The BSE Auto index is up 131 per cent over the last 12 months, which makes it the third-best performing index. The strong performance of auto-sector companies at the bourses is closely linked to their business fundamentals. The major players from this sector, such as Hero Honda, Bajaj, Tata Motors and Maruti, have all registered high volumes in the last one year.
The buoyant performance of companies in this sector is closely linked to the robust economic recovery witnessed in India. In urban areas, especially, improving job prospects in a host of sectors, including IT, have boosted consumer sentiments, and hence the demand for autos. Rural demand, of course, held firm even at the peak of the crisis and continues to be so. (Over the past several years the government has been raising the minimum support price at which it buys grains from the agricultural sector, and this has led to wealth getting transferred to rural areas.) The generous Sixth Pay Commission grant, which put a lot of disposable income in the hands of government employees, also boosted the demand for vehicles in 2009. On the supply side, the launch of new models also played a part in boosting demand.
What next?
After a great run, the auto sector now faces headwinds.
The first and foremost is the possible hike in fuel prices. Since a hike raises the cost of operating a vehicle, it tends to have a negative impact on consumers sentiments and temporarily dents demand.
Several other factors also threaten to raise the costs of vehicles, which would then affect demand. One, more stringent emission norms are being introduced. Complying with them will entail a higher cost for manufacturers. Two, commodity prices have been rising and they will only move higher as the world economy recovers. Three, the roll back in excise duty cut will also raise manufacturers' cost. Four, as monetary tightening by the central bank gathers pace, banks will raise their auto financing rates.
Of all these variables, the most worrying, according to some analysts, is rising commodity prices. Says Surpiya Madye of ICICI Direct: “Rising commodity prices is the key concern as it could bring profitability under pressure. Although companies are planning to pass on costs, that will not offset the total impact of rising prices, only provide some cushion to margins that will get squeezed.”
The right picks
In the two-wheeler space Hero Honda remains analysts' favourite. Says Madye of ICICI Direct: “On the back of continued momentum in demand from the rural market and improving demand in the urban market, the cumulative increase in (year-to-date) sales was 23.6 per cent in spite of a strong FY09 base.”
In the four-wheeler segment, Maruti remains one of the top picks. In a recent report, HSBC Securities and Capital Markets states that concerns about Maruti's sales being affected post the excise duty rollback and increasing competition are overdone as demand continues to be strong. It further adds: “Market share loss is likely to be limited to bigger towns. Wide reach within the country should help the company tap rural demand and grow its volumes.”
Further, according to a recent note from Motilal Oswal: “(We) prefer players in segments less vulnerable to competitive dynamics - Bajaj Auto, M&M and Hero Honda.”
Robust CV sales
Sales of commercial vehicles are closely linked to the state of the economy. As the economy improves further, sales within this sector are likely to gain momentum. According to Fitch Ratings, the switchover to new emission norms from April 2010 should support demand for commercial vehicles (CV) during Q110, as operators pre-empt their purchases to save on higher costs as manufacturers are likely to raise the prices of models that comply with tighter emission norms.
This article was originally published on May 20, 2010.
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