Auto Sector Recovery is Not Real. It’s a Mirage Created by Inventory Pileup

All is well, when it comes to two-wheeler and passenger-vehicle sales. Or so we have been told over the last few days.

The small industry which has developed over the last few months, and whose main job is to shout recovery recovery at a drop of a hat, is at it again.

But should we believe them? Or rather how much should we believe them?

As per Autocar domestic sales of passenger vehicles (of India’s major car companies) in September 2020, went up by around 35% to a little over 2.75 lakh units. The September 2019 sales had been at a little over 2.04 lakh units.

In fact, August 2020 sales of the same set of companies had been at around 2.01 lakh. When we take that into account, the recovery has been very good.

As per Rushlane, the domestic sales of India’s major two-wheeler companies in September 2020 stood at 17.81 lakh, up 11.6% from September 2019, when sales had stood at 15.95 lakh.

Varied reasons have been offered for this recovery. Let’s take a look at these reasons pointwise.

1)  The pent-up demand is leading to higher sales (How do you argue against something like that?)

2) The economy is getting back on track. (Well!)

3) People do not want to use public transport due to the fear of the covid-pandemic and hence, are buying two-wheelers and cars. (Common sense and how do you argue against something like that).

4) Very low interest rates offered by banks on car loans. Take a look at the following chart.

Low interest rates

Source: ICICI Securities.

Car loan interest rates are as low as 6.5%. This has also helped push up sales. Along with low interest rates, many banks are offering very high loan to value, when it comes to entry-level cars. This means if the price of the car is Rs 5 lakh, some banks are willing to offer 95-100% of this price as a loan.

Also, as a research note authored by ICICI Securities analysts, Kunal Shah, Renish Bhuva and Chintan Shah points out, banks are offering, “cost-optimised financing schemes (tenure up to 7-8 years, step-up EMI, balloon EMI, low down payment options, scheme for low EMI for three months, etc).”

So, not only can customers borrow easily, they can do so in many different ways.  They have better choice and all this is encouraging them to borrow (But are they borrowing is the real question?).

5) Also, the agriculture sector continues to do well, and this has meant increased purchasing power in rural India, which has led to an increase in the purchase of two-wheelers. (This is a story as old as the ages, when urban India doesn’t do well, rural India has to).

These are the reasons that have been offered for India’s automobile sector doing well. Now let’s take a look at whether a recovery has really happened.

1) What automobile companies refer to as domestic sales are essentially dispatches to dealers or factory gate shipments. These are units leaving the manufacturing facility for sales to consumers. They haven’t been sold as such. Generally, company dispatches are a reasonable indication of end consumer sale. But this time companies are building up inventory at the dealer levels in the hope of sales picking up during the so-called festival season. The building up of inventory has been necessitated by the new BS VI environmental norms, which has led to the requirement of building new inventory.

This does not mean that the whole dispatch ends up as dealer inventory but a substantial portion does.

2) Hence, a better way of looking at data is to look at the number of registrations. This data is released by the Federation of Automobile Dealers Association (FADA). As per this data, in August 2020, 1.79 lakh passenger vehicles were registered. This is around 25,000 units lower than the dispatches of 2.04 lakh units carried out by major car companies during August.

When it comes to two-wheelers, the gap is bigger. In August 2020, as per FADA nearly 8.99 lakh two-wheelers were registered. In comparison 14.94 lakh two-wheelers from major companies had been dispatched.  There is a gap of close to six lakh units, which has ended up as inventory.

Take a look at the following table, which gives registration numbers of different kinds of vehicles.

Who is really buying?

2W = Two wheelers. 3W = Three wheelers. CV = Commercial vehicles. PV = Passenger Vehicles (Cars). TRAC = Tractors.

The sales and registration of commercial vehicles remains down in the dumps. This is hardly surprising given that the investment in the economy has totally collapsed. As per the Centre for Monitoring Indian Economy, the value of total new investments announced during July to September 2020, stood at Rs 58,601 crore, the lowest in fifteen years (without adjusting for inflation).

In fact, tractors are the only vehicles which have shown an increase in registration. This is due to the agriculture sector doing well and the rural rich doing well.

As per the VAHAN data released by the government, the total number of motor cars (as they call it) registered in August stood at 1.75 lakh . As per this data around 8.81 lakh two-wheelers were registered in August 2020, telling us the same story. Clearly, a significant portion of dispatches until August were for building inventory.

(Vahan data covers 1,242 out of 1,450 RTOs in the country. Hence, there is bound to be some discrepancy between company dispatches and registration numbers. But six lakh units, which is the difference in August in case of two-wheelers, is too huge to be just explained by this. FADA also refers to the Vahan database)

We do not have the September data for registrations as yet. But what we know clearly is that dealers have a lot of inventory piled up in the months up to August. And there is no reason for this to have stopped in September as well.

3) In fact, there is another factor that needs to be taken into account and that is the base effect. Two-wheeler and passenger vehicle registrations were already slow around this time last year. Hence, it makes sense to compare the 2020 numbers with the registrations that happened around this time in 2018. The registrations of motorcars as per Vahan data in August 2018 stood at around 1.96 lakh (compared to 1.75 lakh in August 2020). When it comes to two-wheeler registrations they stood at 12.12 lakh (compared to 8.81 lakh in August 2020). Hence, in that sense we are two-years behind when it comes to real consumer sales.

4) Let’s take a look at bank loans on this front. This is where things get very interesting. More than three-fourth of cars and two-wheelers were bought on loans before the covid-pandemic struck. The RBI does not give a proper division of different kinds of ‘vehicle loans’. But I guess even an overall number can be used to draw some inferences. The overall vehicle loans given by banks between end of March and August have contracted a little. This means that on the whole, people have been repaying loans and net-net banks haven’t given any fresh vehicle loans. While net-net between end March and end August there has been no fresh lending of vehicle loans by banks, some lending has happened in July and August. This stands at Rs 5,167 crore.

The question is if banks aren’t giving out vehicle loans how are all these vehicles being bought? Of course, banks aren’t the only financiers of vehicle loans, the non-banking finance companies (NBFCs) also finance the buying of vehicles.

Are NBFCs filling up this space? The NBFCs are also dependent on banks for financing. This means that NBFCs borrow from banks and then lend that money out.  The overall bank lending to NBFCs has contracted by 1.3% or Rs 10,620 crore, between end March and end August.

Hence, the ability of NBFCs to continue financing vehicles, when their borrowing from banks has come down, is rather limited.
This does not mean that banks are not interested in financing any kind of vehicle. They seem to be interested in financing cars but not two-wheelers. What this means is that if “genuine sales” don’t pick up, the huge inventories that the two-wheeler dealers have built up will become a problem for them. Car dealers will face the same problem though not of the same proportion.

5) Also, as far as financing goes, while banks are looking to finance a higher loan to value for entry level cars, that doesn’t seem to the case for cars as a whole. As Vinkesh Gulati, the president of FADA told Bloomberg Quint: “It has come to down to 65%-70%.”

6) Finally, what is surprising is that September also had the 16-day Shraad period from September 1 and September 17, when people believe it’s inauspicious to make purchases. In this scenario, it becomes even more difficult to believe that passengers vehicle sales (car sales) went up by as much as 35% during the month. It’s looking more and more like an inventory pile up at dealer level than genuine sales.

As Gulati had told in mid-September: “This year all festivities will begin a month after Shraadh gets over and this period is also not considered to be good for sales in the North, East and West of the country. We are expecting September to be below August and also below last September.”

To conclude, as the economy opens up, automobile sales are bound to improve gradually. Nevertheless, there are several nuances that need to be kept in mind, before announcing an auto sector recovery. The auto-sector in India forms around half of the manufacturing sector and hence, is very important. And given that, it is important to analyse it carefully.

From the looks of it, the difference between genuine registrations at the retail level and the company dispatches, will only go up in September as the inventory pile up continues.

In fact, this inventory build-up might also be responsible to some extent for the increase in goods and services tax collections seen during September. The trouble is that the end consumer is yet to pay this tax.