Brokerages see margin expansion at auto firms as outlook turns positive

Higher volumes and softer raw materials to drive expansion

Brokerages expect margins of auto companies, particularly passenger vehicle makers, to expand in the quarters ahead due to softer raw material prices and higher volumes, as the chip shortage eases in the third quarter. Many of the companies have seen an upward revision in their estimates by the brokerages, as a result.

The optimism for the quarters ahead also comes from a very positive management commentary and improved outlook. However, benefits of lower steel and precious metal prices are being neutralised by an increase in the price of crude derivatives.

Car market leader Maruti Suzuki India will be a key beneficiary of the lower RM costs and strong volumes as production and deliveries pick up pace.

Maruti expects new products (recent and future models) to help the company attain a dominant position in UVs. As of September 2022, its order-book stood at 412,000 units, the company said at the investor call.

“Driven by better scale and pricing, we expect Ebitda margin to expand, from 6.5 per cent in FY22 to 9.5 per cent in FY23E and to 11.5 per cent in FY25E,” wrote Raghunandan N L, analyst at Emkay Research wrote in a post earnings report. Emkay has target price of Rs 11,000 on the stock. Its current market price as on November 14 was Rs 9152.40. The brokerage has pencilled in an 11 per cent growth in the volumes in FY23.

To be sure, quite a few companies didn’t see the benefits of lower commodity prices in the September quarter--if anything they saw the residual impact of higher prices as they were still left with material bought at higher prices.

One such was Eicher Motors. The company’s motorcycle arm, Royal Enfield (RE), is yet to gain from declining input prices and was unable to protect gross margin from dipping due to rising sales of Hunter—the company’s latest 350cc model priced at Rs 1.66 lakh.

“The same (margin improvement) should be visible from Q3 as gross margin starts improving with price hikes and commodity price decline benefit seeping through,” wrote Basudeb Banerjee, analyst at ICICI Securities, in a recent research note. The company’s management has guided for margin expansion. It also expects a better operating leverage to cushion a slight margin dilution due to Hunter pricing.

Mahindra and Mahindra, which delivered a better-than-expected second quarter performance, is another firm whose forecasts have been revised. The upgrades come on the back of a higher-than-expected average selling price of Rs 7.62 lakh --- up six per cent quarter-on-quarter.  With successful SUV launches and a strong order book of 260,000 units, M&M plans to expand SUV capacity from 29,000 units per month in FY22-end to 39,000 and 49,000 units in FY23 and FY24, respectively. Its domestic UV share has improved by 200 bps since FY22 to 17 per cent.

“We expect margins to improve from here on, led by improved chip supplies to service healthy order book, fixed cost optimisation, decrease in RM cost and aggressive pricing,” wrote Mansi Lall, analyst at Prabhudas Lilladher in a November 14 report. She expects commodity tailwinds to further improve margins and has built in 300 bps expansion over FY22-25.  

Like Royal Enfield, the management of TVS Motor Co is also optimistic about the road ahead. Better availability of chips will help ramp up production of premium motorcycles, which in turn will improve the mix and drive margin expansion. Though the supply side started easing in Q2FY23, it still impacted production of premium motorcycles, restricting full benefit of the improvement in the mix.

“We raise our FY23/FY24 EPS estimate by 5/7.5 per cent, led by an upgrade in volumes on supply-side improvements and a favorable rupee," Jinesh Gandhi, research analyst at Motilal Oswal wrote in a research report.

Even as the road ahead for most firms looks smooth due to a strong order book and better chip supplies, inflationary trends could play spoilsport, cautioned analysts. Moreover, Ebitda margins for most have still to catch up with the pre-Covid levels.