Downgrade cycle for auto firms to continue, more concerns likely to follow

The BSE Auto index has been among the worst performers, losing 21 per cent in 2018. Given the multiple factors such as lack of new models, higher cost of financing, aggressive pricing and increased discounting across segments, analysts expect the sector to disappoint on the returns front for the second consecutive year.

Brokerages have started downgrading firms across segments, be it two-wheelers, passenger vehicles or truck makers. Recently, CLSA downgraded the Eicher stock, cutting its earnings estimates by 6–13 per cent for FY19–FY21, which took the Street by surprise. The brokerage then turned negative on Bajaj Auto, changing its recommendation from ‘outperform’ to ‘sell’. Slowing US truck sales also prompted brokerages to prune their expectations from leading forging companies such as Bharat Forge.

Slowing sales volumes, which have intensified over the last couple of months, are expected to continue and will impact auto majors such as Maruti Suzuki, Mahindra & Mahindra, Bajaj Auto and Eicher Motors. Given the volume decline, auto companies are circumspect about growth prospects and are pruning their estimates for FY19.

While crude oil has cooled significantly from its 2018 highs, the same is not fully reflected in the prices. With petrol and diesel continuing to hover above Rs 70 and Rs 65, respectively, for a litre, fuel costs are hurting. 

The passenger vehicles market — particularly the volume-heavy entry- to mid-market segments — tends to be sensitive to fuel cost prices. This is already impacting Maruti Suzuki. The passenger cars market leader trimmed its sales forecast for FY19 to 8 per cent, from a double-digit figure earlier.

Certain annual expenses, such as insurance premium, also saw an upward revision last year. Given the impact on two-wheelers (another price-sensitive segment) volumes for two-wheeler majors such as Hero MotoCorp, Bajaj Auto, TVS Motor and Eicher Motors have remained patchy.

After many years of double-digit growth, Eicher plans to reduce its production levels and says sales will record a high single digit growth, as compared to its earlier guidance of 15 per cent growth.

This is why, despite retaining faith in the premium motorcycle maker, CLSA feels volume growth will remain a concern. Downgrading its target price on Eicher from Rs 30,000 to Rs 22,300, they say the stock may remain under pressure until volume growth picks up.

In case of Bajaj Auto, where CLSA has trimmed estimates by 4–6 per cent, the brokerage isn’t positive on exports and says the domestic two-wheeler business will also face a big regulatory cost push over the next two years.

Ashok Leyland is also faced with a similar slowdown in commercial vehicles, given the relaxation in axle load norms and lower cargo demand. Its peer Tata Motors is faced with a double whammy, as neither the Indian market is holding up nor is its luxury brand Jaguar Land Rover (JLR) showing any sign of consistent growth.

While analysts at HSBC Global Research feel FY20 will have an extremely favourable base for JLR and that the downside to Tata Motors’ stock is limited, the upside triggers look weak. “Demanding relative valuations, stress in balance sheet and cash flow, as well as long-term business challenges, all limit upside,” they say.

Financing purchases have also become difficult since mid-October for auto buyers, who are increasingly dependent on vehicle loans.  Even as liquidity concerns have eased slightly for lenders, brokerages expect demand and profitability of auto makers to take a hit.

Consequently, inventory is already piling up. A report by ICICI Securities notes that despite deep discounts for eight out of ten top car models, inventory levels remain elevated. “Discounting pressures are thus likely to remain elevated on account of weak consumer sentiment,” it states, indicating that profitability may take a deeper hit.

For investors, it hasn’t been a positive start and they may have to contend with lacklustre returns on auto stocks for yet another year.