Karachi, July 27, 2022 (PPI-OT): Autos: What to expect from the recent price hikes

Looking back, as a result of 25%/27% PKR depreciation between 2018-2020 vs. US$/JPY respectively, along with imposition of taxes, auto makers resided to aggressive price hikes in the range of 28%-44% similar to what we have seen recently.

We present changes in prices and volumes of key car models over the periods mentioned above and assess the movement in gross profit of all three manufacturers.

With recent price hikes announced by automakers amid free fall in PKR against the US$, along with rising interest rates and adverse measures taken by the regulators, we foresee a massive deterioration of purchasing power of auto consumers leading to a decline in volumes of up to 25% during FY23 adding pressure on gross margins in the sector.

Another cycle of lower volumes and lower margins

To address macro headwinds, car manufacturers have opted for aggressive price hikes now and then, with another cycle being witnessed since the past couple of months. This has led to auto volumes declining by 35-40% in the last round of crisis (FY18-20), albeit including impact of COVID-19 for three months, leading us to anticipate a similar situation to repeat this year.

The state of affairs could deteriorate further this time around with woes of worsening purchasing power of auto consumers added by delay in auto productions over scarcity of FCY to import raw materials. As per reports, most auto players have already stopped advance bookings for vehicles citing uncertainty and higher production costs as prime culprits.

Moreover, despite the aggressive price hikes, the cost pressures have not seemed to completely reach to the end consumer in previous cycles, leading to contraction in margins as companies lose the benefit of economies of scale with reducing volumes too, which is also not ruled out in the ongoing scenario.

What leads to repeat the sticky cycle?

Raw materials: Raw materials make up for the major chunk of costs involved in the production of Autos (90-95% of total costs for the listed players) which are primarily composed of steel, copper, plastic, aluminium and glass among others. Industry localization in Pakistan stands around 50-55% in terms of parts. The number drops significantly when translated to localization in terms of value due to import of high value parts such as engine and transmission components. Industry stakeholders have been pushing local auto assemblers for higher localization, however, local manufacturers of Auto parts have stressed the need for higher volumes in the industry for production of high value parts to become feasible.

Currency exposure: Production of Autos relies significantly on imported raw material from various countries with Japan and Thailand being among the top destinations. Due to this dependency on imports, movement in US$ and JPY remains a key factor in determining production costs for automakers.

Price hikes and their impact on demand

Demand in the sector bears a strong correlation to factors such as GDP growth rate, interest rates and prices of vehicles. Price hikes directly dent purchasing power of consumers negatively impacting demand although the intensity of impact tends to differ over higher and middle-income segments.

Looking back as shown in the table above, we can see as a result of 25%/27% PKR depreciation against the US$/JPY and imposition of taxes, auto makers resided to price hikes in the range of 28%-44% leading to a negative impact on demand. The highest drop in sales came from PSMC’s Wagon R and Swift declining by 75%/68% respectively whereas among the least impacted was INDU’s Hilux dropping by just 29% over the 2 years. With a stable currency and lower interest rates, demand picked up pace thereon throughout CY21.

To gain a better perspective of the trade-off for higher prices vs lower volumes or vice versa, we have a look at the auto player’s gross profit generating ability over the past six years of operations. We can see from the table above that the gross profit per car of all three manufacturers has declined over the years and at best has returned to 2017 levels. This shows that despite the price hikes, the auto makers are losing gross profit per car which means they will have to draw in more volumes to maintain gross profits at the same levels as before, holding all else constant.