The domestic auto industry is going through a rough patch. The outbreak of COVID-19 will hit India's already struggling automobile sector significantly and brokerages warn that the sector may take longer than expected to recover from the blow.
Brokerages highlight that the industry sales volumes are down nearly 16 percent so far in FY20. The auto industry was readying for the transition for the upcoming switchover to BS-VI norms with effect from April 1, 2020, that needed intense deliberation and strategising in areas related to products, pricing, production & inventory management. The outbreak of coronavirus has come as a serious blow.
A report by brokerage firm ICICI Direct stated that SIAM's (Society of Indian Automobile Manufacturers) estimates had shown the present suspension of production activities at OEMs and ancillaries would cost the industry nearly Rs 2,300 crore per day in lost revenues.
"Q4FY20 (till March 15) was witness to production rationalisation at most OEMs as the focus remained firmly on the rundown of BS-IV stock. With half of March slated to be a washout, the quarter is another poor one," said ICICI Direct.
ICICI Direct expects industry volumes to decline sharply (nearly 40-50 percent) in Q1FY21E amid plant closures, accounting for at least two months of subnormal operations (one month of complete closure i.e. April 2020 and corresponding one month of gradual resumption of work i.e. May 2020).
"Our reworked estimates bake in another year of de-growth at the industry level in FY21E (-5 percent), after adjusting for some pent up recovery in the second half of FY21E. We see meaningful growth returning to the industry only in FY22E post normalisation of BS-VI environment, expected uptick in economic activity and consumer spending and build in nearly 10 percent volume increase for that year," ICICI Direct said.
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As per the estimates of the brokerage firm Motilal Oswal Financial Services, in March 2020, wholesale volumes are estimated to decline nearly 37 percent, 40 percent and 68 percent year-on-year (YoY) for 2Ws, PVs and CVs, respectively, due to lockdown and BS-VI transition. Tractors volumes are expected to decline by about 16 percent YoY.
The stocks are now available at cheaper valuations and brokerages see it as an opportunity to buy quality stocks from the sector.
"Valuations appear attractive but given the uncertain macro environment and the threat of possible prolonged impact of coronavirus, we prefer stocks offering higher visibility of demand recovery, better competitive positioning, the scope of higher operating leverage and strong balance sheet," said Motilal Oswal.
As per Edelweiss Securities, after the sharp correction in stock prices, valuations have turned favourable despite the near-term uncertainty as the structural story is intact (demand as well as free cash flow generation) and pricing discipline will ensure benefits of easing commodities will be retained.
Stock recommendations from the sector
ICICI Direct said at this juncture, its preference from the sector are those business models that are capital efficient in nature (RoE, RoCE of more than 15 percent), possess healthy balance sheet (debt: equity less than 0.5 times) and are more domestic (India) centric in nature.
"We maintain our view that these businesses remain better placed to navigate the current downturn effectively and emerge stronger from it, leaving themselves primed for eventual recovery down the road. Among OEMs, we have valuation comfort and assign 'buy' ratings to Hero MotoCorp, Mahindra & Mahindra, Bajaj Auto and Ashok Leyland while assigning 'hold' rating to Maruti Suzuki, Tata Motors, Eicher Motors and Escorts," ICICI Direct said.
Among ancillaries, ICICI Direct has a 'buy' rating to Exide Industries and 'hold' ratings to Apollo Tyres and Bharat Forge.
Edelweiss Securities said it preferred stocks which have, or can have, strong product cycle and margin tailwinds.
Tata Motors, Eicher Motors and Hero MotoCorp are its top picks from the sector.
"We prefer Tata Motors which is a ‘buy’, as it is on the cusp of a strong product cycle. Moreover, the recent GBP depreciation will favour the company as it has a higher exposure to China and can benefit from its revival," Edelweiss said.
"Hero MotoCorp is a play on rural demand with attractive valuations. However, our structural concerns on its ability to gain market share in scooters, premium motorcycles and export persist," said Edelweiss.
"Eicher Motors' new product cycle can catapult, not only domestic volumes but also exports," said Edelweiss.
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