Even as the automobile sales figure remained in the negative in August on a year-on-year basis, analysts saw a glimmer of improvement as the gap of fall has been improving sequentially.
August witnessed some recovery in sales sequentially although on a year-on-year (YoY) basis all categories, except tractors, reported de-growth.
Many auto stocks have been on the rise lately as the sequential improvement instilled optimism in the market. Investors are now hoping that the sector will continue to rise in tandem with the economic recovery of the country.
Looking at their historical prices, the stocks still have a long road to travel. The monthly volumes have led to some form of enthusiasm among investors but sustainability is the key.
Too early to bet on the sector?
Experts point out that the rally in both two-wheelers and four-wheelers may be overdone as household income could remain weak in the medium-term while the steep run-up has led to rich valuations for most stocks.
Rusmik Oza, Executive Vice President, Head of Fundamental Research at Kotak Securities points out that inventory levels at dealers end were very low in March due to the transition from BS-IV to BS-VI norms.
April went under lockdown and the economy started opening in phases since May. The low inventory levels at dealers end and pent-up demand have led to higher production and dispatches figures from factories.
"If the festival season is quite then manufacturers would have to cut production in November and December. The market is attaching inordinate importance to near-term demand drivers such as the desire for personal mobility and strong rural demand. However, it is ignoring challenges with long-term demand drivers," Oza said.
Shashank Kanodia, Analyst, ICICI Direct is of the view that a large part of demand recovery optimism is already built into the prevailing stock prices of key sectoral companies, with limited upside seen in most of the counters.
"To put things into perspective, the auto index has actually outperformed the broader index recovery post-March 2020 lows. The Nifty Auto index is up nearly 75 percent against Nifty which is up by nearly 50 percent since March 2020 lows. On the demand front, prevailing auto retails are at nearly 75 percent of pre-COVID levels with recovery pace slow in three-wheelers as well as CV space," Kanodia said.
Pent up demand and inventory push prior to the festive season is expected to push the monthly auto sales numbers higher in the next few months but one should not get carried away by it, analysts warn.
"One must exercise a certain degree of caution given the sharp rally in auto stocks as there is a possibility of a slowdown in demand post the festive season once the pent up demand is exhausted which can create headwinds for the sector later on," said Jyoti Roy-DVP- Equity Strategist, Angel Broking.
Should you avoid the sector completely?
Anyone willing to bet on this sector must be extremely prudent in picking stocks. One can look at tractors and two-wheelers as they are expected to see a rise in volume owing to a better outlook of the rural economy.
"Auto sector certainly is not a blanket buy at this point in time. However, one can selectively still bet on the rural-centric players in the farm machinery as well as two-wheeler space. It is largely driven by robust farm income amidst healthy government spends as well as normal monsoon 2020," Kanodia of ICICI Direct said.
ICICI Direct is positive on Mahindra and Mahindra, given their leadership positioning in the domestic tractor segment as well as reigniting capital allocation strategy.
ICICI is positive on Hero MotoCorp also, given its leadership in the domestic motorcycle segment and smart market share gains in the retail market post-COVID-19.
Oza of Kotak Securities said he is positive on only Bajaj Auto. "Bajaj Auto looks good in the two-wheeler space because of its diversified exposure and success in the export market. It has maintained its market share in the motorcycle segment and is well placed to capture market share in the electric scooter segment with the launch of Chetak," Oza said.
Kotak has a one-year price target of Rs 3,400 for Bajaj Auto. Kotak sees decent upside still left in both Escorts and Mahindra & Mahindra.
Kotak has a 'sell' rating on Maruti as it is trading at rich valuations of 32 times on FY22E even after building in 60 percent earnings growth in FY22E.
"We have a very cautious view on the overall sector mainly due to deteriorating return on equity and rich valuations. The demand conditions were weak for the sector even before the outbreak of the pandemic given the slowdown in household income growth," Oza said.
"After the sharp decline in FY21, we expect motorcycles and car segment volumes to report healthy growth of 14-20 percent and 15-20 percent, respectively, during FY22-23E. Most of this recovery seems to be priced in the current stock prices. If there is a correction in two-wheeler stocks then one can look at investing in them as strong rural demand could help in better volumes," Oza added.
Angel Broking has a positive outlook on the entry-level two-wheelers and tractor space and expects demand to remain robust for the segments, driven by a strong rural economy.
"Endurance Technologies, Hero MotoCorp and Swaraj Engine are our top picks in the auto space. We expect Hero MotoCorp and Endurance Technologies to be among the biggest beneficiaries of increased demand for entry-level two-wheelers while Swaraj Engine would be one of the biggest beneficiaries of increased demand for tractors," said Roy of Angel Broking.
According to the Federation of Automobile Dealers Associations (FADA), total auto sales, across categories, declined 26.81 percent to 11,88,087 units last month as against 16,23,218 units in the year-ago month.
The theme of recovery remains hazy for the sector as a lot will depend on how the economy remains in the wake of COVID-19.
The overall demand is still not back to pre-COVID-19 levels as banks and non-banking finance companies (NBFCs) continue to have a cautious approach towards funding.
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