India is the fourth largest automobile market in the world after China, US and Japan.
The automobile sector in India contributes around 7 % of the GDP.
However, in the recent past, the sector has been on a down streak for a number of reasons such as oil prices, weak rupee, rising insurance premium etc. A majority of these factors have taken the road to recovery and this is expected to have a positive impact on the auto sector.
Emerging themes in the auto sector
Bharat Stage VI Emission Norms
The Bharat Stage Norms are standards instituted by the government of India to regulate the emission of air pollutants from motor vehicles. The norms were introduced in the year 2000 and are based on similar norms in Europe called Euro 4 and Euro 6. As on April, 2017, all vehicles were mandated to adhere to BS IV Norms.
The new government policy mandates that by April, 2020 all vehicles must be complaint with BS VI Norms. The introduction of BS VI Norms calls for upgradation in the technology which helps reduction of emission of pollutants. BS VI also makes on-board diagnostics (OBD) mandatory for all vehicles. OBD device informs the vehicle owner or the repair technician how efficient the systems in the vehicle are.
Compliance with BS-VI norms will require higher investment in technology to upgrade vehicles in stock and those which are newly produced. This has dual implications. One is that there will be fewer new launches till the deadline. Secondly the prices of the newly introduced vehicles from April, 2020 will be higher since the vehicles will cost automakers more and they will pass on the additional cost to the buyers. The Bharat Stage VI-compliant fuel too will also be more expensive. This is likely to impact the overall demand in this sector at least during the period which is in proximity to the deadline.
In order to provide ease in the process towards compliance, many auto makers moved then Honorable Supreme Court which reject their plea and upheld the validity of the deadline.
New third party insurance norms
In line with the Supreme Court order in this matter, the IRDAI (Insurance Regulatory and Development Authority of India) directed all general insurance companies to offer only long term third party insurances for motor vehicles. As per this direction, general insurance companies are directed to issue only three-year insurance for 4 wheelers and five-year insurance to two wheelers. The direction also mandates the premium for the entire term be collected in the beginning at the time of sale of vehicle itself. The amount so paid in excess of first year premium would be considered as “Premium Deposit” or “Advance Premium” and be recognized as income upon maturity of the relevant period for which the premium is paid.
This has led to increase in premium itself in addition to increasing the burden of new purchase. Hence, this has been considered as one of the contributing factors to the weakening demand. However, as the policy changes are gradually absorbed the negative impact due this rise in insurance premium is expected to subside.
Rural demand outlook
The rural demand been providing the much needed support to the melancholy of the sector. The overall increase in government spending has been a major contributor to the increase in consumption demand in the rural space. There have been a number government initiative such as rising of the MSP (Minimum Support Price) for Kharif crops, increased rural infrastructure spending, etc., which have contributed to this rise in rural demand.
Other policy impact
The Society of Indian Automobile Manufacturers (SIAM) provides posits a positive outlook towards the recent interim budget with respect to the auto sector. The tax exemption up to 5 lakhs is likely to increase the disposal income of the middle class and have an impact on sales volumes of two wheelers and small four wheelers.
However, the budget also introduces customs duty on lithium ion batteries from nil to 5%. This will be disadvantageous to the e-vehicle segment which is at a very nascent stage in India.
The sector is also largely influenced by the interest rate regimes, as it affects cost of capital, EMI rates, cost of financing etc. After a series of rate hikes amidst weakening rupee and rising commodity prices and inflation, in February, the RBI cut rate by 25 bps (basis points) for the first time. With the reduced pressure on inflation, this is likely to impact the auto sector positively.
Overview of the sector performance
The NSE Auto Index data has recorded a fall from 11000 levels to as low as 8500s in the period between August, 2018 to November, 2018. It is pertinent to observe the movement of oil prices in the period. During this period the crude oil prices rose as high as $85 per barrel. The period was also marked by poor performance of the rupee and rising interest rates. Adding fuel to the fire, consumption demand in the Diwali season also fell below expectations. The relative stabilization of these factors is being gradually absorbed by the market. New product launches, reviving consumption demand and base effect posit a scope for improvement in this space.
However, it would also be pertinent to note that this revival is not reflected in the market sentiment. Over the past 6 months the price to earnings ratio (PE) of the index has fallen from 30 to 23 vis a vis Nifty 50 which has been trading at an average of 25-26. A selling spree can be observed among the institutional investors as well, wherein large number of mutual funds are dumping auto stocks from their portfolio.
From a fundamental performance point of view also, the sector as a whole has not reported good numbers. This could be a fall out of the various factors discussed above. While analyzing the sector it is crucial to look at the volume of sales inter alia other factors such as inventory turnover, debt equity ratio etc.
Top Auto Stocks
Tata Motors is one of the most prominent stocks in this sector. But, it has been reporting losses for three quarters in a row now. The challenge lies in its troubled overseas arm, Jaguar Land Rover. JLR which is the largest automobile manufacturer in UK, has been suffering serve pressure from across the globe. Amidst sweltering pressure from what seems to be a “No deal Brexit”, the company has been struggling with its operations and has resorted to workforce rationalization as a part of its turnaround strategy.
The JLR sales in China has fallen by 50% in Q3, FY 19 due to what the company claims as network and supply chain issues. Though Tata Motors has taken measures in streamlining dealer incentives and inventory levels, the uncertainty in this market looms at large. The rising aversion to diesel vehicles, increased compliance issues related to the EU Worldwide Harmonized Light Vehicle Test (WVLT), have been serious matters of concerns when it comes to the EU market.
The Company has demonstrated commendable turn around in the domestic market wherein it has grown its market share across CV (Commercial Vehicle) and PV (Passenger Vehicle) segment. However, there are some challenges which have impacted domestic performance also.
Across markets, the company had been affected by rising commodity prices which had a dual impact. Firstly, it increased the input prices and thereby increased the cost of production. Secondly, it affected the oil prices thereby the demand side of the market and create unfavorable exchange rates.
With increased pressures on the financials, the company’s debt to equity ratio has been increasing and is expected to increase to 142% up from 56%.
Bajaj Auto is the second largest two wheelers manufacturer and the largest three wheeler manufacturer in India, with exports to more than 70 countries. The company enjoys a market share of 16% in the domestic motorcycle market and more than 58% in the three wheeler market. Motorcycles contributes around 84% and three wheelers contribute around 16% to its total volumes.
From Q3 FY 19 results, it can be seen that though the volumes grew by 25%, earnings grew only by around 16%. This can be attributed to the margin pressures from rising input prices, the regulatory mandates and aggressive market share targets set by Bajaj Auto.
When it comes to inventory management, the channel inventory stands at 4-6 weeks which is the approximately the industry average. After the release of Pulsar Neon, new launches are set to take place in premium space which is likely to drive volumes in the coming quarters.
Eicher Motors which is the parent company of luxury brand Royal Enfield, also runs a Commercial Vehicles arm under a Joint Venture with Volvo.
In Q3 FY 19, the sales volume of the luxury arm of the company fell by 6% owing to prices shock which came from a number of avenues. Regulatory mandates such as deployment of ABS (Anti-lock Breaking System) and compulsory long term third party insurance has been major contributors in this regard. With the compliance deadline line for BS VI just round the corner, the price pressures due to regulatory mandate is likely to continue.
When it comes to inventory turnover, Royal Enfield’s channel inventory is around 30-35 days, with stock at dealers at less than 2 weeks which is fairly tight in contrast to 6-8 weeks ‘dealer inventory for other two wheeler companies. The company added 20 dealers in the Q3 FY 19, taking the total count to 878 and is likely to hit 900 by year-end. The new launch of the RE Twins 650 has also been well received and has a waiting period of 5-6 months.
With respect to the performance of the Commercial Vehicle business, the sales volume rose by 4% year on year. However, earnings were down 40% year on year due to margin pressure on account of increased discounts and rising finance and input costs.
Maruti Suzuki India
Maruti Suzuki has been enjoying market leadership across segments namely PV, UV and Vans. It has been a prominent brand in the Indian market from its perceived low cost of ownership and high dealer and servicing network.
In the recent Q 3 FY 19 results, the company reported retail volume growth of 4.9% vis a vis volume growth of industry standing at 4.5%. Volumes in Rural market which constitutes 39% of its portfolio also grew by 13%. After a disappointing Diwali demand, the company has taken significant inventory liquidation efforts. Response to new launches Ertigo and Wagon R was strong and expected to drive volumes going forward.
EBITDA margins were hit by 300 bps as a result of adverse exchange rates, rising commodity prices, high sales promotion expenses among other issues. Overall the company has been one of the better performers in the sector with a debt free, cash rich balance sheet, holding cash surplus of approximately Rs. 34000 cores.
Ashok Leyland is one the largest Commercial Vehicles, Trucks and Bus manufacturers in the world and its shares have been on a downward streak for almost a year now.In the Q 3 FY 19 results it reported a fall in sales volume by 6% year on year and a fall in earnings by 15% year on year.
The increased maximum load carrying capacity of heavy vehicles and rising interest rates have seriously impacted the demand and consequently the sales volume. The export slow down due to political uncertainty in the markets in Sri Lanka and Middle East have also seems to have affected volume growth.
The tax benefits from the recent merger with subsidiaries also did not significantly create any positive impact on the sliding margins. The poor performance of Ashok Leyland in its Q 3 FY 19 results in an already grim environment of the auto sector has caused a number of research analysts to downgrade the stock.
The somber performance of the auto stocks in the recent times and the very cyclical nature of the sector only shows that uncertainty looms at large. Thus, forcing the hands of a lot of players take adverse positions in this regard.
Disclaimer: the views expressed here are of the author and do not reflect those of Groww.
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