Auto stocks have been witnessing decent traction of late despite the headwinds such as higher inflation, rising rates and slowing economies.
The Nifty Auto index has gained 3 percent year-to-date (YTD) in the calendar year 2022 (CY22) against a 4 percent fall in the benchmark Nifty50.
After underperformance for many years, auto shares come back quite strongly. The timely arrival of the monsoon and the latest move by the government to reduce steel prices are positive for the auto stocks.
Sneha Poddar, AVP Research, Broking & Distribution, Motilal Oswal Financial Services expects demand to improve sequentially for PVs on the back of easing supply chain issues. MHCVs are likely to benefit from the government’s push for infra activities while LCVs should gain from the last mile mobility.
The recent cut in excise duty for fuel augurs well for CV demand though there is no immediate respite. However, there would be a slow recovery in 2Ws and tractor volumes. OEMs and auto component players are indicating that the gradual improvement in chip supplies is projected from Q2FY23 onwards.
"Full normalcy is expected to restore towards end-CY23. Further, Commodity cost inflation slowed in Q4FY22 and most of the OEMs indicated that the commodity prices are stabilizing and there should be some improvement in gross margins as the benefits of stable commodity prices and price hikes reflect in P&L," said Poddar.
Auto stocks are very sensitive to rate hikes and the economic growth of the country. As the inflation is elevated, crude oil prices are soaring, the end of the Ukraine war looks remote, and rate hikes are looming, economic growth is expected to lose steam. In such a gloomy scenario, how should one play the auto theme? Should one buy, hold or sell them?
The road ahead
Many analysts believe that the auto stocks may see gains in the coming months even as the volume may remain under pressure as the outlook for the rural economy is better because of the prospects of an above-normal monsoon.
"We have a positive view on the auto sector. Though we expect the industry volume to remain under pressure over the next three-four months, the diminishing impact of Covid and rural recovery would support gradual improvement every month. On the other hand, ongoing global geopolitical issues amid Russia Ukraine war have a negative impact on the businesses environment, which creates negative demand sentiment for consumption. The key monitorable is how the war situation pans out in the coming days," said Mitul Shah, Head of Research at Reliance Securities.
The sector has high hopes for the retail demand which is expected to remain strong as the normalcy returns after the pandemic.
"We expect retail demand to remain strong in FY23. We expect the automobile industry to witness double-digit growth in FY23, while we expect M&HCVs (medium and heavy commercial vehicles) and 3W (three-wheeler) segments to outperform with more than 30 percent volume growth in FY23. Nonetheless, long-term fundamentals continue to remain intact for the automobile sector, in our view. The auto sector grew in 2022, primarily due to sequential improvement in volumes, likely softening of commodity costs ahead and fuel price cut by the government through lower taxes on it," said Shah.
Shah said investors should remain invested from a medium to long term perspective. "However, valuation is an important parameter behind every investment. Therefore, based on price run up and valuation one should keep booking profit in select Auto and Auto ancillary companies. Our broader advice is to stay invested," said Shah.
After a subdued performance in the last few years, some analysts find them ripe for buying.
"If we see the relative margins of the auto companies as well the Quarter- on –quarter basis results we can track an improvement along with increasing volume and revival in the sector, they are expected to give better returns in future. I believe Auto stocks are likely to outperform the broader market in the near term," said Akhilesh Jat, Category Manager - Equity Research, CapitalVia Global Research.
Mansi Lall, Research Associate at Prabhudas Lilladher believes that the passenger vehicle (PV) and commercial vehicle (CV) segment may continue to fare better than the two-wheelers (2Ws).
"Growth momentum in PV sales will continue this year led by strong demand for SUVs/premiumisation, healthy order backlog caused by chip shortage (which is expected to improve from the second half of FY23) and new model launches. CV segment will continue to outperform on the back of infrastructural activities, LMDs, e-commerce and private/public transportation as the economy fully opens up," said Lall.
Deepak Jasani, Head of Retail Research, HDFC Securities thinks that the sector does not have large downsides from here, though it may take time to rise materially from here. Within auto, tractors, PVs, and CVs have been doing well lately despite the supply constraints, and rising input prices. and high fuel charges.
"Investors can reshuffle their holdings within the Auto space in favour of performing segments and hold on to them for one-two quarters post which a fresh review may be done," said Jasani.
Analysts point out that after witnessing chip supply issues over the last two years, the sector seems to be witnessing demand recovery once again by reducing chip shortages.
"The intensified commodity cost inflation is also slowing down which is getting compensated by higher price hikes. This should result in improvement in margins in subsequent quarters. Thus we suggest investors remain invested in order to benefit from a gradual recovery in the sector as the cycle has just turned around," said Poddar.
Auto stocks to buy
TVS Motor and Mahindra and Mahindra are the top picks of Reliance Securities.
Shah of Reliance Securities believes TVS Motor's outperformance will continue on the volume front on the back of strong products and improved brand equity recently, while its rising exports at a better exchange rate would help on the margin front.
"Its recent increased focus on the EV segment through new launches, as well as strategic tie-ups globally, would take it to a new scale on the EV platform. Its double-digit EBIDTA margin in this challenging situation is commendable. We expect it to give a positive surprise on margins and earnings front," said Shah.
For Mahindra and Mahindra, Shah believes that new products and the company’s stronger presence in rural markets would drive M&M’s overall volume and profitability, going forward.
"We believe that the government’s focus on agri income and rural thrust would revive the rural economy in FY23E and would support tractor sales, though near-term slowdown is inevitable. Strategic decision on capital allocation, focus on core business and investment, better traction from high margin tractor segment and ongoing better traction in automobile segment would result in steady expansion in M&M’s valuation multiple.
Ashok Leyland and Tata Motors are preferred picks of the brokerage firm Prabhudas Lilladher in the OEM space. Both these companies are expected to continue to benefit from the cyclical upturn, improving fleet utilization and freight rates.
"Ashok Leyland will continue to regain its lost share on the back of model launches and revival in the bus segment due to the opening-up of the economy. Also, Tata Motors will benefit from its revamped portfolio, customer preference for SUVs, rising EV penetration and global PV recovery," said Lall of Prabhudas Lilladher.
Poddar of Motilal Oswal Financial Services prefers 4Ws over 2Ws on the back of strong demand and a stable competitive environment.
"We prefer companies with higher visibility in terms of demand recovery, a strong competitive positioning, margin drivers, and balance sheet strength. Maruti and Tata Motors are our top OEM picks," said Poddar.
Brokerage firm CapitalVia Global Research pointed out high food prices are in favour of farmers that may help revive tractors as well as two-wheeler demand in rural areas. Mahindra & Mahindra, Maruti and Tata Motors are the top stocks of the brokerage.
Disclaimer: The views and recommendations made above are those of individual analysts or broking firms and not of MintGenie.