PLI Scheme to make India’s AC component production more cost competitive: Ind-Ra
Due to PLI Scheme, the cost of manufacturing in India could be cheaper in the range of 8%-12%, depending on the AC component, Sanjuta Goel, Analyst, India Ratings and Research (Ind-Ra).
The new production-linked incentive (PLI) scheme aimed at encouraging domestic production of white goods will reduce import dependence over the medium term, according to India Ratings and Research (Ind-Ra).
The PLI scheme for ACs
will provide an incentive of 4%-6% on incremental sales of goods manufactured in India over a period of five years. The minimum investment varies depending on the nature of projects (i.e. large or small) as well as upon the nature of component. India’s high reliance on imports in the sector exposes companies to forex risks as well as supply chain disruptions, on account of dependence on select geographies. As such, the scheme is likely to see increased investments from various domestic and global players in the sector.
The total budgetary allocation for the scheme is Rs 62.38 billion; however, the split between air conditioners (ACs) and LEDs is not available. Assuming 60% of the total budgetary allocation goes towards AC segment, Ind-Ra estimates the scheme has the potential to generate incremental revenues in the range of Rs 650 billion-750 billion. Furthermore, accounting for the benefit derived from PLI scheme, the agency expects that the cost of manufacturing in India could be cheaper in the range of 8%-12%, depending on the component.
Critical components largely imported
As per Consumer Electronics and Appliances Manufacturers Association (CEAMA), out of the total 75% components (by value) being imported, assembling is completely done in India. Also, critical components such as compressors, condensers, blower motors and PCB circuits, which account for 55%-60% of the total cost of a room air conditioner (RAC), are largely imported.
Over the last few years, several players have been working towards indigenisation and backward integration for various parts such as compressors, motors, outdoor and indoor units, heat exchangers, among others and have established manufacturing units in India. For instance, Highly Electrical Appliances (JV of Hitachi Group) and Midea Group (GMCC) have set up / are setting up their compressor facilities in India. However, these are still small in size and inadequate to cover for the entire industry. As such, the Indian RAC industry continues to depend on imports, especially from China and South East Asia, for majority of critical components.
Given the small size of domestic RAC industry and lower cost of imported components, it does not make economic sense for AC or component manufacturers to invest in local units. However, in view of various incentives/ policies launched by the government, Ind-Ra believes that the industry could see increased investments by large players mainly to increase backward integration. Some global players could also consider India as their alternate supplying destination. Large contract manufacturers, which account for around 40% of the total ACs manufactured in India, could also invest in this space as they are likely to achieve economies of scale faster than other players.
Moreover, Ind-Ra believes that large players could look at outsourcing manufacturing of non-critical components to their contract manufacturers. However, the Indian companies could also look at investing in critical components through a strategic or technological partner due to lack of technological expertise. Ind-Ra believes that localisation of non-critical components would happen faster than that for critical components due to lower scale of investments as well as less technological expertise required towards the former.
Government’s focus on increasing domestic manufacturing
Over the past few years, the government of India has increased the import duty on completely built units and even components to boost local production. For instance, the import duty on RAC compressors has been increased to 15% in the Union Budget 2022 from around 7.5% until September 2018. Similarly, fully finished AC units now attract an import duty of 20% against 10% earlier while AC units with refrigerants are now completely banned since October 2020. As per CMIE, this has helped to reduce AC imports (net of exports) in India to 40% in 9MFY21from 49% in FY18. This has also resulted in companies shifting from importing completely built units, to imports of components and sub-assemblies for RACs.
Ind-Ra believes that the increase in import duty along with incentives under PLI scheme
would make Indian products more competitive than their Chinese counterparts which are otherwise 15%-20% cheaper. The government has also undertaken other measures such as subsidies on capital expenditure, lower corporate taxation rate, allowing 100% FDI in electronics industry to attract global companies to set up their plants in India.
Ind-Ra also expects that the reliance on imports would reduce over the next three to four years as the government could announce the phased manufacturing programme for ACs, similar to that announced for mobile phones, and the import duty could increase to the extent of 30% for RACs and 20% for compressors by FY25.
Favourable fundamentals to support growth in medium to long term
The second wave of COVID could impact the potential purchasing power of consumers and weaken consumer sentiments, thus impacting the overall demand in the near term. However, the extension of work from home especially during peak summers could partly compensate for the same. Nevertheless, the gradual recovery in residential real estate, rising temperature, and improved availability of electricity bode well for AC demand in the medium to long term. Moreover, the fairly low AC penetration in India (at less than 10%) compared to other emerging countries and other white goods offers a long-term growth potential.
The agency expects that the white goods industry has the potential to grow at a CAGR of 15%-18% over the next five years. Ind-Ra believes that the facilities to be set up would largely be used as import substitution, while substantial exports from these units is unlikely in the medium term.
Interim challenges could delay investments
The government has hiked the import duty on key raw materials used in manufacturing of ACs such as copper, steel, aluminium and plastic injection moulding components. Even if there is localisation of components, import of some raw materials such as specialised steel could increase, thereby increasing the cost of manufacturing of these components. Moreover, the increasing input cost could force manufacturers to increase the prices for end-consumers and hence impact the demand in the interim. Furthermore, the PLI scheme notification mentions the timeline for application as six months which might have to be extended as companies could take time to re-evaluate their business strategies amid the second wave of COVID.
Strong financials to support investments
The credit metrics of most large AC manufacturers are fairly strong with either net cash position or net leverage for the industry remaining below 1.0x.
The capex incurred over the last few years in the sector has also been in the range of 3%-4% of the revenues. As such, the companies are well positioned to undertake incremental capex without impacting their credit metrics materially. However, for component manufacturers, the leverage is still in the range of 2.0x-2.5x and hence the investments are likely to be small.
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