Future looks good for auto ancillary sector, but firm raw material costs could cap gains.
Auto ancillary companies, which went through some tough times in the last two years, are all set to deliver strong volumes in the current fiscal. In fact, this should help them deliver healthy returns on the bourses, too. Results of companies (like Exide, Bharat Forge, etc) that have been announced so far also validate this trend.
The $19.2-billion Indian auto ancillary sector, which grew about four per cent year-on-year in 2009-10, is expected to grow by over 15 per cent on the back of a rising demand across segments in the current fiscal. With auto makers increasing prices, component suppliers are likely to hang on to their margins despite the rise in input costs.
| ATTRACTIVE BETS | |||
| in Rs crore | Revenues | EPS (Rs) | P/E (x) |
| Amara Raja Batteries | 2,098 | 24.2 | 8.4 |
| Apollo Tyres | 8,436 | 9.2 | 6.8 |
| MRF | 8,049 | 1012.0 | 7.6 |
| Omax | 1,040 | 11.1 | 5.0 |
| Subros | 1,124 | 7.2 | 6.9 |
| Sundram Fasteners | 1,874 | 5.7 | 8.9 |
| E:2011-12 Estimates | |||
While domestic demand is strong, overseas demand presents a mixed bag as there's encouraging demand from the US market (which accounts for a quarter of exports), even as the EU (40 per cent of exports) is not yet out of the woods.
Investments to meet demand
Auto component companies are lining up Rs 9,000 crore in the current fiscal for setting up new capacities and upgrading existing ones. This would be 33 per cent higher than what was invested last year.
Bosch, for example, is betting big on diesel engines and has a Rs 2,000-crore investment plan till 2012. Similarly, Bharat Forge and Amtek Auto recently raised over Rs 900 crore to fund their expansions in the non-automotive business.
Margins: A mixed bag
While auto ancillary companies are expected to post a 20 per cent revenue growth, and there will be operational gains on account of higher utilisation of capacities for the June quarter, the rise in raw material costs will be a key risk, according to analysts. For example, the sharp rise in natural rubber prices will lead to a drop of 200-250 basis points in margins of tyre companies in the June quarter, believes research firm Batlivala & Karani.
Metal prices, too, are relatively higher on a year-on-year basis. Though raw material costs have gone up across the board, battery makers, however, are reaping the benefit of a drop in lead prices, with product prices remaining the same.
We look at the prospects of the five largest companies by market value in the sector. Among others, analysts are betting on Automotive Axles (led by medium and heavy commercial vehicle demand), Apollo Tyres (which is going in for radialisation and expansion), SKF India (is seeing improving market share) and Pricol (valuations).
Amtek Auto: While its overseas business (40 per cent of revenues) continues to be under pressure with capacity utilisation at 35 per cent, the company will be relying on the surge in domestic passenger vehicle numbers (four wheelers form 70 per cent of total revenues) and diversifying into non-automotive space to improve its revenues and profitability. At the current price, the stock is trading at 8.4 times its 2011-12 earnings estimates. Given the 22 per cent rise over the month, accumulate on dips.
Bharat Forge: Led by strong performance from its overseas operations on the back of restructuring and improving automotive demand, the company posted a 66 per cent jump in consolidated revenues to Rs 1,012 crore for the June quarter. While operating profit doubled, the company posted a net profit of Rs 62 crore from a loss of Rs 46 crore in the year-ago quarter. Given its focus on the non-automotive business, which fetches higher operating profit margins, profitability is likely to improve. While the prospects are bright, investors can avoid the stock as it is trading at an expensive 18 times 2011-12 earnings.
Bosch: Given the improving outlook for commercial vehicles, or CVs (fuel injection systems to CV and tractor makers make up more than half of the company's revenues), and the demand for common rail diesel engines for cars, sales to original equipment manufacturers (OEMs) are likely to grow over 35 per cent in calendar year 2010 (CY10). Credit Suisse believes margins are likely to improve due to operating leverage, favourable exchange rate and strong after-market sales. The stock trades at 13 times its CY12 earnings per share (EPS) of Rs 441. Buy on dips with a two-year perspective.
Exide: Robust demand and higher realisations helped the company post a 27 per cent jump in revenues and a 35 per cent growth in net profits year-on-year in the June quarter. The company’s operating profit margins were higher as over 40 per cent of raw material (lead) was sourced from captive supply. Going ahead, higher replacement demand and increased sales in the standby power segment should lead to revenue growth of 15 per cent over the next couple of years. Analysts have pegged a target price of Rs 150-155 (including its stake in ING Vysya Bank) which, given the current price, points to a marginal gain. Invest on dips.
Motherson Sumi: While the domestic story looks good, given that 68 per cent of its consolidated revenues come from its European operations, higher revenue growth going ahead will depend on the demand in the euro zone. However, its long-term contracts with leading European car makers provide comfort which, along with the company’s track record of improving the margins of its European business consistently over the last few quarters, should support profitability. Expect 15-20 per cent returns from these levels over the next one year.
