Kotak Institutional Equities turned bearish on global auto ancillaries Motherson Sumi, Balkrishna Industries and Bharat Forge citing subdued volumes in coming years.
"These stocks are trading at 19-25X FY2021E EPS estimates, which in our view is very expensive due to (1) cautious forward guidance by most of the global original equipment manufacturers (OEMs) and (2) valuation of global peers is at significant discounts compared to Indian counterparts," said the brokerage.
After reading commentaries by global OEMs and auto component players, the research house feels global auto volumes are likely to remain subdued till CY2021 and most players are focused on cost-reduction efforts due to pressure on profitability.
Kotak sees risks to Indian component suppliers' earnings (Motherson, BHFC, Balkrishna and Varroc Engineering) as they are linked to global auto OEM demand.
Motherson Sumi Systems share price was up 0.07 percent at Rs 134.20, Balkrishna Industries up 0.73 percent at Rs 840.60 and Bharat Forge up 1.08 percent at Rs 459.50 on the BSE, at 1156 hours IST.
The current market price of Motherson Sumi (assuming fair multiple of 18X for standalone operations) suggests that the subsidiary is trading at P/E multiple of more than 20X despite its global peers like Faurecia, Plastic Omnium and Magna International trading at 8-10X FY2021E EPS estimates with superior return ratios, Kotak said.
The brokerage has sell rating with a fair value of Rs 110 (implying 18 percent potential downside from current levels) for Motherson Sumi, sell rating with a fair value of Rs 375 (implying 17.5 percent potential downside) for Bharat Forge and reduce rating with a fair value of Rs 850 (upside 1.85 percent) for Balkrishna Industries.
However, it has a buy rating on Varroc Engineering with a fair value of Rs 520 (implying 16.88 percent potential upside). The stock is fairly priced at current market price compared to its peers; however, risks related to global growth slowdown persist, it feels.
IHS Markit has downgraded its global light vehicles (passenger vehicles plus small commercial vehicles of up to 6-ton capacity) sales forecast from flattish growth at the beginning of the year to decline of 6-8 percent YoY in CY2019E.
Global sales have already declined by 7 percent YoY during first half of CY19 led by (1) double-digit volume decline in China due to high private debt levels and US-China trade tensions, (2) steep decline in India on account of high cost of ownership, weak economic growth and challenges related to liquidity and financing and (3) weakness in Europe led by stricter emission regulations and higher focus on electrification.
Global auto OEMs such as VW, Daimler, BMW, etc. expect CY2019 to be flattish in terms of volume growth. VW has cut down its sales growth guidance from 25 percent to 20 percent over CY2016-20.
"Most of the global OEMs are emphasizing on cost-reduction initiatives, which we believe will put further pressure on profitability of auto ancillaries," Kotak said.
Motherson Sumi's global peers' (Plastic Omnium, Faurecia and Magna International) operating margins have remained under pressure over the past two years led by (1) slowdown in the automotive segment, (2) pricing pressures from global OEMs and (3) negative operating leverage.
Most of the global components players do not expect the automotive market to rebound till CY2021 (on a lower base as well), which is a big cause for concern, Kotak said.
Varroc Engineering's global peers' (Koito and Stanley Electric) EBITDA margin declined by 100-300 bps YoY in Q2FY20 as revenue growth remained under pressure.
Motherson and Varroc Engineering derive 34-64 percent of its consolidated revenues from global OEMs.
Kotak expects revenues from existing plants of SMP (MSS) and VLS (Varroc Engineering) to remain flattish to low single-digit growth over FY2019-22, which it believes can turn to negative if the global automotive slowdown persists.
There is an additional risk of slower-than-expected ramp-up from new plants of SMP and VLS in such a challenging environment, which will put further pressure on margins, the brokerage house feels.
Bharat Forge has guided for 3,45,000 Class 8 Truck production volumes in CY2019 (versus 325,000 production volumes in CY2018) due to strong order backlog but weakening order intake. The company expects US Class 8 trucks production to decline by 20 percent YoY and Europe M&HCV industry to decline by 7-8 percent in CY2020.
Order inflow for US Class 8 trucks continued to decline by 50-65 percent on a YoY basis over the past four months.
"Profitability in the oil & gas segment will also remain under pressure as North America oilfield activity has slowed down meaningfully. Halliburton (one of the biggest customers of Bharat Forge) US revenues declined by 10 percent YoY in Q3CY19 and the company has cut down its spending to 2 percent of the sales from 9 percent of the sales at the beginning of the year. We expect export revenues from the CV segment to decline at 18 percent CAGR over FY2019-22 for Bharat Forge," Kotak said.
Disclaimer: The above report is compiled from information available on public platforms. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
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