Automobiles Comeback: improvement expected to sustain, says Sharekhan

As expected, Q2 FY21 was a comeback quarter for the automotive industry post a washout in Q1 (on account of Covid-19 led lockdown). The auto universe revenues (ex-TAMO) grew 6% yoy (broadly in line with estimates of 4% growth). All the segments (except CV) witnessed a decent recovery driven by strong rural sentiments, pent up demand and increased preference for personal transportation. Automotive OEM revenues grew 5% yoy driven by a recovery in volumes and price hikes. Automotive ancillary companies (due to faster pick up in replacement demand) delivered slightly better performance with revenue growth of 7%.

Operating margins of the Sharekhan automobile universe improved 130 bps yoy to 14.2% (better than our estimates of 13.6%). Operating leverage due to healthy top line growth and cost control measures led to margin improvement. Gross profit margins of the auto universe declined by 80 bps yoy, impacted by the pricing pressures on account of the Bharat Stage 6 norms. Automotive OEM operating margins improved 90 bps yoy while auto ancillary players (with better replacement mix) margins improved 230 bps yoy. Universe net profit declined 6% y-o-y (in-line with expectations of 5% drop)

Outlook Sales near Pre-COVID levels; expect improvement to sustain:

Automotive volumes have been recovering since the Government unlock measures announced in May 2020. Increased preference for personal transportation, strong rural demand and improving economic growth has led to a recovery. Automotive retail sales have reached near Pre-COVID levels in the festive season in the October to November period. While PV sales are higher compared to last year (likely high single digit growth), 2W volumes are marginally lower compared to last year. Various management commentaries of auto ancillary players indicate that the trend of improvement is likely to sustain post festive season. Passenger vehicle players have indicated positive growth momentum post festive season while tractor demand is expected to continue to grow in double digits due to strong farm sentiments. CV players have indicated sequential improvement to continue while 2W players expect trend of sales improvement to sustain.

Valuation:

FY22 likely to witness strong recovery; retain positive view:

Automotive volumes declined in FY20 due to slowing economic growth, rising cost of ownership due to mandatory insurance and safety regulations and implementation of BS-VI emission norms. Growth in FY21 would be impacted by economic slowdown on account of COVID-19 and Sharekhan expects a double-digit drop in automotive volumes (excluding tractors). However, after two consecutive years of a decline, Sharekhan expects a strong recovery from FY22. Expected normalisation of economic activities and pent up demand are likely to lead to strong double-digit volume growth. Strong volume growth would drive up earnings as well as valuation multiples. Sharekhan retains their Positive view on the Auto sector.

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Key risks:

1) Second wave of COVID-19 can impact the economic activities and the demand
2) Delayed recovery in economic growth and consumer sentiments.
3) Commodity prices have increased and could impact profitability if recovery is slow.

Preferred Picks:

Hero MotoCorp, Bajaj Auto and M&M in OEM Space.

Balkrishna Industries, Mayur Uniquoters, Bosch, Schaeffler, Suprajit Engineering in Auto Ancillaries Space.

Leaders for Q2 FY2021:

Hero Motocorp, Apollo Tyres and TVS Motors

Laggards for Q2 FY2021:

Ashok Leyland, Eicher Motors and Bajaj Auto