“Deseasonalising” the impact of the goods and services tax (GST) launch last year will be a difficult task. Typically manufacturers cut back manufacturing in June and then pushed out massive volumes to dealers in July. There were also the usual glitches with moving to a totally new system, so sales glitches were seen across August-September.
As a result, sales data is skewed in both directions for several months due to unusual base effects. We will probably need to club data across a three or four month period - say, June-September - to get a clear sense of how manufacturing has grown year-on-year for 2018 compared to 2017. This process will be further complicated by the spillovers across two quarters with the key months of June and July.
The automobile industry is a good example of how messy this base effect could be. Sales expanded by over 30 per cent across the industry in June 2018 versus June 2017, which would be an incredible result in a normal month. But, sales fell sharply year-on-year in July 2018, for several companies. For the fiscal year overall, volume growth is expected to be strong across most auto segments. The Q1'FY19 results so far, indicate that there has been volume growth, for sure, even discounting base effects. But margins have also dipped, leading to companies missing profit estimates in several cases.
The NSE Auto Index has lost ground through the past seven months, even as the Nifty (which includes auto stocks such as Maruti Suzuki, Mahindra & Mahindra, Tata Motors, Hero MotoCorp, Bajaj Auto, etc) has surged. High demand has been on good monsoon expectations, leading to improved rural sentiment.
But margins have been affected by several adverse factors. First, interest rates have risen and this affects financing costs at a working-capital-intensive industry like auto. Higher rates can also affect demand since the vast majority of buyers use financing.
Second, commodity costs have risen and risen appreciably for a whole range of inputs. Metals have been bullish. The rupee weakening has also meant a rise in import costs for certain raw materials. Of course, this could also result in higher export earnings. In addition, auto companies have offered discounts to get rid of inventory and to keep market share in a competitive scenario.
Since costs will rise, and prices can't be hiked much due to competition, consumption will be the key. Manufacturers are betting on stronger rural demand, given hopes of a normal monsoon and higher MSP (minimum support prices; for agri-produce), which could result in firmer rural sentiment. That means a stronger market for two-wheelers and maybe, for tractors. Commercial vehicles could get hit by new axle norms, which will mean higher costs for companies and there would be a heavy dependence on industrial activity picking up. The recent truckers' strike could prove a temporary dampener.
The Auto index is generally highly-correlated to the Nifty. The underperformance of the past six months is unusual. Technically, we'd expect the broader index and the Auto index to start aligning again. This could happen in two ways. One would be a pickup in share prices across the auto industry. The other could be a correction in the Nifty. The optimists would expect auto prices to pick up, given higher sales, even if margins don't improve. The pessimists would expect the Nifty to correct down. Given the very long value chain for automobiles, it may be a lead indicator. That imply the broader market is more likely to correct down.