For the automobile sector, which was already passing through a lean patch, the coronavirus outbreak couldn’t have come at a worst time.
The sector has been witnessing one of the worst cyclical downturns over the past six quarters and is likely to remain under pressure in the near-term as the pandemic rages.
In FY20, automobile volumes declined on account of weak economic scenario, price increase due to BS-VI transition, inventory correction by original equipment manufacturers (OEMs) and COVID-19 impact in March 2020, said Rusmik Oza, Executive Vice President, Head of Fundamental Research at Kotak Securities.
“We expect the near-term to be challenging for the auto sector due to lack of near-term demand catalyst in view of economic impact from COVID-19. We expect the auto sector to gradually recover from the second half of FY21, supported by rural demand and expected improvement in the economic scenario," Oza said.
While the lockdown has caused serious disruptions in production and operations, the near-term outlook shows stress even after the lockdown is lifted.
A report by brokerage firm Anand Rathi said most Maruti dealers indicated that they had 30-40 days inventory since March and it would take two months to liquidate.
"Assuming operations resume in June, dealers are expecting sales of only 20 percent of the inventory in the first month. Dealers suggest that even after the lockdown is lifted, they expect losses for about three-four months," Anand Rathi said.
The report added that a dealer’s survey showed about 60 percent of March bookings were still willing to go ahead with purchases after the lockdown. The rest had been cancelled, citing budget constraints, job uncertainty and greater expenses.
Dealers are reworking cost reductions, renegotiating rents, reducing staff, inventories, salaries and incentives to ensure continuity in operations. Most dealers indicated full payment of salaries to staff but were unsure of continuing this from May if the lockdown continued, said Anand Rathi.
There is some hope for two-wheelers as rural-dominated states are less affected by COVID-19 and with the expected cash-flow from the rabi crop to farmers and assuming operations resume from May, dealers expect better sales from July possibly till the festival season, Anand Rathi said. Dealers in urban markets were negative about festival sales, it added.
On the earnings front, the Q4FY20 was a challenging quarter for the sector due to weakness in the economy, falling sales and the viral outbreak.
The production of automobiles was impacted sharply by the lockdown-related disruption and the BS-VI transition, as component availability was hit by the shortage of parts from China and Europe.
Most auto players are expected to report fall in sales, volume and PAT. The numbers of Q1FY21 may come even poorer.
"We expect the adverse impact on volumes to be visible in Q1FY21, which forms 21-25 percent of yearly volumes across segments. In our base case, we factor in a significant hit to Q1FY21 volumes (up to 80 percent fall across segments) in domestic and overseas markets and a gradual recovery in subsequent quarters, resulting in a drop in FY21E volumes," said brokerage Emkay Global Financial Services.
Stocks to watch out for
Vinod Nair, Head of Research, Geojit Financial Services, said auto stocks could be good contra bets as there was some demand postponement in the passenger vehicle segment due to the change in the emission norms starting April 1, 2020.
"Now that the carmakers have converted their entire fleet to BS-VI vehicles, we expect some buying to start in June, provided the salaried class or the urban demand is less impacted. We also assume that the calibrated move by the government and RBI will spur the rural demand and will open up selective auto stocks during the second half of the year," he said.
Brokerage: Geojit Financial Services
Maruti Suzuki | Buy | Target price: Rs 6,100
MSIL will be a direct beneficiary once the demand shoots up, due to an all-time low base, zero debt and higher brand visibility, the brokerage said.
It is one of the largest passenger car companies in the world and accounts for over 50 percent of the domestic market. The stock is trading at its 5-year historical low. The brokerage values MSIL at 19 times FY22 EPS with a target price of Rs 6,100.
Minda Industries | Buy | Target price: Rs 300
Minda Inds is a preferred and a tier-1 supplier to major automobile companies. Its diversified portfolio caters to every segment of the industry.
"Scaling up the product line in controllers and sensors for BS-VI vehicles will drive growth for the company in FY21. We factor 23 percent earning CAGR over FY20-22E, and arrive at a target price of Rs 300 (25 times FY22 EPS)," said the brokerage.
Brokerage: Kotak Securities
Eicher Motors | Buy | Target price: Rs 19,500
Limited competition in over 350 cc segment, further penetration into hinterlands and aggressive product launches are the positives for the company.
Kotak said the company had only 3-4 percent market share in Uttar Pradesh and Bihar and given its aggressive plan to expand studio stores and high aspirational levels of customers across hinterlands, its market share in such states could improve significantly.
Escorts | Buy | Target price: Rs 1,080
Tractor industry is expected to revive in FY21 led by a normal monsoon and an increase in minimum support price (MSP) of Rabi crops, which is expected to boost rural income.
Kubota, Japan has announced it will buy a 10 percent stake in Escorts through a preferential allotment at a price of Rs 850 per share.
"We believe the partnership with Kubota can open up significant potential for exports for Escorts Ltd. Over the last few years, Escorts has gained share in states where it has a relatively strong presence," Kotak said.
The brokerage expects Escorts’ tractor volumes to grow at a 4 percent CAGR over FY19-22E and EBIT margins to remain stable nearly 12-13 percent in the same period.
Mahindra & Mahindra | Buy | Target price: Rs 625
Kotak expects overall tractor volumes to grow at a 3 percent CAGR over FY19-22E. This will result in revenue and EBIT mix of tractor segment in M&M and MVML to improve to 36 percent and 68 percent, respectively in FY22E.
"SOTP based fair value works to Rs 625 wherein we assign 13 times to the core business of M&M and MVML, 17 times to the tractor segment and 7 times to the automotive segment," Kotak said.
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