Auto Stocks In Top Gear

With the market sentiment reversing in July, auto stocks are back in the limelight and remain hot favourites amongst investors. The question is whether the auto stocks will continue to outperform in 2022 and beyond? Yogesh Supekar discusses in detail the opportunities in the automotive sector and shares the outlook 

Recovery in auto stocks along with banks is always cheered by investors as most investors hold auto and banking stocks in their portfolio. Auto stocks are widely held and hence when the automotive sector does well it helps boost investor sentiments. If you wonder what is common between Galaxy Bearing, Kranti Industries, Rolex Rings, Shanthi Gears, Lumax Auto Technologies, HBL Power Systems, Mahindra and Mahindra, etc., you will find that most of the stocks are trading at 52-week highs with some trading at lifetime highs, thus outperforming the markets in 2022 – and they all belong to the same sector i.e. the automotive sector in India. 

In fact, surprisingly the BSE Auto index is trading at lifetime highs when the BSE Sensex is trading lower by ~9 per cent from its all-time highs. The BSE Auto index has jumped higher by 182 per cent since March 2020 lows and is the top performing sectoral index on YTD basis, with only BSE Power index performing better than the BSE Auto index. Says Rahul Gaikwad whose diversified portfolio is skewed towards auto stocks: “My diversified portfolio has a higher weightage for auto stocks, simply because the auto business is easy to understand. These products (automobile) are visible on the roads, and it is not very difficult to understand which company is doing better than the others.” 

“With new product launches why should anyone be surprised if Mahindra and Mahindra is outperforming and trading at record highs? Only a couple of years back analysts were bearish on the auto prospects; however, the industry has bounced back ferociously and as of today i.e. 2022 it is creating wealth faster than most other industries in India. Another reason to remain invested in the sector is the dividend-paying capacity of the industry. Bajaj Auto is a consistent dividend payer and I am holding its shares purely as a dividend play for several years now. Dividends matter for long-term investors and I would say higher dividends helped me remain invested in certain auto stocks in spite of the visible headwinds,” he adds. 

Reasons for Outperformance

The auto stocks are doing well owing to fresh buying into these stocks. With Large-Cap auto stocks grabbing the limelight, most investors are able to ride the positive momentum in the large-cap auto stocks with confidence. Fresh buying in recent months has been witnessed in large-cap auto stocks such as Mahindra and Mahindra, Tata Motors, Hero Motors and Maruti Suzuki. On the technical front, the Nifty Auto index is trading at its lifetime high and all indicators highlight positive momentum. A significant alpha has been generated by the Nifty Auto index in 2022. One of the key reasons for the enthusiasm amongst the investors in the automotive industry has been the development in the electric vehicle (EV) segment in India. Fresh, large ticket size investments have recently taken place in the EV space that has triggered valuation race among automotive companies. The EV momentum is not restricted only to the large automotive players but even small companies have been able to ride the positive momentum in EV space. 

For example, one of the top multibagger stocks in India, Gensol Engineering has invested in US- based EV start-up with a plan to launch an affordable e-car with 200 km range in India. Gensol Engineering aims to set up its research and development centre for technology development and a start of production (SOP) in the first quarter of 2023 in Pune with a capacity of 12,000 cars per year in the first phase. With a small market-cap of over ₹ 950 crore, Gensol Engineering’s shares have jumped higher by more than 630 per cent in 2022 alone. To cut a long story short, the EV story is finally catching investors’ imagination and the whole automotive sector is expected to reap rich dividends from the change in the trend in India and globally. 

The electric vehicle trend is expected to spread at a rapid pace. The government is trying to curb carbon emissions while reducing reliance on petrol and diesel which is creating a substantial demand for electric vehicles. It is estimated that from 2020 to 2027, the electric vehicle market shall grow at a CAGR of 44 per cent to achieve 6.34 million unit annual sales by 2027. By 2030, the electric vehicle industry is expected to create five crore direct and indirect jobs. The Indian automobile industry is expected to record strong growth in 2022-23, post recovering from the effects of the pandemic. Electric vehicles, especially two-wheelers, are likely to witness positive sales in 2022-23. 

India is aiming to have 30 per cent of its passenger vehicle sales as electric vehicles by 2030. Already, home-grown players such as Tata Motors and Mahindra Electric along with foreign players like MG Motor and Hyundai are competing for a share of this pie. One of the other strong reasons for the auto stocks to do well is the rise in demand for its products in the post pandemic period. A definite change in consumer mindset towards usage and ownership of automobiles has triggered a new wave of demand for the products that can suit the aspiration of millions of consumers in India. Says Ricky Kirpalani, Lead Sponsor, First Water Capital Fund (AIF): “Automotive as a sector has faced a lot of headwinds post the pandemic which it has yet to fully recover from.” 

“The biggest issue plaguing the sector has been the supply chain disruptions leading to semiconductor shortage and resultant loss of production. All this came at a time when demand was very robust in the aftermath of the pandemic with preferences shifting towards personal mobility as opposed to shared transport options. Now with early signs of the semiconductor shortage alleviating, there is a hope that production can be ramped up going forward; however, the rising interest rate scenario is clearly a dampener as far as demand is concerned. The auto stocks have performed reasonably well over the last few months and could be market performers from here on,” he adds.

INTERVIEW 

Mitul Shah Head of Research, Reliance Securities 

"We Believe that the Market would Stabilise by Mid-FY23" 

What is your view on auto stocks? The revenue growth in 1QFY23 is expected to be very strong on YoY basis due to low base, while inflationary pressure is likely to impact margin and profitability of the automotive companies in the quarter. However, on a positive note, in terms of demand side, the industry volume is expected to improve gradually every month in the coming months backed by favourable monsoon-led rural recovery and festival season kicking in 2QFY23. Retail demand is expected to remain strong in FY23. Recent global geopolitical issues amid the Russia-Ukraine war have had a negative impact on businesses environment, which has created negative demand sentiment for consumption in the past few months. 

This also led to a sharp jump in crude prices, which was a key negative factor for the automobile sector, resulting in a sharp correction in stock prices during the previous 3-4 months. However, the scenario has completely changed recently as commodity prices have softened and crude prices have also corrected from the peak. These are two major drivers triggering auto stock performance as lower crude prices (lower fuel prices) support healthy demand and lower commodity prices benefit automotive makers on the margin front. Hence, the bottom-line gets benefitted from both these factors. We expect the automobile industry to witness double-digit growth in FY23, while we expect the medium and heavy commercial vehicles and three-wheeler segments to outperform with 30 per cent plus volume growth in FY23. 

How will equity markets perform? The Indian equity market continues its volatility and has corrected ~13 per cent from its peak in October 2021 and about 5 per cent in a month. The recent rate hike by the Reserve Bank of India (RBI) following the US Federal Reserve’s rate hike has created unprecedented turmoil in the markets. The US is experiencing 40-year-high inflation levels and the market sentiments are currently revolving around the expectation of further rate hikes in the near future. Consumer confidence is at a record low, indicating possibility of recession in the US by 2022-end. Selling pressure from FIIs remains a key trigger behind the market fall as they have sold more than USD 39 billion over the past nine months – the largest sell-off recorded since 1952. 

However, it is expected to slow its pace of selling in the near term. Another headwind is crude inflation, which has been impacting the overall product cost across categories due to energy cost and transportation cost. The Russia-Ukraine war-triggered supply disruptions are likely to sustain and keep commodity prices elevated. Further, the Indian rupee hitting a record low of ~80 against the US currency creates additional pressure on equity. Therefore, we expect the market to remain under pressure in the near term. However, we expect FII inflows to return in 2HFY23, while the DII investments would continue in 2022, thus restricting a sharp fall to some extent. We believe that the market would stabilise by mid of FY23 and stable commodity prices, inflation under control and gradual economic recovery would help a strong bounce-back in 2HFY23. We have FY23-end Nifty target of 19,000. 

INTERVIEW 

Siddharth Vora Head (Investment Strategy and Fund Manager – PMS), Prabhudas Lilladher 

"We Believe that the Market would Stabilise by Mid-FY23" 

Why are auto stocks outperforming?

The automotive sector is doing well due to:

•  Supply chain issues around chip shortage normalising that will help OEMS fulfil the large order books, thus supporting volume growth.
•  Key commodity and energy costs coming down sharply, thus aiding margins. n Crude coming off is a further tailwind from the demand perspective.
•  Strong monsoon and improving farm incomes bodes well for rural demand outlook likely to be bottoming out. Rural demand improvement bodes well for two-wheelers, tractors and entry level passenger vehicles.
•  Strong structural commercial vehicle (CV) up-cycle with robust volume growth, improving margins outlook and supply issues coming down keeps the CV space upbeat.
•  Passenger vehicle segment has seen a situation of strong demand as visible from their large order books and customer waiting periods. This is supported by a slew of new product launches by various OEMS across the SUV category, which is the most preferred vehicle type. Thus, we see volume trajectory to be very healthy. As the chip shortage situation gets under control, the delivery pipeline will improve significantly. Further tailwinds from crude, commodity and energy costs bode well for margins for OEMS, given the price hikes are already taken amidst a strong demand environment. 

What is your outlook on the equity markets?

We are seeing a sharp rally in equities especially in Mid-Caps and Small-Caps since mid-June. We are seeing equities rebounding globally. There are three reasons for this rally:

1. The markets were in an oversold zone after correcting 20-25 per cent from their peak.
2. The sharp fall in commodity prices, especially metals and natural gas, has contributed to the view that inflation might have peaked out and we will see inflation softening from here on.
3. The third reason is that all the bad news seemed to have priced in, be it high inflation or recession in the developed world. 

The current rally is supported by FIIs reducing their selling intensity and now turning net buyers over the past few days. If this buying sustains, we are going to see higher levels in indices. The fall in commodities due to the fear of recession is good news for central banks which have been trying to contain the inflation aggressively. The recent CPI of 7.01 per cent in June was lesser than expected as a result of various policy steps taken by the RBI and the Government of India. While the moderation in commodity prices might contribute to lower food and goods inflation, the services inflation is still elevated. Globally as well, we are observing high wage inflation and tight labour markets leading to high demand for services. 

As such, it would not be as easy to nudge out inflation till the demand for services is high. Going forward, the inflation trajectory, central banks action and intensity of recession will decide the direction of markets. Currently a mild recession is priced in the markets; however, a hard landing will change the dynamics. We think the probability of hard landing is less in the US, though a mild recession cannot be ruled out. All in all, the markets are going to be reacting to the data coming out globally and hence we are expecting to remain volatile for another 1-2 quarters. In terms of metre, our techno metre is pointing ‘buy’ since the 15,700 levels. There is an increase in risk appetite among global investors as indicated by RORO and the valuations look ‘fair’ as of now. 

Automotive Sector Outlook

As far as month-on-month sales goes, the outlook for the automotive industry has seen gradual improvement. The enthusiasm towards the sector could be linked to new launches, improved availability of semiconductor chips, lowering of commodity prices and optimistic consumer sentiment in rural areas. The issues related to raw material are gradually disappearing with correction in the international competitive environment. The passenger vehicles segment will be supported by pent-up demand, new launches and greater penetration of electric vehicles. Besides, domestic steel prices have corrected due to the imposition of export duty. Meanwhile, sales volume in the tractor segment is expected to gain traction due to the likelihood of a normal monsoon, higher agricultural prices and recovery in the rural economy. In short, the outlook remains positive for the automotive sector. 

Technical outlook : Nifty Auto Index

The Nifty Auto index is trading at lifetime highs, as it gained 185 per cent from the March 2020 lows. On Friday, it had formed a reversal-like candle on the daily time frame after a rally of 18.77 per cent from the June 20 low. On Monday, it traded below the Friday low and as a result, got the confirmation of a reversal pattern. The index may retrace back towards 12194, which is a 23.6 per cent level of the prior swing, and 20DMA (12137). If the index closes below the level of 12484, it may move lower for another 3-5 days. The RSI is also coming down from the overbought condition. The MACD histogram also shows a decline in momentum. As of now, no bearish signs are visible on the chart, but fresh long positions can be avoided for time being. Momentum traders can take profits off the table and wait for another opportunity to enter at lower levels. 

Conclusion

The fortunes of the automotive sector are linked with the economic growth in India and to an extent the global economic growth. The automotive sector in India has been deprived of growth in the past decade or so. Tata Motors is yet to cross its all-time highs made in 2015, while the shares of Maruti Suzuki are still trading below their all-time highs made in 2018. The growth for different sub segments of the industry has grown at 3-6 per cent on an annualised basis over FY10 to FY20 when compared to 10-12 per cent growth over FY00 to FY10. Higher interest rate is also an important factor that affects the demand for automotive sector products. 

However, if one were of the view that inflation has peaked and that the rise in pace of interest rates will slow down and also support economic growth, the broader picture for the automotive sector is promising. The fresh trigger for the industry in the form of EVs cannot be ignored by investors. The scope of India’s EV market growth rests on availability of capital for original equipment manufacturers, battery manufacturers and charge point operators as well as improvements to infrastructure and diversified options for consumers. On ground, several states are showing keen interest in promoting the usage of electric vehicles. 

To realise India’s EV ambition, it is expected that India will need an estimated annual battery capacity of 158 GWh by FY 2030, which provides huge investment opportunities for investors. The improving customer sentiment, easing raw material prices, semiconductor issue getting resolved, reducing supply chain woes, innovative products appealing to customers, steady economic growth despite headwinds for India and quality leadership in the automotive sector are some of the reasons why investors may not go wrong while investing in the sector. The risk that needs to be considered is that of rising inflation. If not tamed, it will lead to steeper rise in interest rates and raw material prices again. Looking at the pros and cons, it makes sense to allocate a sizeable portion of the portfolio to the automotive sector.