What is in store for auto stocks?

The vehicle sales in the country witnessed a steep dip in August, continuing to fall for 10th consecutive month. Vehicle sales across categories registered a decline of 23.55%.

It is clear from the numbers that the decline is fairly broad-based and the magnitude of the decline is very high across players. The numbers also show a simultaneous decline in the exports which indicates weak consumer demand overseas too. Auto industry worldwide is under stress, stringent emission, and safety norms, phasing out of diesel vehicles and mainstreaming of electric vehicles are some major reasons that have led to declining auto sales worldwide.

The slowdown in the Indian economy, weak consumer sentiment, tight liquidity and non-availability of finance has weighed in heavily on the auto industry in India. Other important reasons that have contributed to the weakness include new safety norms starting April 1, 2020, higher insurance costs, higher ownership costs.

The stress in the sector is reflected in the performance of the listed stocks in the auto sector. The BSE AUTO index has been the worst-performing sectoral index, down 34% from its yearly high against 8% fall in Sensex. Individual stocks have taken a significant beating: market leader Maruti has lost 28% from its highs, other major players such as Mahindra & Mahindra; Tata Motors have been punished more severely by the markets.

Sectoral Outlook

The distress in the auto sector has been finally acknowledged by the decision-makers -- both the Government and the Central Bank have started working on finding ways to revive the sector. The government action is twin focused -- one to boost consumer sentiments through various incentives, the second set of government action is in terms of providing sufficient liquidity to the auto sector.

The Reserve Bank has already swung into action with the latest round of interest rate reductions and provisioning for more funds to the NBFC sector, the primary lender to the auto consumer. The government has already announced several measures in the last fortnight, clarification on norms for BS-VI transition, reduced depreciation and other measures in the offing bode well for the sector for the upcoming festive season. The finance ministry has also announced slew of measures to bring relief to the automobile sector.

There are good chances that the GST rates on non-electric and hybrid automobiles may be reduced further. The timing of the government’s intervention in the sector is critical: a well-timed and focused bailout would go a long way in turning around the fortunes of the most critical sector of the Indian economy.

Outlook for auto stocks

After the government has swung into action, auto stocks have rallied from their lows, the BSE auto index is up by almost 8%, individual stocks have rallied on an average by 10%.

Since the stocks were beaten down to such an extent some relief uptick was always on the cards, however for the stocks to show a meaningful trend reversal the current trend of declining sales has to slow down, the September and October sales number would be telling and a clearer picture will only emerge once the proposed measures start showing meaningful results in the short term.

We believe that the sustainable positive momentum is still a few quarters away, the auto industry is going through structural changes at this moment, these changes have to play out and after that new players with better strategies and product lines would take the leadership role. It can be said without a doubt that the sector has gone through a Price-Equity (P/E) re-rating and the premiums that the market leaders once commanded would no longer be available.

Investors should not buy individual stocks just because they have fallen significantly --although Maruti has corrected sharply it’s still trading around its five-year average PE, whereas M&M is trading well below its average PE, so from a pure valuation perspective M&M is cheaper to own.

Eicher Motors is trading well below its historical PE but the competitive landscape has changed and its leadership position is being challenged by new entrants, therefore, the stock has been re-rated.

Investors have to be discerning in making their investments into the sector and would also have to evaluate stocks on their competitive positioning.

Select stocks in the segment with robust and diverse product pipelines with a focus on electric vehicles are expected to out-perform their peers in the next three to five years. We believe that the turn-around in the sector is still a few quarters away until then auto sector stocks would be volatile, our expectation is that the two-wheeler stocks would be the front-runner stocks in the turn-around phase, therefore investors can look into buying good quality stocks in this space in a stepped manner.

(The writer is the Director Wealth Discovery/EZ Wealth)