Case 010Macro and commodity sensitivityHard

Coravi Auto Parts sells 45% of its output to the US, and a 25% tariff is imposed. Customers absorb 40% of it. What happens to volumes and EBITDA, and how would you defend your view under challenge?

Franklin TempletonSan Mateo · 2024

The situation

Coravi Auto Parts makes machined engine and transmission components. Revenue is Rs 3,000 crore, of which Rs 1,350 crore, 45%, is sold to US vehicle makers. The EBITDA margin is 15%, Rs 450 crore, and each rupee of lost US sales loses 35 paise of contribution, because materials, power and freight go away with the volume.

The US imposes a 25% tariff on these parts. Treat it as 25 rupees per 100 of today's price. US customers agree to bear 40% of it; Coravi cuts its price to absorb the rest. Customers facing a higher landed cost shift some orders to suppliers elsewhere, roughly one for one: a 10% higher cost loses about 10% of volume. In the interview, the portfolio manager challenges every assumption you make.

Your task

Size the hit to US volume and EBITDA, then defend the number: which assumption matters most, and what would change your mind?

Quick check

Which assumption moves the EBITDA hit the most?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

US volume falls about 10% and EBITDA falls about Rs 230 crore, roughly half, from Rs 450 crore to about Rs 220 crore. Coravi absorbs 15 of every 25 tariff rupees through a price cut on the 90% of volume it keeps, which costs about Rs 182 crore, and loses Rs 47 crore of contribution on the volume that goes. The number rests on the 40% split; defend it by showing the whole range, from Rs 118 to Rs 338 crore.

Step 1Why split the tariff before sizing it?

When a toll is added to a highway, it is shared between the truck owner, who earns less per trip, and the shopper, who pays more for goods. Nobody pays all of it. A tariff is paid in three ways: by the customer through a higher landed cost, by the exporter through a lower price, and by both through volume that disappears. Coravi's hit depends on which of those carries the weight, so split it first. Of 25 rupees per 100, customers take 10 and Coravi 15, so Coravi now receives 85 and the customer pays 110.

Split the tariff before you size it: who pays each rupee of the 25?Before: Coravi's price to a US customer100After: the customer's landed cost of 110Coravi now receives 85Tariff 25old priceCoravi: 15Customer: 10Volume-10%landed costup 10%
Of a 25 rupee tariff on each 100 rupees of Coravi's US price, US customers absorb 10, so their landed cost rises to 110, and Coravi absorbs 15 by cutting its price to 85; the 10% higher cost to customers costs Coravi about 10% of its US volume.
Step 2How big is the hit to volume and EBITDA?

Volume first. Customers' landed cost rises 10%, and with roughly one for one switching, about 10% of US volume goes elsewhere. Then EBITDA, in two parts. The price cut of 15% applies to the 90% of volume Coravi keeps, Rs 1,350 crore x 0.90 x 0.15, about Rs 182 crore, and it falls straight to EBITDA because costs do not change. The lost 10% of volume costs 35 paise of contribution per rupee, Rs 1,350 crore x 0.10 x 0.35, about Rs 47 crore. Together that is about Rs 230 crore, half of Rs 450 crore.

Rs croreBeforeAfter
US revenue1,3501,032.8
Price cut on retained volume(182.2)
Contribution lost on 10% of volume(47.2)
EBITDA450.0220.5
EBITDA margin on total revenue15.0%8.2%
The tariff cuts Coravi's US revenue from Rs 1,350 crore to about Rs 1,033 crore and its EBITDA from Rs 450 crore to about Rs 220 crore, with the price cut on retained volume doing four fifths of the damage.
Step 3How do you hold your ground when every number is challenged?

Separate facts from judgements, then show the range on the judgement. The US share and the margin come from the accounts; the 40% split is an assumption. Plot the EBITDA hit against the split and the whole debate fits on one page: from Rs 338 crore if Coravi absorbs everything to Rs 118 crore if customers do. Then say what would move you along the line. If rival suppliers in other countries face the same tariff, customers have nowhere to switch, so they absorb more and volume holds. If Coravi is the only exporter hit, it absorbs more.

The answer hangs on one assumption: who absorbs the tariff1002003000Coravi absorbs it all: -338Base case, customers 40%: -229.5about 51% of EBITDA of 450Customers absorb it all: -1180%20%40%60%80%100%Share of the tariff absorbed by US customers; y axis is EBITDA lost, Rs crore
Coravi's EBITDA loss falls from about Rs 338 crore if it absorbs the whole tariff to about Rs 118 crore if customers absorb all of it; at the assumed 40% customer share the loss is about Rs 230 crore, roughly half of today's Rs 450 crore.

Close with the mitigants and their timing, because the challenger will ask. Moving volume to Europe or the domestic market takes a year or more and usually at a lower price; setting up assembly in the US takes longer. A weaker rupee would help at the margin. None of these changes the first-year number much, which is why the first-year hit and the three-year hit should be stated separately.

Where candidates lose it

The common error is to apply 25% to US revenue and call Rs 338 crore the hit, as though Coravi pays the whole tariff and loses no volume. Or the reverse: say customers pay it, so there is no impact. Both skip the split, which is the whole question.

Under challenge, the losing move is to abandon the number the moment it is questioned. The winning move is to show the range and say which fact would move you along it.

What the interviewer asks next

  • Rival suppliers in two other countries face the same tariff. How does your 40% assumption change?
  • How would you value Coravi if the tariff is expected to last two years rather than indefinitely?
  • What would you ask management on the next call?
  • How would a 5% depreciation of the rupee change the EBITDA hit?

Asked at Franklin Templeton, Equity Research, San Mateo, 2024 (Wall Street Oasis): I was stress-tested, and virtually every comment I made was under heavy scrutiny.

Company names and figures are illustrative.