The auto sector is at a crucial juncture. After a turbulent 2021 with multiple challenges such as the shortage of semiconductors, inflation, and supply chain issues the rate hike by the RBI is another blow to the sector.
RBI governor Shaktikanta Das on May 4 surprised many by hiking the repo rate by 40 bps and CRR by 50 bps. This decision was surprising because the April meetings’ commentary had mentioned a gradual rate hike even as the overall tone was slightly hawkish.
Rate hikes aside, the ongoing Ukraine war is also a major near-term headwind for the sector as it has triggered an increase in input costs and raised uncertainty in terms of the resolution of the chip crisis.
Auto segment volume performance in April 2022 was partly impacted by supply-side constraints, especially in passenger vehicles (PV) and two-wheelers (2W) segments.
"Tractor segment performance came in above our expectations mainly led by better crop price realisations. CV segment performance came in line with our expectations. We expect M&HCV segment volume recovery to continue led by a pickup in economic activity and improving fleet utilization levels. Domestic 2W segment volumes came in below our expectation, partly impacted by chip shortage," brokerage firm Kotak Securities pointed out.
Has the rate hike made the auto sector less attractive?
The auto sector is rate sensitive sector because, in case of a rate hike, banks raise their lending rates which can discourage consumers to buy vehicles on bank credit. However, it is only a short-term factor and in the long term, the sector's fate will depend on several fundamentals such as economic revival, inflation and government policies.
After the recent 40bps rate hike by RBI, headwinds for the automobile sector have increased as the vehicle purchases depend on vehicle financing to the tune of 40-90 percent.
"Vehicle finance penetration is 40 percent for 2Ws, while its as high as 90-95 percent for CVs. Rate hike increases the overall cost of ownership for the consumers. Therefore it impacts the sentiment of consumers to some extent," said Mitul Shah - Head of Research at Reliance Securities.
Shah added that the sector is already derated in the last two months due to demand weakness and higher raw material price impact.
"Current valuation is at the lower end of the historical average. Therefore we don't expect any further debating, though the sector would remain under pressure for some time. We suggest a 'buy' on every decline. TVS Motor and Maruti Suzuki are our top picks within the sector," said Shah.
Santosh Meena, Head of Research, Swastika Investmart also concurs that the rate hike is negative for the sector.
"This decision will be negative for the automobile sector in the short term. The automobile sector is already bearing the brunt of chip shortage and high raw material prices; this will further exacerbate their problems," said Meena.
"However, the current interest rates are still near a record low, demand remains extremely strong for passenger vehicles whereas the supply remains low, so the overall effect for the PV will be minor but the two-wheeler sector will be more impacted, as the customer base is price sensitive. We need to be extremely vigilant about RBI’s action in the future, as too many rate hikes might derail the demand recovery for PV and deteriorate their affordability," said Meena.
Arun Agarwal, Deputy Vice President - Fundamental Research, Kotak Securities said while the rate hike is marginally negative for the sector, he does not expect a significant impact of this move on auto sales.
"We expect gradual demand recovery to continue in the sector over the medium term. Long-term investors can use correction to add select good stocks in auto space post considering the stocks valuation and future growth outlook," said Agarwal.
The contra bet
Many auto stocks are available at attractive valuation after the recent correction and some analysts believe due to normal monsoon, the sector can be a contra bet at this juncture.
"On a one-year forward basis, the Nifty auto is trading at 21.5 times in line with its historical avg at 22 times. However, the ongoing demand and supply gap owing to the shortage of semiconductors and the cost of borrowing going up due to the increase in repo rate could put further pressure on the industry. We expect normal monsoon prediction and opening-up of the economy and ramp up in the electric vehicle volume numbers to bring revival in demand by the second half of the year. In the short term, we have a positive stance on the CV and PV sector and a neutral stance on 2W," said Saji John, Sr Research Analyst at Geojit Financial Services.
On the front of inflation, Mansi Lall, Research Associate at Prabhudas Lilladher highlighted commodity inflation is expected to impact margins in the first half of FY23 cross companies. However, multiple price hikes have been taken by OEMs over FY22 and now in Apr-22 will aid in cushioning the margin decline, along with economic recovery.
"After witnessing two years of volume decline which dampened profitability for the overall sector; the OEMs are trading at an attractive valuation at a discount to their long-term trading multiples. One can contemplate investing for one-two years perspective, although near term volatility can’t be ruled out," said Lall.
Mohit Nigam, Head - PMS, Hem Securities believes the auto demand will revive led by a pickup in economic growth and revival in the rural sector.
"With ease in semiconductor issues and cooling of raw material prices, we may witness a sharp uptick in auto stocks which are currently sitting at very attractive valuations. So, yes we see the auto sector as a contra bet at this juncture," said Nigam.
Disclaimer: The views and recommendations made above are those of individual analysts or broking companies and not of MintGenie.