Q3 auto preview: Another dull quarter likely; Maruti among top picks

It has been a tough third quarter (Q3FY18) for companies in the automobile segment. The second quarter of FY19 saw demand tapering off for most of the companies, thanks to a host of headwinds faced by the sector. Unexpected change in insurance policy and rising fuel prices led to a lackluster festive season. However, adding insult to the injury is the current liquidity crunch, which has slowed down loan disposals and, in turn, the demand for the automobile sector.

Two-wheeler companies have been fighting hard while competition among them has been quite brutal, with Bajaj Auto Ltd entering low-end segment by offering five years of service, warranty and insurance. This has pressurised other original equipment manufacturer (OEMs) to indulge into higher discounts. However, the biggest blow has been slowing demand in two-wheelers, partly led by change in insurance policy, followed by higher crude oil prices (and in turn petrol prices). This indeed resulted in lower-than-expected sales during festive season, leading to a pile-up in inventory at dealer levels. 

Inventory levels at dealers’ hand now stands at 6-8 weeks, while production at OEMs continues to be high. We believe two-wheeler OEMs in Q3FY19 are likely to post a de-growth to the tune of 5-7 per cent YoY in their earnings, while EBITDA margins are also likely to contract by 50-100 bps, thanks to an increase in the selling expenditure. We believe Hero Motorcorp has been the biggest loser, while biggest weakness in demand was witnessed by Royal Enfield. Bajaj Auto, on the other hand, continued its run albeit on lower base.

Segment-wise performance

Passenger vehicles (PVs) has faced wrath of increasing cost of ownership, with rise in insurance premium, followed by increased fuel prices. Tightening of funding by NBFCs (non-banking financial companies) also played a role in demand being muted but subnormal participation by rural led to fall in sales volumes. While industry continued to struggle, most PVs OEMs launched new vehicles and new variants of existing models to boost buying interest. 

In Q3FY19, we expect Maruti Suzuki to continue its leadership, while its first buyer models (Alto, WagonR and etc) find less takers and as competition heats up in entry level space. The company’s top-selling model Baleno and Brezza continues to do well while in December it has seen some slowdown in demand. Exports, on the other hand, have been the biggest drag for Maruti Suzuki, falling close to 20 per cent in Q3FY19. Financials for Maruti Suzuki is not likely to see any improvement, with EBITDA margins to remain under pressure owing to higher inputs purchased during previous quarters.

Commercial Vehicles (CVs), which had a dream run in H1FY19, is now under severe pressure led by liquidity crisis which emerged post IL&FS issue. As 100 per cent of CVs are financed, it has been the most hit segment in automobiles. While liquidity has played its part in curbing demand, real-estate and construction projects have also seen a considerable slowdown, thereby, impacting the incremental demand for CVs. We expect a lean quarter for Ashok Leyland with revenues falling by 7-8 per cent, followed by 50 bps dip in EBITDA margins.

Top picks

The quarter gone by has faced many headwinds, much of which is already reflected in the stock prices. However, one more lackluster quarter cannot be ruled out. We prefer PVs over two-wheelers, and remain positive on Maruti Suzuki. In CV space, Ashok Leyland is our top pick, with recent fall in stock price factoring in major negatives.