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Auto sector faces new headwinds, under pressure; what to buy?

Government initiatives along with the economic recovery are expected to help the automobile sector, which has also pinned hopes on the upcoming festival season

August 31, 2021 / 10:22 AM IST

The automobile sector was under pressure ever before the coronavirus outbreak owing to piling up inventory, changes in regulatory norms and faltering economic growth.

Following the outbreak that upended lives and businesses, the sector has been beset with a new set of problems such as fresh COVID-19 waves, chip shortage, increase in commodity prices and possible higher competition with a shift to electric vehicles.

There have been brief stints of gains as well but every rally in the sector has normally been followed by a fresh spell of profit-booking.

The Nifty Auto index has risen just 8 percent in 2021, so far, against a 21 percent rise in the benchmark index Nifty.

Automobile sales numbers for August will start trickling in from September 1.

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Brokerages expect the positive trend to continue in commercial vehicle (CV) and two-wheeler (2W) segments, while passenger vehicle (PV) volumes may show the pressure of chip shortage.

The tractor segment is likely to see a mixed performance.

"CVs and 2Ws should continue to see positive momentum on a sequential basis. PV volumes are likely to be hit by the semiconductor chip shortage, despite a healthy order book. Overall, we retain a positive view on the auto sector," said brokerage firm Emkay Global Financial Services.

Also read: Semiconductor shortage | Maruti Suzuki to cut vehicle production by 30-40% in August: Report

The shortage of semiconductors has emerged as a new headwind for the sector. Semiconductors are used in several parts of a vehicle including chassis, convenience, safety, advanced driver assistance systems,

infotainment, etc.

Milan Desai, Lead Equity Analyst at Angel Broking said the semiconductor shortage and its recovery are likely to be extended by another quarter, owing to infection in SE Asian geographies and the passenger vehicle original equipment manufacturers (OEMs) have highlighted the resultant impact on production.

The Indian auto sector’s Q1FY22 earnings were weak as localised lockdowns lowered the volumes and the negative operating leverage hurt the margins.

Also read: Maruti Suzuki to hike prices in September

The road ahead

For the near term, the sector is pinning hopes on the upcoming festival season.

"With the opening up of showrooms, the inquiry levels have improved and we believe that the festive seasons can be crucial for the lagging 2W segment which has been impacted on account of the higher cost of ownership/operation," Desai said.

As the monsoon is expected to remain normal this year, positive sentiment in the rural economy augurs well for tractors and two-wheelers.

Shrikant Chouhan, Executive Vice President, Equity Technical Research, Kotak Securities, is of the view that the pick-up in economic activities after lifting of restrictions may result in a gradual volume recovery in the commercial vehicle segment.

"Overall, while there are certain challenges in the near term, we expect healthy demand recovery for automobile over the medium to longer-term," Chouhan said.

Harsh Patidar, Auto Analyst at CapitalVia Global Research believes the government's initiatives can boost the prospects of the sector.

"The government is planning to reduce imports of automobiles and components. Moreover, it is planning to infuse more than Rs 50,000 crore through PLI schemes," Patidar said.

The national scrappage policy might help in revamping the whole sector as it would systematically phase out old and unfit vehicles in an eco-friendly manner, he said.

The Centre could announce certain incentives for scrapped vehicles if they want to retire or scrape their vehicles. “Scraped vehicles will generate cheaper raw materials which might be reused to manufacture new vehicles, which might turn out to be eco-friendly and beneficial for the balance sheet as well," Patidar said.

The government’s initiatives along with the economic recovery would help the automobile sector.

What to buy?

“Considering that the CV industry production and domestic sales in FY21 were near their 12-year lows, we remain positive on the Indian CV space due to the expected sharp uptick in volumes," said Desai.

"We are positive on Ashok Leyland, Escorts, and Bajaj Auto. Given the favourable risk-reward due to earnings outlook, low valuations, and attractive dividend yield, we also like Hero MotoCorp."

Chouhan of Kotak Securities has Bajaj Auto and Mahindra and Mahindra as the top picks from the sector.

Patidar believes auto ancillary stocks might do well which include Bharat Forge and Bosch.

Li-ion-based battery manufacturers such as HSIL, Exide, Amara Raja Battery can sees traction as well, Patidar said.

Mahindra and Mahindra and Tata Motors have smartly moved to electric vehicles manufacturing and might turn out to be better compared to their peers.

"I expect Mahindra and Mahindra to touch Rs 1,000 mark and Tata Motors to Rs 370 in the next one year. Investors can add these quality stocks in any meaningful correction," Patidar said.

Brokerage firm Motilal Oswal Financial Services prefers companies with higher visibility in terms of demand recovery, a strong competitive positioning, margin drivers, and balance sheet strength.

"Maruti Suzuki and Mahindra and Mahindra are our top OEM picks. In auto components, we prefer Bharat Forge and Apollo Tyres. Tata Motors is our preferred global play," Motilal Oswal said.

Disclaimer: The views and investment tips expressed by experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
Nishant Kumar
first published: Aug 31, 2021 10:22 am
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