Rocky road ahead for auto exporters as demand woes may delay recovery

Tata Motors has the biggest exposure to the Chinese market among Indian automakers and should benefit from a recovery in the China market
The NSE Auto index was the second-biggest gainer in April among Nifty sectoral indices. It was up 25 per cent over the last month with more than a fourth of those gains coming in a single trading session on Thursday. While all the automakers gained, top gainers among auto names were companies having high exposure to overseas markets.

Tata Motors surged over 19 per cent, while Bharat Forge and Motherson Sumi gained over 9 per cent each. Other gainers included Varroc Engineering, Bajaj Auto, and Mahindra CIE, which gained 5 per cent each.

The optimism was led by expectations that the start of production at facilities and the opening of retail outlets across the world — especially in Germany, China, and South Korea — and gradually in green zones in the country, would reverse the falling sales chart in key markets. In addition to hopes that recovery will take hold by second half of FY21, benign commodity prices which would cushion cost pressures and valuations which are lower than ten year averages also boosted stock prices.
While leading automakers in Europe, such as Volkswagen, Fiat, and Volvo, have started production at some of their plants in the continent, production facilities in the US are expected to start shortly. China Automobile Association, a trade body, indicating that sales in April are at almost the same levels as they were last year, also helped sentiment.

An analyst at a domestic brokerage says: “Unlike the domestic market, production and retail outlets have started in developed markets. Further, massive stimulus programmes could help revive demand, which is not the case in India.”

While these indications are positive, the key trigger continues to be a bounce back in auto demand, which many analysts fear will not come in a hurry, given the sharp contraction in global economies and the hit to personal consumption. Thus, brokerages say, even though China has seen a recovery in auto sales and global central banks are unleashing money to revive their economies, investors should await clear signals of a demand recovery. Till then, they advise investors to adopt a cautious approach and look at stocks that are in a better position to gain from a recovery a few quarters down the line.

Kotak Institutional Equities believes Motherson Sumi is well placed to capitalise on the recovery in auto demand once the pandemic starts to wane as seen in China, where auto sales are limping back to pre-Covid levels. Hitesh Goel and Rishi Vora of the brokerage expect the company to generate robust free cash flow in FY21 despite the challenging impact of the Covid-19 pandemic driven by prudent cost management and low capex. The other positive is the reduction in debt from Rs 8,590 crore at the end of Q3FY20 to Rs 7,150 crore at the end of March 2020 quarter. Europe and the US account for 60 per cent of the company’s sales.

Balkrishna Industries, which gets 68 per cent its sales from Europe and the US, is expected to be less affected than auto peers given that the agricultural segment accounts for 60 per cent of its revenues. Further, it gets about 75 per cent of sales from the replacement segment, which is expected to be more resilient. A steep drop in crude oil prices will boost margins as 35-40 per cent of its raw material costs are crude oil-linked. The company, which has started partial operations recently, is a top pick of Sharekhan, which highlights the strong return ratio and the debt to equity ratio of 0.3, which is among the lowest in the tyre sector.
Tata Motors has the biggest exposure to the Chinese market among Indian automakers and should benefit from a recovery in the China market. However, JPMorgan’s Gunjan Prithyani and Vibhav Zutshi highlight that its global exposure (especially to the US and the UK) and high operating and financial leverage makes it disproportionately vulnerable to Covid-19 disruption. High cash burn at JLR and structural headwinds in India business (commercial and passenger vehicles) among other things lead them to recommend investors to sell into any relief rally in the stock.

Bharat Forge also faces multiple headwinds as key segments of commercial vehicles (domestic and Class VIII trucks in the US) and oil and gas, together accounting for half the standalone revenues, are undergoing a steep downturn.

The weakness in crude oil prices is also the reason for analysts being cautious on two-wheeler exporters, Bajaj Auto and TVS Motor. Hetal Gandhi, director, CRISIL Research, said: “Demand from West Asia and Africa, key export destinations for the two-wheeler industry and dependent on crude oil exports, would be impacted because of lower crude oil prices.”

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