Improving outlook, upgrades to keep wheels turning for auto companies

In addition to volumes, margins, too, are expected to expand

The S&P BSE Auto Index has been one of the biggest outperformers among sectoral indices over the past year with returns of 26 per cent. By comparison, the benchmarks – the National Stock Exchange Nifty50 and the S&P BSE Sensex - managed about 6-8 per cent during this period. Improving demand, falling raw material costs, and rising product realisations, led by the premiumisation of portfolios, have led to a revision of growth estimates and upgrades by domestic brokerages.

While most segments, except for tractor, put up a sluggish volume performance in February, brokerages expect multiple triggers to assist the sector.

In the commercial vehicle (CV) sector, volumes in the small and intermediate vehicle space are expected to improve on last-mile connectivity and e-commerce.

Medium and heavy CV sales are on course to sustain momentum, led by improved economic activity, infrastructure projects, further improvement in fleet utilisation levels, and replacement demand, observes B&K Securities.

Domestic entry-level/commuter in the two-wheeler segment and exports will feel the squeeze, given the rising cost of ownership and pressure on rural incomes and macroeconomic challenges/lack of foreign exchange availability in destination markets.

However, the premium segment in two-wheelers is expected to outperform as the semiconductor supply eases. In addition, research analysts Shashank Kanodia and Raghvendra Goyal of ICICIdirect believe that the premiumisation trend in the two-wheeler space will gain traction amid rise in disposable income as a result of changes to the new tax regime.

Passenger vehicle (PV) players, too, will gain from easing supply challenges, which, coupled with order backlogs, are expected to help PV majors post double-digit growth over the next few years.

Analysts of Motilal Oswal Research, led by Gautam Duggad, expect the improving narrative on demand, supply, and margins to help the automotive (auto) sector’s earnings to grow significantly on a flat base of five years. A sharp 26 per cent earnings upgrade (the sharpest in five years with the exception of a pandemic-hit quarter) for the Nifty Auto in the third quarter of 2022-23 (FY23) and positive management commentaries offer a stronger outlook for the sector, they add. The brokerage believes the worst of the downcycle is behind for the auto sector, even as valuations seem reasonable.

Given high expectations, listed are four mid- to large-cap companies (largely domestic market-driven) which are expected to post sales growth of over 15 per cent and earnings by at least 30 per cent over FY23 through 2024-25 (FY25).

While several other companies, especially parts suppliers and exporters, fit the bill, some brokerages are cautious, given the exposure to Europe, currency volatility, and weak target market economies.

Ashok Leyland

The only listed pure-play CV maker has multiple triggers going for it. In addition to a strong demand outlook, the company has been able to expand its market share to 32 per cent, from 27 per cent in 2021-22 (FY22).

The company, according to Prabhudas Lilladher Research, is expected to sustain its share gains, led by CV upcycle, bus segment revival, network expansion, and new products.

Further, price retention due to strong demand, lower input prices, and operating leverage will lead to margin expansion of 275 basis points over FY23-25, says the brokerage.

Maruti Suzuki India

The past four years have been an uphill climb for the largest PV maker, given weak volumes, supply disruption, a weaker product portfolio in the high-growth sport utility vehicle segment, and rising input costs.

While these led to a halving of its net profit in three years, analysts at Jefferies expect demand and product and margin cycles to align favourably, driving a near quadrupling of net profit over FY22-25.

Further, the stock is trading at 21x its 2023-24 earnings, lower than its last 10-year average of 24x.

Escorts Kubota

While a partnership with Osaka-based Kubota Corporation will help the company in the medium term, given increased operating efficiencies, potential market-share gains, and higher exports, a deterioration in margins in recent quarters and overall market share are causes for concern.

PhillipCapital Research has a cautious view on the stock.

“While the outlook for industry growth has improved recently, we maintain a cautious view on the stock due to relatively high inventory, leaving limited room for incremental channel filling, continued pressure on margins, adverse product mix, and recent loss in market share,” says the brokerage.

Motherson Sumi Wiring India

Given that it predominantly supplies to PV makers, supply disruption and demand woes impacted the wiring harness major.

Notwithstanding the headwinds, the company has been outperforming the sector and gaining share.

Choice Equity Broking is positive on the company due to higher penetration of wiring harness, a portfolio that is immune to electric vehicle transition, access to technology from the parent, strong demand, and lower capital expenditure, which will lead to a higher return on capital employed.