SBI Mutual Fund recently launched its Automotive Opportunities Fund (NFO closing on May 31). As the name suggests, this thematic fund will ride the wave in the automotive sector. Unlike several other sectors where companies are more or less similarly placed, the auto sector today is the most divided, with not just different companies catering to different segments whose business cycles vary but even within the broader segments like two-wheelers, passenger cars, and commercial vehicles, companies are vastly different from each other going by their existing stakes in the different sub-segments and, therefore, how they are playing the EV game.
While the emergence of electric vehicles is an opportunity in terms of the potential to replace existing vehicles, this will come at a colossal economic cost as the existing IC investments will be written-off even as new investments are made in the EV technology. For the incumbents in any segment, it’s like you step on the accelerator only to stay in the same place. This longer-term risk does seem to be underplayed by the market as companies are clocking good numbers emerging from a long spell of demand slump and each player carefully playing the game escaping cannibalisation of their portfolios.
But over the long haul, can a fund focused on a segment that is subject to colossal disruption create value? We pose these hard questions to the young fund manager from SBI Mutual Fund who has the distinction of navigating one of the toughest sectors of the past decade and coming out on top. Tanmaya Desai currently oversees an AUM of approximately Rs 8,900 crore across funds such as the SBI Healthcare Opportunities Fund and SBI Magnum Global Fund (as co-manager). The SBI Healthcare Fund, with a corpus of Rs 2,667 crore, has delivered a 25.47% annualised return compared to a category average of 20.47% over a five-year period, and a 16.21% return versus a 15.62% category average over a 10-year period.
What is the opportunity set for your fund?
Around 134 stocks, including approximately 20 original equipment manufacturers (OEMs) and 114 auto ancillary companies. We are also considering dealers and trading companies. Combined market cap is Rs 30 lakh crores plus, and their profit pool is over Rs 1 lakh crore.
How are valuations looking?
Nifty Auto, with 16 stocks, predominantly large-cap, is around 22X one-year forward earnings. This is pretty similar to the historical valuations over the past 12 years. So it is neither cheap, nor expensive.
What is the play on then?
Significant earnings potential especially in two-wheelers and commercial vehicles. Vehicle penetration is not yet at its peak. We see high single-digit volume growth and strong demand for premium brands across categories. SUVs now make up over 50% of sales, up from 8% a decade ago, and more people are buying premium motorcycles.
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Addressable market in India is much smaller than is usually portrayed, which is why we see interruptions in growth in what is otherwise a secular story. Is the under-penetration argument really valid?
Usually, while the average per capita income in the country is around $2,500, about one-third of the population has an income above this level. In this segment, car penetration is approximately 100 cars per thousand people. This is in stark contrast with the remaining two-thirds of the population, whose per capita income is less than $2,500 and where car penetration is even lower. This suggests that as per capita income rises and people move into higher income brackets, there is significant potential for growth in car penetration. This trend is evident when we compare with countries like South Africa, Brazil, and China, where the average car penetration ranges between 175 to 225 cars per thousand people.
How long do you expect the premiumisation trend to continue?
Hard to say, but there is considerable room for growth. For example, the braking system content per vehicle in India is about $600, compared to $1,500 in some emerging markets, $2,000 in the US, and $3,000 in Europe. This indicates significant potential for increasing premium features. Additionally, the average cost of a car in India is half of what it is in China and a quarter of that in the US, which reflects lower level of premiumisation.
What’s your portfolio strategy? Holding period, churn, etc.?
The benchmark predominantly consists of 85% OEMs, mostly large caps, and around 15% small- and mid-cap auto ancillary companies. We will put about 60% in large caps and 40% or possibly more if liquidity permits, in small and mid-caps, mainly auto ancillary firms. For OEM selection, we will employ a top-down approach, and for ancillary companies, bottom-up approach. Idea is to create a mid-to-long-term portfolio within the auto ancillary space with minimal churn.
A large part of your opportunity set is cyclical. How do you plan to navigate the downturns?
Not all segments go through a downturn at the same time. Passenger cars and two-wheelers are relatively less cyclical. Besides, there are a number of auto ancillary companies that supply multiple OEMs across different segments. Hence, the cyclicality of one particular segment may not totally derail the growth story of these companies. Within OEMs also, it's never the case that everything does well in tandem and the whole idea is to find out the OEM segments which at one point will do better than the other.
But auto ancillary companies are equally vulnerable to downturns…
Many auto ancillary companies are expanding their range of components. For instance, casting companies that primarily served the two-wheeler industry are now becoming more important due to the focus on light weighting, and their casting products are now relevant for the two-wheeler industry, passenger cars, and export opportunities. Bearings are another example.
How do you see EV disruption playing out?
Two-wheelers and passenger cars is where EV disruption is happening. In two-wheelers, EV penetration today is at around 5-6%. EV disruptions would be a worry if incumbents did not have any EV portfolio. The top three OEM companies have market shares of anywhere between 10-20% in the space.
Right now, they are not coming at the cost of IC volumes. In the future, they may be cannibalising…
If there are companies that are doing nothing about future technology, then one would be worried. The general expectation is that EV penetration in two-wheelers will increase due to improving cost of ownership. However, ICE engines are unlikely to be completely displaced even in the next 10 years. Thus, a company needs to maintain not only its ICE platform but also develop EV and possibly CNG platforms.
EV technology could make a lot of auto components redundant …
True. But many structural components remain relevant in the EV ecosystem. Out of our investing universe of 134 companies, over 75 are not significantly disrupted by EV technology. Components such as tires, lighting systems, wiring, mechanical cables, sunroofs, alloy wheels, and instrument clusters remain relevant to both IC and EV.
Would you agree there is a high chance of de-rating of the auto sector when the IC starts to go down?
While the market may sometimes discount growth faster than it occurs, under-penetration and improving affordability offer strong growth potential. For example, manufacturing has grown at a 9% CAGR, with the auto sector, a major component, growing at 12% CAGR over a long period. If the incumbents had not invested in EVs or not experienced any success, the market would have de-rated them already. That’s not the case.
How do you view the auto IPOs that may come to market this year – Hyundai, Ola, Ather, etc.?
The new listings will enhance the investable universe. During our visits to auto hubs like Pune and Gurgaon, we've identified numerous promising unlisted auto component companies. We anticipate that some of these companies will go public in the next few years, further expanding our investment opportunities.
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