Reformative PLI Scheme-(OEM, Auto component and ACC batteries)

“Markets are like women- always commanding, mysterious, unpredictable and volatile”

Rakesh Jhunjhunwala

At this point when I am writing this article on the last day of 2020, nifty had been fighting to breach its 14000 mark around some time, and subsequently reached (14000), indicating that bulls have muscled themselves up. Markets seems exceptionally overvalued, conflicting every other interview conducted on CNBC by Lata Venkatesh and Anuj Singhal indicates next day shall be sunnier and brighter with delight. At this point, whenever somebody comes to me for a stock suggestion, I give an analogy of a halogen balloon which has already released from your hand, in case you are tall (deep pocket), try to catch it, just look to it, it doesn’t burst.

Continuing my discussion on PLI scheme, the segment which I would like to further scout in this write-up is Auto sector. It can be fairly said that Auto sector and our GDP growth rate are almost correlated, with our GDP slowing down in 19-20 to our 11 year low of 4.2% on one side, and our Auto empire performed worse, with a de-growth of 18% in car segment and 17.76% in motor cycle segment. Given the industry had reached its peak in the year 2018-19 at $57 billion, there after been de-growing at a much faster rate. No doubt raw material pricing did play a crucial role, as the industry were obligated to pass on the bitter pills to their consumers, but these signs were sufficient to indicate that restoration of GDP figures and our ambitious 5 Trillion plan demands some fuel to Auto empire.

From the total outflow of the scheme, Rs 57,042 crore shall be utilized incentivize the automobiles and auto components manufacturing sector, Rs 18,100 crore is allocated towards Advance Chemistry Cell (ACC) Battery manufacturing (mostly lithium-ion batteries for EVs) and Rs 6322 crore towards specialty steel mostly used as raw material for Automobile Manufacturing. If I aggregate these figures, a whooping Rs 81,464 crores i.e 40% of all sectors under PLI is specifically strategized for Auto industry revival.

Ecosystem of the Auto Industry

Firstly, let’s start to understand the whole ecosystem of Automobile segment in simplistic manner. The products which we receive from the dealer as a consumer are assembled and manufactured by Original Equipment Manufacturers. The Original Equipment Manufacturers referred to as the OEMs are the vehicle producers that assemble passenger cars, utility vehicles, commercial vehicles, two wheelers and three wheelers. Inputs for the Original equipment’s include Auto components, which are manufactured by Auto Component Manufacturers, which are further segregated into Tier 1, Tier 2 and Tier 3 suppliers. Tier 1 are the prime suppliers to OEM in terms of volume, as Tier 2 and 3 are the prime suppliers to Tier 1. Some of the Auto Components include Batteries, Steering systems, Brakes, Shock absorbers, Bearings, Air Conditioning systems, Tyres, Wipers, transmission system, Chasis and glass. One another essential input or raw material in this chain is Steel.

Steel is an alloy, meaning that it is made by combining iron with another element, usually (but not always) carbon.

There are essentially 3 steps to steelmaking-

·        Ironmaking Process

·        Steelmaking Process

·        Continuous Casting Process

Under steel making process, we have 2 distinct methods, which are Basic Oxygen Furnace (BOF) and Electric Arc Furnaces (EAF)

BOF(yes it uses oxygen) uses steel scrap along with iron and coal with varied temperature heating or cooling depending on which finished product you desire (Hot rolled coil or cold rolled Steel)

EAF(yes it uses electric charge) without use or limited use of coal mixed with Direct Reduced Iron (DRI) and pig iron for chemical balance to get over to Finished products.

BOF is preferred for superior quality , where as EAF is cheaper to produce as less of raw material required.

Below table from Alpha Invesco by Zain Iqbal further help us to understand the process!

Figure 1

Not much deep diving into intricacies, if you want to further enhance your knowledge base towards Auto segment and Steel. Below 2 links shall be of real help. Especially Zain Iqbal has extensively explored and beautifully written a blog, which could help you to understand operational aspect of any steel company.

https://www.alphainvesco.com/blog/steel-industry-in-india/

https://investorsareidiots.com/retirement-investments-equity-fixed-income-currencies-commodities-economy/home/home-2/homespage/2015/09/automobile-industry-original-equipment-manufacturers-oems-and-auto-component-manufacturers-acm/#:~:text=Privacy%20Policy%E2%80%8E-,Automobile%20Industry%20%E2%80%93%20Original%20Equipment%20Manufacturers%20(OEMs),and%20Auto%20Component%20Manufacturers%20(ACM)&text=The%20Original%20Equipment%20Manufacturers%20referred,two%20wheelers%20and%20three%20wheelers.

First key input in the steel-making is Iron-ore. Below graph from Figure 2 can help us to have a graphical representation of Iron ore prices, as it is pictorially evident that prices have almost rosed 70-80% in last 2 months.

Figure 2

Data from Market Index

Second input to Steel i.e Coal is even more volatile, given trend indicates rise is almost 45.12% in the given year till November. Coal prices were expected to stabilize or reduce basis quarrel between Australia and China, as China reducing their imports and Australia with excess supply of coal. India as a big importer of Coal can hopefully have few pieces of the coal cake with some extra cream of reduced prices due to excess supply.

Figure 3

Data from Market Insider

 Steel prices have been rising for the past four months. Icra’s Jayanta Roy said that HRC(Hot rolled coil) prices have strengthened in the international market by nearly 18% in the last two months leading to a significant rise in the Indian steel prices. From May onwards, the state-run miner has been constantly raising the price to take it to Rs 3,450 per tonne from Rs 2,250 a tonne in May. In November, it raised the price twice. With effect from December 2, NMDC raised the price for both lump and fines ore by Rs 500 a tonne to Rs 4,500 per tonne and Rs 4,110 per tonne respectively. As we can see the trend continuing from Iron-ore to Steel to Auto to Consumers. Problem which steel manufacturers usually face in recent times are prices of their input are exorbitantly high, domestic coal producers get margins exporting rather supplying to domestic steel producers. Global prices are times higher are beneficial, therefore this problem shall prevail un till government rigs with some duties.

Now as we know the influential factors and the rationale behind the cause of Auto company stock movements, lets further understand the economics behind the scheme.

With the PLI scheme, various manufacturers shall set up greenfield plants in India, thereby employing sufficient number of individuals. We recently had consecutive rate-cuts this fiscal year, therefore cheap loans are available to consumers. Car loans range from 7-8% depending upon the bank you choose, that gives an option for a middle-class individual to own a car, which often used to be considered as a luxury. Loans are disbursed on the basis whether the person has a decent employment history, which is exactly what PLI caters to. Thereby on consumption basis we can predict revival of GDP growth in Future years ahead.

Advance Chemistry Cell (ACC) Battery

Lithom-ion battery price trend

Figure 4

Source: Axiom

Figure 5

Source: Economic times

Incentives worth Rs 18100 crore belongs to this segment, which is specific to Lithium-ion Batteries. Lithium-ion battery pack prices, which were above $1,100 per kilowatt-hour in 2010, have fallen 89% in real terms to $137/kWh in 2020. By 2023, average prices will be close to $100/kWh, according to the latest forecast from research company BloombergNEF (BNEF), as a conclusion, the cost of Lithum-ion batteries are reducing basis technological innovation, on the contrary lead prices have their own narrative, from figure 5 it can be easily observed that after the sharp dip in Oct, lead has been acting alike all metals in the market, i.e rising each day.

Understanding Lead and Lithum historical prices is requisite before we start understanding the battery Universe, as it shall prove to be our groundwork for our analysis. Though it seems quite evident from the charts that Lithum is the most probable way to go, but few points are worth considering.

·        As electric vehicle starts evolving, prices of Lithum are expected to substantially rise, producers of Lithum are not fully prepared to keep pace with demand disruptions.

·        On the contrary, you might even face dips in lead prices if original equipment manufacturers turn in EVs favour

·        EV charging takes 6-7 hours at a charging station, 7-8 hours at home, 5-6 hours with a fast charger, even if costs get ever controlled, there needs technological advancement in terms of convenience cost.

·        Electric vehicles are predicted to break-even with diesel/petrol-based vehicles close to 2024-2025, therefore Indian consumers which are highly price sensitive need no more than miracle to shift towards EV.

·        Government aren’t losing hope, with estimates of 69000 EV charging stations to be build in near term, with tax exemption given for loan on EVs under 80C along with the PLI theme, government probably gambled all-in(poker), leaving the ball in consumer’s court.

Exide and Amaraja Batteries are the Industry leaders driving the battery lot. Exide entered India in 1957 having a first mover advantage, thereafter Amaraja batteries entered in 1987, with an aggressive approach, as it rose its market share as huge as Exide in no time. Both companies have a different story to say, let’s look at some key differences to understand their future narratives.

Building up on the differences, its clear PLI scheme is meant for Exide in a direct manner, with major market share towards Automobiles, Exide has received some head start in this race due to this scheme. Not to forget, PLI has some spills in Telephone/Mobile segment along with some in Solar PV, so Amaraja has its share of benefits, only less when compared to Exide. Also, when it comes to Lead acid batteries, these battery companies always have the power of negotiations as Auto segment as a whole has received a decent chunk.

Below article gives a consumer stand point, as a review towards difference between Exide and Amaraja Battery, please do have a look:

https://www.carfitexperts.com/exide-vs-amaron-a-complete-guide/#:~:text=Amaron%20batteries%20come%20with%20a,deliver%20optimal%20performance%20for%20years.&text=Exide%20car%20batteries%2C%20on%20the,72%20months%20for%20certain%20batteries.

An addition to this list, we have Panasonic Energy India Ltd in the listed space. It came to my focus due to a JV with Tesla in 2018. With Nitin Gadkari announcing Tesla’s entry into India, Panasonic has received a contract to manufacture 4680 Batteries. It can be a multi-bagger depending on Tesla’s domination once it enters India.

Debate

There has been excess debates on this scheme not benefiting our domestic Producers SMEs , rather shall fill pockets of the rich. With less than 14% of the Auto-component manufacturers from the whole Auto space fitting in terms of the Eligibility criteria’s, sadly to say this argument is true, but if we understand what government actually wants threw this theme, we shall be further delighted to encourage this scheme.

Government wants to boast exports, as they want global biggies to enter our markets. With this we shall indeed have survival of the fittest, this is how the world works. But Indian Auto-manufacturers/components can indeed form joint ventures with the Global biggies, in short if planned correctly the whole eco-system can party together. Further below article shall help us to have clear picture in terms of eligibility and what Industry experts feel about the PLI theme.

https://auto.economictimes.indiatimes.com/news/industry/etauto-exclusive-pli-scheme-draft-offers-benefit-to-big-auto-manufacturers-only-here-is-why/79751658

Conclusion

There is yet much to explore in Automobile manufacturing and components. I shall further explore companies in Auto-mobile (Bajaj Auto- Chetak) and Auto components (Motherson Sumi) in the future part of this series.

There are pros- Output oriented, export oriented, as well as there are cons- Pressure on domestic industries, planning and execution without corruption, as only time shall be the best judge to answer.