Business of auto dealerships is in overdrive: CRISIL

This is reflected in the upgrades outnumbering downgrades in Credit Rating and Information Services of India Ltd (CRISIL) portfolio of auto dealerships during the 12 months through January 2011; CRISIL upgraded seven of its outstanding ratings in the auto dealership sector, and downgraded one.

These were CRISIL’s observations from a study it conducted on its 126 rated entities in the auto dealership sector, which accounts for around 23 per cent of the commercial vehicle (CV) and passenger car market (based on revenues) in India.

Auto dealers constitute the critical last-mile link between the auto manufacturer and end customer. Hence, the dealers’ fortunes mirror those of the auto makers. This is reflected in healthy growth in the revenues, size, and profitability of CRISIL-rated auto dealers in the last two years, in line with the growth trajectory of auto manufacturers.

Demand for passenger cars and CVs witnessed a year-on-year growth of 25 per cent and 35 per cent, respectively, in 2009-10 (refers to financial year, April 1 to March 31), and are expected to grow at 30 per cent each in 2010-11.

CRISIL believes that the business risk profiles of auto dealers will continue to benefit from the surge in passenger car and CV demand, and grow by around 15 per cent annually, over the medium term.

This is based on the premise that increasing affordability and new car launches will fuel demand for passenger cars, while rising industrial activity and healthy freight traffic will drive demand for CVs.

Typically, auto dealers operate in a restricted geography, within a limited size, and their margins are low. The average operating margin of CRISIL-rated entities was 2.50 to 2.75 per cent, historically; however, the average margin has improved to about 3 per cent in the past two years.

Says R Vasudevan, Head, CRISIL Ratings, “The improvement in profitability was supported by the surge in sale of vehicles in the past couple of years; the dealers benefitted from economies of scale, higher commissions, and increased share of revenues from the high-margin spares and services segment.”  The auto dealers’ financial risk profile is constrained by their highly leveraged capital structure, stretched liquidity, and weak debt protection metrics.

The total outside liabilities to tangible net worth (TOL/TNW) ratio of CRISIL-rated players was 5 times as on March 31, 2010. “However,” says Gurpreet Chhatwal, Director, CRISIL Ratings, “CRISIL-rated players, whose ratings were upgraded over the past 12 months, improved their working capital management by reducing inventory holdings, thus strengthening their capital structure and liquidity.”

The dealers whose ratings were upgraded reduced their average inventory holding period by 25 per cent in 2009-10, compared with the three preceding years, thereby improving the TOL/TNW ratio to 4 times.

Adds Gurpreet Chhatwal, “Continued higher dependence on external sources of funding to meet incremental working capital requirements will constrain auto dealers’ capital structure and liquidity, and may restrict much of the benefits of improved business prospects.”