Auto component exporters may get benefit from US-China trade deal

Stocks of auto component companies, which derive a significant portion of their revenues from overseas markets, have been outperforming domestic peers over the last three weeks. Motherson Sumi, Bharat Forge, and Balkrishna Industries are some of the stocks which have gained up to 14 per cent. Among auto companies, Tata Motors, India's major automobile company with big exposure to global markets, too, saw a sharp rally of about 18 per cent. 

One of the key reasons for the rally has been the recent approval of the US-China phase 1 trade deal by American President Donald Trump. This is a relief to companies which are part of the global auto supply chain. An analyst at a domestic brokerage says that China is the world’s largest auto market, both by volume and profitability. Any uptick in volumes in that market will boost the margins of the auto companies and their suppliers, he says. While the details will be announced on January 15, analysts expect the trade deal to be the first step towards a sustainable demand improvement. In the Chinese market, inventory levels, which had spiked given weak economic sentiment and transition to the China 6 norms have started to come off, according to the China Automobile Dealers Association. The situation is expected to resolve over the next couple of quarters as the new standard is implemented across China.

Another trigger for the rally is the expectation of an improvement in the European auto market. Analysts at JM Financial say: “With clarity over Brexit, US-China trade and the end of regulatory issues in the European Union (EU), pent-up demand and new model launches in the battery electric vehicle and plug-in hybrid electric vehicle space points to a relatively better market scenario than in CY19. As a result, Motherson Sumi and Tata Motors are best placed to gain from a EU recovery.”

 

After the transition to the new real driving emissions (RDE) procedure, volumes in the EU have recovered. The recovery in the second half of CY19 helped cushion the January-to-November sales decline to 0.3 per cent. Carmakers in the EU had recorded a fall of 3.1 per cent in the first half of CY19. Global carmakers and ancillary units indicate that recovery in the EU is expected to continue in CY20. 

 Among the auto parts suppliers who stand to gain from the recovery is Motherson Sumi. The stock is up 48 per cent over the last three months on strong September quarter results and improving outlook for global auto demand. Analysts at Goldman Sachs believe Motherson Sumi will post strong earnings growth in FY21 on the back of ramp-up of new plants and execution of fresh orders, normalisation of commodity prices and improvement in profitability of its subsidiary, SMP. However, given the sharp run-up in prices, investors can consider the stock on dips. 

 The other beneficiary of the improving outlook is Balkrishna Industries, which makes tyres for specialised applications. Led by the US and EU markets, the tyre offtake for the agriculture and off-the-road (OTR) segments in November grew 12 per cent, the fastest in over 14 months. Nishant Vass of ICICI Securities believes that CY20 could mark the resumption of restocking as confidence among distributors could rise with the waning impact of the US-China trade dispute. Despite the recent rally, analysts expect the stock to gain a further 25 per cent. 

The outlook for Bharat Forge though is a bit mixed. The near-term worry is its biggest segment – commercial vehicles, which is facing headwinds both in India and the US. In the long run, the company has a target of increasing its share of passenger vehicles from 12 per cent to about 25 per cent over the next five years. The company is also looking at electric vehicle components, light-weighting components, and defence to power its future growth. While the stock has gained 11 per cent since October, investors should await a recovery in the CV market before taking an exposure, or buy on corrections.