Iran Autos Report Q3 2008

International sanctions are having a disastrous effect on the Iranian automotive industry, with output slumping as European majors have cut exports of vital parts and components to Iran, according to BMI's latest Iran Automotives Report.

While GDP growth and private consumption are holding up - albeit at relatively modest rates compared to Iran's regional peers - car production slumped 27% year-on-year (y-o-y) to 156,000 units in the first two months of the current Iranian year (beginning 20 March 2008). The decline is largely related to the impact of UN sanctions aimed at forcing Iran to give up its controversial nuclear research programme and the US's unilateral sanctions targeting the Revolutionary Guards and more than 20 Iranian companies, banks and individuals, as well as the defence ministry.

Reports indicate that Renault's joint venture with Iran Khodro and SAIPA, manufacturing the Logan model (marketed as the Tondar in Iran), is operating at less than 25% capacity, leading to a massive backlog in orders. Assembly plants manufacturing Peugeot, Citroen and Volkswagen (VW) models from imported completely knocked down (CKD) kits are also experiencing a sharp drop in production volumes. As a result of the sanctions covering dual-use technologies and the failure to provide letters of credit due to US pressure on European banks, Iranian carmakers are struggling to import parts from Europe. BMI forecasts a 15% drop in car sales in 2008/09 as a result of the production cuts, with the slump set to continue over the forecast period. While Iran has potential for annual sales of up to 2mn units, we believe that annual sales will not exceed 1mn units over the next five years. The slump in domestic production at a time of rising demand means that the automotive trade deficit will widen further over the forecast period. BMI has revised downwards its forecast for exports - most of which are in the form of CKD kits for foreign joint venture assembly lines - for 2012/13 from US$5.25bn to US$3.75bn as a result of anticipated financial problems in the automotive sector resulting from the sanctions, which are affecting the entire supply chain.

Although we believe that the new mass-market models being built in Iran - notably Iran Khodro's Aryan and Samand models - fit the requirements and price range of less-developed emerging markets, concerns remain about the long-term viability of joint ventures in the context of the sanctions regime. With a high level of Iranian-manufactured content in the Samand, Iran Khodro's 'world car' will not face the problem of a shortfall in parts availability as a direct result of the sanctions regime, but the financial impact of sanctions on Iranian carmakers will be felt by debt-ridden Iranian parts makers, leading to disruption of Samand CKD kit exports.

Firms across the Iranian manufacturing sector are struggling with rising levels of debts with many effectively insolvent and unable to pay their workforce. The automotive sector is not exception. Despite the government's stated aim of achieving greater self-sufficiency in automotive parts, the Society of Automotive Spare Parts Manufacturers claims that by mid-2008 parts producers were owed unpaid debts of around US$1bn by vehicle manufacturers. The possibility of several parts supplier going bankrupt is a further setback for automotive production in Iran. Yet, carmakers are reporting rising profits, indicating that the main problem is not the profitability of the automotive industry but the country's complicated and poorly enforced commercial legal code, which undermines the effectiveness of the Iranian judicial system. Net profit at Iran Khodro rose to US$534mn in 2007, compared with US$292mn in 2006, on the back of a 10.8% y-o-y rise in sales revenue to just under US$8bn. There is certainly interest in maintaining high profitability of politically well-connected carmakers, at the expense of parts suppliers by defaulting on loans. Political interference in the judicial process is rife, with clerics effectively in control.

Resorting to the court system seldom leads to speedy dispute resolution and written contracts are only rarely of any use in investment disputes. Consequently, automotive parts makers are at the mercy of the interests of the ruling political class and its business interests.