Denso India Ltd Management Discussions

DENSO INDIA LIMITED ANNUAL REPORT 2011-2012 MANAGEMENT DISCUSSION AND ANALYSIS The year under review was not only a difficult year for the Company, it was a challenging year for the Indian economy as well. The Indian economy substantially slowed down during 2011-12, as compared to the previous year. Overall GDP growth rate dropped from 8.4% in 2010-11 to 6.5% for the year 2011-12. The growth rate which had dropped down to 6.7% in 2008-09 was expected to rebound and be around 9% or more during 2011-12. However, contrary to expectation, with every passing month in 2011, it became more and more evident that the rate of growth was on the decline. Index of Industrial Production (IIP) growth declined from 8.2% in 2010-11 to 2.8% in 2011-12. Growth rate of eight core industries declined from 6.6% during 2010-11 to 4.4% in 2011-12. Diverse factors lead to this unforeseen down turn. The global factors like the Euro zone crisis, recession in Europe, sluggish growth rate in industrialized nations like USA, stagnation in Japan, political crisis in the Middle East also contributed to the slowdown. Such drastic reversal from the upward swing to global melt down and consequent weakening of India economy led to a general negative outlook and depressed market sentiments. During 2011-12 the Rupee depreciated by over 14% against the US$, 13% against the Sterling Pound, 8% against the Euro and 15% against the Japanese Yen. The cascading effect of Rupee depreciation was sorely felt on the already high imported commodity prices. The Indian markets also saw a large decline in the in-flow of funds from the Foreign Institutional Investors partly due to the concerns over the longer term impact of higher current account deficits and partly due to risk aversion to invest in volatile markets. The flight of capital by foreign investors was also influenced by the melt down in Europe. Sovereign debt problem of euro area weighs heavily on global recovery. Concern about sustainable solution to the sovereign debt problem and vulnerability of the banking sector still persist. Heightened risk aversion and the resultant slowing of capital flows will have a significant adverse impact on emerging and developing economies including India. Spiraling oil prices, high inflation, rising interest rates severely dampened business sentiments thereby contributed to the slowdown. The year 2011-12 started with 9.7% inflation which touched double digits in September 2011 and thereafter declined to 7.7% in March 2012. The major factors contributing to such inflation were high prices of vegetables, eggs, meat and fish due to change in dietary pattern of rural households, increasing global commodity prices leading to higher cost of production and continuous high prices of crude oil. OPERATIONS: The factors which led to general negative outlook and depressed market sentiments affected the Company adversely. The margins of the Company remained under severe pressure during the year due to rising input costs, adverse foreign exchange scenario and weakening rupee, disturbances and labour unrest with major customers, fluctuating economic growth and fierce competition causing a loss of Rs. 722 million after tax. The margins and profits are under pressure not only in the Company but the situation is more or less same with competitors and other Auto components supplier as well. Same is the scene with car manufacturers. The end customers are continuously demanding better features, higher specifications at lower cost in the new cars and in new models of the present cars. The margins are therefore under pressure with car manufacturers also. The car manufacturers in turn pass on this pressure to the components suppliers. The problem was worst confounded due to labour unrest at Manesar plat of Maruti Suzuki India Limited (MSIL), which is our biggest customer. This severely disturbed production schedule of the Company putting inventory and imports out of sync with production. The Company faced challenges of erratic demand due to fluctuating economic scenario affecting growth in automobile sector during the year. It was therefore necessary to import more material & components and carry higher inventory to ensure 100% committed supply to the customers. This was necessary to retain market share. Even though these put pressure on profit margins and enhance working capital exposure, nevertheless are imperative to retain market share and customer confidence. The auto components industry is facing the pressure of erratic economic growth. With the increase in competition, this pressure is likely to increase further in the coming years. The Company is therefore aiming to bring in more efficient, cost effective and newer technology products where price realization could be better. FACTORY AT HARIDWAR Your Company had established a factory at Haridwar in year 2009, mainly to cater to the needs of M/s Hero MotoCorp Ltd. plant at Haridwar as well as to avail tax incentives being offered by the Government of Uttarakhand. The Companys factory at Haridwar is fully operational and performing satisfactorily. M/s Hero MotoCorp Ltd. (previously Honda Honda Motors Ltd.) is witnessing positive growth and has sold 6.2 million two wheelers in 2011-12 up from 5.4 million vehicles sold in previous year. This trend augur well for Haridwar factory of your Company. NEW FACTORY AT BANGALORE Your Company will set up a new factory at Bangalore during 2012-13. This proposed factory at Bangalore will cater to the requirements of two wheelers manufacturers in southern India and mainly supply to Honda Motorcycle and Scooter India Pvt. Ltd. (HMSI) which is one of the main customers for two wheelers products of the Company. HMSI plans to put two plants in South. To secure HMSI growing business in South, in the presence of strong competition, the company has decided to establish this new factory. The Company is in process of taking suitable premises on lease at Bangalore to set up the Factory. SMALL MOTOR BUSINESS Pursuant to the Special Resolution passed by the Shareholders of the Company in terms of the provisions of Section 293(1)(a), of the Companies Act, 1956, under postal ballot system, the Company has sold Small Motor Business i.e Front/Rear Wiper, Power Window Motors, Blower Motors, Electric Fan Motors and Engine Cooling Modules to DENSO Haryana Private Limited, a DENSO group company, on a going concern basis, by way of slump sale. The consideration for the sale on a slump sale basis is Rs. 1,477 million, out of which 90% amount i.e. Rs. 1,329 million has been received on signing the agreement and balance 10% will be received on closing date, along with the adjustments on account of changes in working capital position and additional capital investment, relatable to Small Motor Business up to the closing date, which is scheduled to be in October 2012. The Companys Electrical Parts Business for four wheeler segment i.e Alternator and Starter and Electrical Parts Business for two wheeler segment i.e GDI and Magneto hold the key to growth and profitability in future. Alternator/Starter (in case of four wheelers) and GDI/Magneto (in case of two-wheelers) businesses constitute the core businesses of the Company since they contribute to vehicle engine performance by optimizing fuel cost and reducing emissions. With increased fuel costs and regulatory drive towards reduction in emissions, and with the DENSOs inherent strengths in technical innovation, these two businesses are expected to be the growth engine for Companys success. Accordingly, the Company has decided to focus and concentrate on these two businesses (i.e. Alternator/ Starter and GDI/ Magneto businesses). From an operational perspective also, the transfer of Small Motor Business would improve capacities within the existing manufacturing facility, which would be used for expansion and growth of other two businesses. OPPORTUNITIES AND THREATS: Though there are projections of good growth of the Indian car and two wheelers market in the medium to long term based on growth in household income of burgeoning middleclass in India, there are challenges also for the industry. The market will be subject to economic cycles and its sensitivity to fuel prices and interest rates, can cause huge fluctuations. These growth prospects will lure more local and international players, the competition will intensify and predictability of volumes and product mix will be increasingly challenged. The vehicle manufacturers expect component industry to improve scalability and develop a reliable and robust manufacturing foundation for growth. To deliver global levels of technology and quality products, the vehicle manufacturers require their suppliers to be able to localize the systems or components supplied by them. The balance will have to be imported and to that extent vehicle manufacturers and component suppliers will be exposed to foreign exchange movements and higher costs. The ability to localize components and systems will open up vast opportunities for component suppliers and to the extent the component suppliers depend on imports, they will be exposed to ever increasing threat of exchange rate fluctuations. The Company is making constant endeavors for localization of various parts and components and identifying cost effective ways of manufacturing them inhouse or through vendors. The other threat or growth bottleneck to which component manufacturers are exposed is in the area of human resources. Good talent is critical for technology absorption, quality manufacturing and cost management. However growth and emerging opportunities in other sectors of Indian economy is making this vital resource scarcer day by day. The prevalent governance slowdown caused by delayed response of the Government machinery to the vital issues requiring immediate attention and quick disposal remains an area of concern. Fiscal Deficit has continued to expand and is estimated to cross 5.9% of GDP by analysts, contrary to budget estimates of 4.6%. Continually high oil prices, the possibility of having to import coal at higher-than estimated rates to meet the rising power gap and the continuing subsidy burdens do not augur well for the economy. SEGMENT WISE PERFORMANCE: The Companys operating business is organized and managed according to the nature of product, with single Primary Reportable Segment comprising of manufacturing and supply of electrical automotive components. OUTLOOK: Market Survey and current trends indicate strong possibilities of high growth rate in automotive market in coming years. However presently the automobile industry is faced with the challenging times with uncertainties on the demand side in coming months, which hopefully is only a short term phenomenon. The total automobile market is expected to grow by double digits annually for the next 5 years. India is emerging as a small car hub in the Asia Pacific region. This is evident from the fact that almost all the major international automobile manufacturers have registered their presence in India and have started manufacturing small cars in this country. These companies are either setting up or expanding their existing manufacturing base not only to enter the domestic market but also for exports. India is gradually becoming a major manufacturing base for export of passenger cars as well as other utility vehicles. Recession in the industrialized nations, stagnation in Japan and China and a relatively large domestic market is making India a much more attractive destination. It is forecast that by 2020 India would be one of the top five automobile manufacturing countries in the world. These positive developments in the automobile sector would augur well for the auto component industry and your company. Customer trends indicate that the local design & development as well as expansion of production facilities is moving towards South & Mid West areas of India. It is expected that fuel price parity shall see higher growth rate in diesel based vehicles. The Competition will become intense and adopt strategy of price differentiation to gain market share. Awareness and regulation on fuel efficiency will become a big trend in India in the next few years as it helps both the economy and the environment. The Company is conscious of these developments and poised to take advantage of these trends. Setting up a factory in Bangalore and decision to focus on Alternator/ Starter (in case of four wheelers) and GDI/ Magneto (in case of two-wheelers) businesses, which contribute to vehicle engine performance by optimizing fuel cost and reducing emissions, are the steps in that direction. The Company has chalked out mid term plan up to year 2015 and has targeted CAGR of 21% in two businesses Alternator/ Starter as well as GDI/ Magneto. INTERNAL CONTROL SYSTEMS: The Company has an adequate system of internal controls to ensure that transaction are properly recorded, authorized and reported apart from safeguarding Companys assets. Well-experienced Chartered Accountant firm appointed by the Company for internal audit, reviews operations at all the establishments of the Company. All significant internal audit observations and follow up actions thereon are reported to the Audit Committee. The Audit Committee reviews the adequacy and effectiveness of the internal audit. HUMAN RESOURCES: Your Directors wish to place on record their appreciation for the commitment and dedication shown by the employees at all the areas of operation of the Company. Various HR initiatives are taken to align the HR policies to the growing requirements of the business. The Industrial Relations remained cordial during the year. As on 31st March 2012 your company had 1057 employees. INSURANCE All the assets of your Company including Plant & Machinery, Building, Equipment, and Vehicles etc. have been adequately insured. CAUTIONARY NOTE: Certain statements in the Management Discussion and Analysis section may be forward looking and are stated as required by applicable laws and regulations. Many factors may affect the actual results, which could be different from what the Directors envisage in terms of the future performance and outlook.