Auto sector's Q4 margins may come under pressure

Volumes remain tepid, inventory levels reach new high

Double-digit volume growth has evaded India’s automakers for almost three years now. The previous time the sector clocked double-digit volume growth was in FY11. Since then, the sector has been struggling to grow volumes, as high fuel and interest costs have depressed demand. Despite this, in the third quarter, automakers have managed to grow sales in double digits and hold on to margins on improved efficiencies. However, this may prove to be difficult in the fourth quarter, as inventory levels have risen sharply for most auto companies to  six weeks now for several players.

Channel checks indicate that demand remains weak and the excise duty cuts are yet to result in improved volumes even though customer enquiries have improved. Two-wheeler dealers have reintroduced promotional discounts and offers even after the cut in excise duty cuts. The trend is similar to one witnessed in January, which saw volumes of Maruti decline by six per cent year-on-year, Hyundai by three per cent and Tata Motors by 28 per cent. The only exceptions to this are Ford and Honda, driven largely by new car launches.

  In February, Maruti may prove to be anexception, thanks to the launch of Celerio, which has seen a spike in bookings. However, this could be at the expense of other models and not necessarily additional demand. Inventory levels have surged across the board. While Hero MotoCorp is holding inventory of six weeks and Maruti’s inventory is five-six weeks. Edelweiss Securities believes enquiries for the new Splendor iSmart remain strong and dealers expect volumes to pick up as supplies improve. In the case of Bajaj Auto, initial favourable response for the Discover 100M has faded and incremental volumes have largely cannibalised the lower priced 1004G.

Analysts expect Maruti to gain from new launches and Hero MotoCorp to gain from pent-up demand. According to Elara Capital, Hero is trading at 12x its FY16 earnings and the price has not factored in royalty expiry, volume growth revival, start of export business, and margin savings via cost cutting.

The outlook for the fourth quarter looks less promising as far as margins go. With inventory levels rising, analysts claim with volumes remaining weak, the thing to watch out for in the fourth quarter would be margins, which have held up so far. In the third quarter, a majority of auto companies reported gross margins that were below estimates, largely because of higher discounts and rise in commodity prices for select players. The only two to report an improvement in margins were Tata Motors and Eicher Motors.