Too early to enter auto sector

It will look attractive if rupee stays weak and sales pick up at the same time

The automobile industry released one of the few positive data points this month. After nine months of declining sales, August saw a 15 per cent jump over August 2012 in car sales. Overall, according to the Society of Indian Automobile Manufacturers (Siam), passenger vehicles, commercial vehicles (CV) and two and three-wheelers combined saw a healthy eight per cent growth over August 2012.

However, the April-August numbers for the industry are negative. Passenger vehicle unit sales are down 5.3 per cent over those five months, while CV sales are down 12 per cent and three-wheeler sales down four per cent. Two-wheeler sales are up nominally to 0.7 per cent.

Vehicle exports during this five-month period were up two per cent in unit terms. However, given that April-June exports were down 5.7 per cent, there has been some turnaround on that front in the second quarter as well. The weaker rupee almost certainly played its part in this.

It's too early to say with any confidence but it is possible the August jump represents a turnaround in the auto sales cycle, rather than being a statistical anomaly. The industry must be having its fingers crossed.

2012-13 saw declines in unit sales and Siam has cautioned it doesn't seem as though this financial year will be much better; it could even be worse. However, the monsoon has been good and that usually feeds into higher rural demand. General elections will also tend to provide a temporary boost to demand. The festive season would probably be make-or-break - if sales don't pick up at that time, 2013-14 will be negative.

The auto components industry must also be hoping that things turn around. The weaker rupee could lead to benefits on two fronts. One is that it represents a barrier against cheap component imports and it's possible that local manufacturers will be able to exploit this. Second, the export competitiveness of local component manufacturers rises. It is possible that, despite lukewarm global growth, they will be able to use the weaker rupee to push sales abroad.

One auto giant has gained from a stronger rupee. Maruti, unlike most Indian companies, is yen-sensitive. Abenomics has effectively weakened the yen and Maruti's costs have reduced as a result. Another Indian biggie, Tata Motors, is now effectively dependent on its performance abroad, in Jaguar-Land Rover, and since that has done reasonably well, it has kept the company afloat.

The sector is a good bellwether for consumption demand and consumer confidence. It's a big-ticket item and almost always bought via retail financing. The CV segment is almost entirely financed. The industry also has an extended value chain and high working capital costs. So, its health is a good proxy for overall economic conditions and for offtake in multiple industries, from metals to consumer finance.

If the August performance is sustained, the industry could lead a turnaround. In the Indian context, the sector has long cycles and individual stocks undergo large price swings over long periods. Blue chips with long-established records tend to multiply in price from the cycle's trough to peak. This creates an opportunity certainly but also a risk.

When you invest in auto stocks, you have to be looking at two- or three-year time frames if you wish to generate the maximum returns. An investor who gets in near the top of the cycle could undergo massive capital losses.

Stocks within the sector are rarely strongly correlated. There are too many differences in business models and risks. This makes stock picking more difficult.

It might be a little early to enter the sector. But if the rupee stays weak and sales pick up at the same time, it will start looking really attractive. The auto component segment looks especially interesting, along with tyres and batteries. So do tractors. This is definitely a sector to watch when Q2 results start coming next month.