Preference for personal mobility will aid the demand for passenger vehicles, while the infrastructure and construction push is good for commercial vehicles.
The Indian auto industry continues to be hit by factors beyond its control. From COVID-19 to the Russia-Ukraine war, the industry has found the going tough over the last two years.
The problem started when the first COVID-19 wave led to the countrywide lockdown in late March 2020. As the situation improved, the sector saw robust offtake due to pent-up demand but a devastating second wave and the accompanying supply chain disruptions, which triggered a global shortage of semi-conductors, again nipping the demand revival in the bud.
Chip shortage continues to be a problem for the original equipment manufacturer (OEMs), preventing them from achieving full capacity utilisation even as the demand continues to be strong.
The Russia-Ukraine war has dented sentiment and may result in a further delay in the revival of fortunes of the beleaguered sector.
The automobile industry has been witnessing weakness on account of multiple headwinds.
The Russia-Ukraine war and the sanctions against Moscow have led to a spike in commodity prices following worries over supply disruptions. The crude has been touching new highs and no respite seems to be in sight
“While sharp rise in commodity cost would hurt margins, probable increase in fuel prices (15-20 percent) post the state election results can result in demand deferment across board,” said Sneha Poddar, AVP Research, Broking & Distribution, Motilal Oswal Financial Services.
“There are fears of semiconductor chip supplies getting adversely impacted as Russia and Ukraine are important sources of noble gases and precious metals used in manufacturing of semiconductors,” she said.
Shortages could further derail chip supplies and continue to impact passenger vehicles (PVs), premium 2-wheelers (2Ws) and commercial vehicles (CVs), negatively.
Darshan Gangar, Research Analyst, Axis Securities concurred with Poddar and said, “A few pockets of the auto industry, especially domestic 2Ws and tractor segments, have been struggling much before the rise in crude prices, owing to soft demand, which has failed to pick up”.
What’s going right?
The passenger and commercial vehicle segments have seen relatively robust demand, which is likely to sustain despite multiple challenges.
“In the PV space, notwithstanding the near-term supply-related challenges, demand outlook is improving with the preference for personal mobility, while new launches have also met with strong consumer sentiments,” said Sanjeev Hota, Head of Research, Sharekhan by BNP Paribas.
On the CV side, the growth outlook is supported by the overall economic recovery led by the construction and infrastructure sectors.
Sreeram Ramdas, Analyst at Green Portfolio, said the headwinds were temporary and the new capex in the semi-conductor space would change the equation and help ease the chip shortage in the next couple of quarters.
“What steers the domestic auto sector of any country is essentially the population and their income and data shows that only 20 in a 1,000 people own a vehicle in India,” Ramdas added.
Considering India is projected to have the fastest-growing middle class in the world, and the fastest-growing economy, the auto sector stands to gain.
“Premiumisation of demand, rising per capita income and strong demand even from non-metro cities are big positives for the sector,” said Arun Malhotra, Founding Partner & Portfolio Manager at CapGrow Capital Advisors.
What’s not right?
Prices of the commodities relevant to the auto industry have gone up by around 15-50 percent over H2CY21 average.
The benchmark Brent crude has also surged to $130 a barrel following the US decision to ban Russian crude oil and Britain’s decision to phase out Russian energy imports by the end of 2022.
“Both these factors would exert pressure on the profitability and demand of OEMs, while sharp inflation in crude oil and rubber will further aggravate under-recoveries and delay in margin recovery for the tyre players,” said Poddar.
Auto component players with sizeable EU operations will see the full impact of hyper-inflation in energy costs in H1CY22. A 100 percent jump in the prices of nickel over the past few days threatens to disrupt production of batteries for electric vehicles.
“The impending fuel price hike after elections and expected rise in third-party motor insurance premiums would likely worsen the situation further as a probable increase in fuel prices will potentially lead to demand deferment across segments,” said Gangar from Axis Securities.
Is it time to go overboard on auto stocks?
The BSE Auto Index touched its peak of 26,814.26 on January 17, 2022 but has since fallen 19 percent (till March 8). The auto sector underperformed broader market indices.
So, does it make sense to invest in auto stocks?
“It is never wise to catch a falling knife at one go, be it in terms of earnings or market cap,” said Basudeb Banerjee, Research Analyst, ICICI Securities.
FY23 profitability is likely to get eroded significantly, if present commodity cost levels sustain for six more months.
“Thus, looking into potential margin revival from H2FY23 and unchanged outlook on demand and margins for FY24, it is time to add stocks in tranches and focus on plays with lean balance sheet,” added Banerjee.
The correction in auto stocks has resulted in softening of their valuations and investors can find value in these stocks.
From an investment point of view, “after the significant under performance, valuation is turning favourable in certain pockets of automotive value chain but we would like to put our bet on PV and CV space, as the demand outlook is more reasonable in this space as compared to others,” said Hota of Sharekhan by BNP Paribas.
The CV industry is on the cusp of an up-cycle, supported by the government’s push on infra, pick-up in economic activities and robust last-mile connectivity and replacement demand.
The demand for the PV industry, too, has remained resilient over the last year, which is reflected in the strong order book and high waiting period for all the OEMs.
“Post the recent stock price correction in the overall auto space along with major headwinds and negative sentiments already priced in, one can use the ‘buy-on-dips’ strategy to accumulate high-quality stocks trading at attractive valuations,” said Gangar from Axis. His top picks are Ashok Leyland, Maruti Suzuki and Bajaj Auto.
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