The automobile sector is staring at more downgrades in days to come as rising crude oil prices, cost pressure, chip shortage and higher inflation are likely to deal a blow to the industry.
The industry has been under pressure for the past several years due to macro headwinds, technological shifts and regulatory changes. Covid-19 came as a strong blow to the sector as it halted the production due to lockdowns and hit the sales also.
Data from Society of Indian Automobile Manufacturers (SIAM) show that, barring a few exceptions, most segments of the sector, including passenger vehicles (PV), commercial vehicles (CV), three-wheelers (3W) and two-wheelers (2W) have been witnessing a fall in domestic sales numbers since FY20 on a yearly basis.
Sales of passenger and commercial vehicles saw an uptick in February, but sales of two-wheelers and tractors remained subdued on account of lower demand and a high base of the last year.
Brokerage firm Motilal Oswal Financial Services pointed out that the ongoing geopolitical crisis is escalating the risks of commodity inflation, fuel price hikes and potential disruptions in supply chains globally, previously witnessed in the second half of CY21. These headwinds arise against the backdrop of some stability in commodity prices and supply chain issues, which emerged in the last 3-4 months.
"Sharp inflation in crude oil and rubber will further aggravate under-recoveries led by the commodity costs and delay in margin recovery for the tyre players. Based on the current spot prices, we estimate under-recoveries at 8-10pp," Motilal Oswal said.
Motilal Oswal further said that while commodity cost inflation will hurt margins, an increase in fuel prices can potentially lead to demand deferment across segments. This would particularly hurt the 2W segment where customers have been impacted by persistent inflation in the total cost of ownership over the last three years.
"Besides, 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 the manufacturing of semiconductors. This could potentially derail the improving chip supplies and continue to impact PVs, premium 2Ws and CVs, negatively," said the brokerage.
"All these headwinds leads to substantial cuts in FY23 earnings per share (EPS) for Ashok Leyland (-19%), Tata Motors (-14%), TVS, Hero MotoCorp and Maruti Suzuki (-12% each). For auto component players, there are major cuts in FY23E EPS for CEAT (-32%), Motherson Sumi, Apollo Tyres (-20% each), MRF (-15%), Endurance Tech (-12%) and Exide and Bharat Forge (-11% each)," said Motilal Oswal.
Ratings agency India Ratings and Research (Ind-Ra) has also revised its outlook for the auto sector for FY23 to neutral from improving, primarily on account of supply-side constraints and a muted rural demand.
"Domestic sales volumes may grow 5-9 percent year-on-year in FY23, after three consecutive years of decline. Passenger vehicle volume could grow 5-9 percent year-on-year in FY23, driven by an intermittent improvement in consumer sentiments and continued preference for personal mobility although supply chain issues could limit the growth," India Ratings said in a report.
The report further said that the commercial vehicle volumes may grow in high double digits of 16-22 percent year-on-year in FY23, mainly supported by medium and heavy CVs, aided by an uptick in economic activities and increased infrastructure spending.
"The ongoing geopolitical tensions Russia-Ukraine situation could increase commodity prices, crude oil prices, and exacerbate supply chain issues. Furthermore, slower recovery in rural sales and further price hikes by original equipment manufacturers could act as possible headwinds for the sector," India Ratings observed.
In the current scenario, Motilal Oswal prefers companies with higher visibility in demand recovery, strong competitive positioning, margin drivers and balance sheet strength. Maruti Suzuki and Ashok Leyland are its top original equipment manufacturer (OEM) picks. Among auto component stocks, Motilal Oswal prefers Bharat Forge and Apollo Tyres.