get a chance to present their questions on a first in-line basis. Participants are requested to use only handsets while asking questions. To ask a question, please press *1 now. To ask a question, please press *1 now. First in line we have Shilpi from Dun Bradstreet. Over to you ma’am.

Shilpi:Hi, Shailesh. This is Shilpi from Dun & Bradstreet. Hello ?

Shailesh:Hi.

Shilpi:Shailesh, I have this question for you for the auto component industry. What is your outlook on the raw material prices?

Shailesh:The raw material prices, I mean, they will be on the rising side.

Shilpi:Alright, and Shailesh, could you give me some kind of outlook in terms of figures for the production and sales value for the auto components.

Shailesh:No, I won’t be able to give, Shilpi, but it will move with the automobile market.

Shilpi:Alright. Okay Shailesh something on the capacity underutilization that is there in the industry because that’s also somewhere between 70%-75%, most of the players are there with such kind of capacity utilization, your views on that?

Shailesh:70%-75% is not a bad capacity utilization, Shilpi, and because products are, I mean, it is not a single product kind of an industry, like, power industry where you..

Shilpi:Right.

Shailesh:..Have to have only one product or the steel industry, the main product is one and there are only small variants of them. These are diversified products so 70%-75% is not bad and in any case, their companies will have to undergo CAPEX. If they want to quote a new product, they will have to undergo this.