Auto Sector – Time to Overweight

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Auto sector companies have witnessed severe demand headwinds in 3Q FY-19, on account of a number of factors coming together at the same time such as (1) Tight liquidity conditions arising from the unwillingness of NBFC to finance, post ILFS event (2) Rising fuel/insurance costs and (3) Severe Farm level Stress leading to weak rural sentiment.

This has led to a sharp stock market sell-off (up-to 20% to 30%) for these companies.

Earnings multiple (one year forward basis) for this sector (other than Maruti) has come down to l3 to 15 range. Even Maruti, the bluest of blue-chip currently trades at 22 multiple.

We see this slowdown as a temporary blip and not a structural issue. More so, as we don’t envisage a general slowdown in India’s Economy. Our take is that the sector has bottomed out in 3Q FY 19 and that the situation will improve hereafter, due to improving liquidity conditions with NBFC’s going forward, significant softening of fuel prices lately, new product launches and also because of a host of measures taken in the recent budget to stimulate rural demand.

As such, we strongly recommend to overweight Auto Sector.

Even though, tighter pollution and safety norms in the coming year, will lead to higher unit prices and margin compression, I expect that in the medium to long term volume growth will sustain at 6 to 7% range for two wheelers and 8 to 9% range for passenger/commercial vehicle and also the tractor segment.

Even if one accounts for the higher risk that the Auto sector faces, as the sector moves on to Electric Vehicles, the earning multiple at current levels looks very attractive.

I see a 15% rebound in NIFTY AUTO index from the current level of 8,100.

Our segment wise take is detailed below:

Passenger Vehicle Segment: (Buy Maruti @ Rs 6,800)

This has been growing at 8 to 9% in the last 3 to 4 years. While sales is likely to slow down to 3 to 4% in FY – 19, growth is expected to bounce back once again to 8% to 9% range in the coming years.

Two Wheeler Segment: (Buy Hero Honda @ Rs 2,700)

Sales has been growing at about 8% in last 3 to 4 years. While sales growth has slowed in second half of FY 19 (YTD at 10%), the sector is expected to revive as money is pumped into the farm sector.

Tractor Segment (Buy Mahindra & Mahindra @ Rs 630)

Has been in upcycle for last three to four years and growing at 17% to 20%. Due to cyclical slowdown and farm sector distress, tractor sales may slow down to 9% to 10% this year. However as money is being pumped inti the farm economy, slow-down may not be sharp. Expect volume growth at 10 to 12% in coming years.

Commercial Vehicle Segment (Buy Ashok Leyland @ Rs 79)

Has been in upcycle for last four years and growing at the rate of 17% to 20%. As such a cyclical slowdown is in the offing. As a result of the demand headwinds witnessed in 3rd quarter, growth may slow down to 13 to 14% range in FY 19. Implementation of BSV1 (pollution standard) in April 2020, will lead to upfronting of demand in FY 19- 20. However, increased axle load will lead to significant slow-down in demand thereafter. We expect the CV sales to slow down to 12 to 14% range in FY 20 and to further slowdown to zero % growth, there-after

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