‘Auto sector on recovery path’: This research house picks its top stocks as it expects better days ahead

The auto sector reported strong growth in its September quarter (Q2FY23) earnings led by a recovery in volumes across segments supported by improvement in the supply of semiconductor chips and early festive season demand, a report by domestic brokerage house Motilal Oswal stated.

In the quarter, the total revenue for MOSL's Auto Universe (ex-Tata Motors) grew 33 percent YoY while EBITDA grew 40 percent YoY (in-line) and adjusted PAT grew 46 percent YoY (in-line) – primarily due to strong volume growth, price hikes, and moderating commodity cost inflation.

According to the brokerage, the quarter saw more upgrades than downgrades for FY24 estimates because of revenue/volume upgrades, and lower commodity prices. Over 5 percent upgrades for FY24E EPS were seen for Amara Raja Batteries (up 14 percent), TVS Motor (up 7.5 percent), CEAT (up 7 percent), and Endurance Tech (up 6 percent). On the other hand, over 5 percent downgrades were witnessed in Tata Motors (down 6 percent) and Motherson Sumi (down 5.5 percent) largely due to cuts in estimates for overseas businesses.

"Sustained demand recovery, improving chip supplies, and softening commodity prices are expected to drive performance from H2FY23E onwards. We prefer 4Ws over 2Ws, aided by strong demand and a stable competitive environment. We expect CV demand momentum to continue in FY24/FY25. We prefer companies with higher visibility in terms of demand recovery, strong competitive positioning, margin drivers, and balance sheet strength," said the brokerage.

Maruti Suzuki and Ashok Leyland are its top OEM (Original Equipment Manufacturers) picks. Among auto component stocks, it prefers Bharat Forge and Apollo Tyres. It also likes Hero MotoCorp as a pure play on domestic 2W demand recovery.

What worked for the sector this quarter:

Volumes

The brokerage pointed out that auto volumes in Q2FY23 recovered across segments. Demand momentum sustained in passenger vehicles (PVs) and commercial vehicles (CVs), while two-wheelers (2Ws) and tractors saw good recovery during the festive season, noted the brokerage.

Wholesale volumes for tractors, 2Ws and PVs grew 5 percent, 8 percent and 32 percent, respectively in Q2FY23; meanwhile the same was up 32 percent and 40 percent for light commercial vehicles (LCVs) and medium & heavy commercial vehicles (MHCVs), respectively, the report mentioned.

Going ahead, the brokerage expects demand to remain robust for PVs and CVs, whereas 2W volumes recovery is likely to sustain, however, tractor volumes are expected to be muted for H2FY23.

Margin improvement

It also pointed out that commodity cost inflation moderated in Q2FY23, with residual raw material (RM) cost impact, which was more than offset by price hikes, as reflected in gross margin improvement of 50 bps QoQ (up 10 bps YoY) for auto OEMs (ex-Tata Motors).

The EBITDA margin for Auto Universe (ex-TTMT) expanded 60 bps YoY (up 80 bps QoQ) to 11.1 percent, driven by operating leverage, it added.

"Majority of the management commentaries indicated the full benefit of commodity price correction would reflect in 2HFY23, due to inventory and lag effect of contracts. OEMs continued to take price hikes in 2QFY23 across segments to offset the under-recovery of commodity inflation. For companies with global operations (especially in the EU), Q2FY23 had seen peak energy prices and inflation in other costs in Q2FY23, with only partial cost pass-through agreed upon with customers, resulting in continued pressure on margins for those operations," revealed the brokerage.

Chip supply improving

Almost all the relevant OEMs and auto component players indicated that chip supplies are improving, with full normalcy by mid-CY23, noted the brokerage. 

Headwind: Increasing debt

As per the brokerage, the continued increase in working capital (due to inventory) led to an increase in net debt in Q2FY23 for companies such as Ashok Leyland (from ₹400 crore to ₹2,670 crore), Motherson Sumi (From ₹280 crore to ₹8,550 crore), Bharat Forge (from ₹940 crore to ₹2,320 crore), Apollo Tyres (from ₹400 crore to ₹5,500 crore), and CEAT (from ₹200 crore to ₹2,340 crore). Meanwhile, Tata Motors' net debt was reduced by ₹800 crore QoQ to ₹59,900 crore .

Earnings

Overall, the earnings were a mixed bag. Eight auto stocks reported a growth in earnings, four declined while Tata Motors reported a loss.

In the Nifty Auto index, only Maruti Suzuki posted a multifold jump in its profit in Q2. The country's largest car maker posted the highest-ever surge in its net profit in the September quarter. It reported a massive 334 percent YoY growth to ₹2,061.5 crore in its standalone net profit for the quarter under review on a low base. Its standalone profit stood at ₹475.3 crore in the same period last year. Total revenue from operations surged 45 percent to ₹29,942.5 crore as against ₹20,550.9 crore in the year-ago period.

According to MOSL, going ahead, the demand is expected to sustain with an order book of 4,12,000 units. The benefits of favorable exchange rates will reflect in H2FY23 on vendor imports (quarter lag). Commodity benefits would reflect in Q3, but may rise from Q4FY23 due to an uncertain macro environment, it predicted.

Samvardhana Motherson International's (formerly known as Motherson Sumi) consolidated net profit surged more than three-fold to ₹288 crore in the second quarter ended September, aided by strong sales across business verticals. The company had reported a net profit of ₹93 crore for the July-September period of last year. Its total revenue from operations rose to ₹18,261 crore in the second quarter of the current fiscal as against ₹14,076 crore in the year-ago period, according to a regulatory filing.

Eicher Motors and TVS Motors also reported a 76 percent and 48 percent YoY jump, respectively, in their Q2 net profit. Bajaj Auto, M&M, TI India, and Balkrishna Industries were the other auto stocks that posted growth in their September quarter PAT.

However, CEAT, MRF, Bharat Forge, and Hero Moto reported a decline in their profit.

Tata Motors was the only auto stock to report a loss whereas Ashok Leyland turned profitable this year against a loss in the year-ago period.