Auto stocks: Rising cost of ownership to impact volumes and margins

Led by two-wheeler stocks that have lost up to 5.3 per cent, the BSE Auto Index was among the highest sectoral losers, shedding 2.3 per cent in trade on Friday. Including Friday, the index has dropped over 20 per cent since the start of the year as compared to gains of 6 per cent for the benchmark Sensex. 

There are multiple headwinds plaguing firms in this space. The biggest concern for the auto sector is the decline in volumes, on the back of higher product prices and running costs. Joseph George and Suraj Chheda of IIFL indicated in a report earlier this month that total ownership cost of passenger vehicles and two-wheelers was up 6-7 per cent year-on-year, primarily driven by a sharp rise in fuel cost. 

Second, after the Supreme Court directive making long-term third-party insurance mandatory, upfront costs of vehicles has risen. Third, with costs for auto financiers rising, analysts expect auto loans to become more expensive, adding to the cost burden. Of these, the rise in fuel costs is the single-biggest deal breaker. Petrol and diesel prices have risen by a sharp 16-25 per cent since the start of the year, which could cause delay in new purchases. 

While analysts have not yet downgraded their volume forecasts, growth is expected to slow down in the second half of the current fiscal, if costs keep spiralling.

The other worry is rising raw material costs that will impact profitability. This will impact firms especially if volumes soften, and passing on raw material costs might lead to a loss in market share. Steel and aluminium prices are on the uptick, gaining up to 16 per cent over the last year. The rupee depreciation is compounding the problem. 

While firms have increased prices, it will be difficult to pass on the entire cost burden as this might impact volumes in the festive season. Analysts expect margins for companies like Maruti Suzuki to fall by up to 80 basis points in FY18. Among two-wheelers, Bajaj Auto is the best placed, given strong volumes for its higher-margin three-wheelers and a larger share of exports that gives it a natural hedge. Mahindra and Mahindra (M&M) is also in a good position, given its high market share in the tractor space, new launches in the utility vehicle segment, and a larger exposure to the growing rural market. 

While there are multiple concerns in the sector, Bharat Gianani of Sharekhan says the correction in the auto space can be used to buy stocks of auto firms with leadership position and strong financial muscle. Companies such as Maruti and M&M will be able to pass on cost escalations to consumers and protect margins.