Auto sector braces for tough road ahead as lockdown hits business

Two-wheeler space worst hit, given higher BS-IV inventory

The auto sector, which has been grappling with multiple challenges over the past year, is headed for tougher times due to the COVID-19 outbreak. Auto makers and suppliers, struggling with muted demand, have shut production facilities both in India and overseas, given the lockdowns announced globally.
 
The supply-side disruption led to a 13.4 per cent fall in the BSE Auto Index on Monday. The sector has shed over 37 per cent over the past month, as the virus threat compounded the sector’s transition from BS-IV to BS-VI, resulting in higher product prices and subdued demand.
 
The impact in FY20 will be felt the most in the last two weeks, given that footfalls have dropped drastically with dealers forced to close down showrooms and the planned transition from BS-IV to BS-VI not happening as smoothly as planned.
 
The two-wheeler segment has been the worst-hit, with inventory to the tune of 15 days. Given the curfew-like conditions, the inventory is unlikely to be consumed before the deadline of March 31. The impact of Covid-19, however, will be felt more in FY21, says CRISIL Research.
 
Hetal Gandhi, director at CRISIL Research, said: “On the supply side, auto makers are not expected to restart production till authorities relax the lockdown measures. On the demand side, the duration and the extent of spread will determine the income loss, and thus will have a bearing on the retail buying sentiment. Despite a low base, expect the first half of FY21 to be subdued.”
 
Analysts believe demand is unlikely to revive even after the impact of the outbreak ceases, as the higher cost of acquisition on BS-VI rollout would dent demand. Two-wheelers and truck makers will be the worst hit, from the sharp rise in costs.

Volume expectations and earnings estimates have been revised downwards for most companies.
 
Shruti Saboo, associate director of India Ratings and Research, had projected industry volumes to drop 12-15 per cent for FY20, and expects the impact of the virus to dent volumes by a further 2-5 per cent.
 
Volumes, according to the rating agency, are likely to drop in FY21 due to weaker consumer sentiment, as well as lower industrial production, leading to reduced transit of goods. Dolat Research has cut earnings estimates by 5-20 per cent for FY22, due to weak domestic demand, rising uncertainty and slower exports.
 
While revenues are expected to be lower in the coming quarters, falling capacity utilisation, partial absorption of the BS-VI price hike, and impairment of the leftover BS-IV inventory are expected to hamper margins. The sharp fall in commodity costs on account of the global demand crash is the only positive for companies.  The only demand trigger is the expectation that the rural segment will do better, given a robust Rabi crop. The lockdown is currently enforced in urban areas that have higher population density than semi-urban and rural areas.
 
CRISIL Research expects profit per hectare of the current Rabi crop to be higher by 8 per cent year-on-year. This, coupled with the fact that prices of horticulture crops have also risen over the year-ago period, should help in rural market outperformance.
 
The rating agency, however, cautions that the acreage for the upcoming Kharif crop, and harvesting of the Rabi crop will be affected if the outbreak spread intensifies in rural parts.
 
The only solace for investors are valuations, which, given the already low expectations, are starting to look attractive. Aditya Makharia of HDFC Securities said: “After the recent bout of correction, valuations for the sector are at the lowest level since the credit crisis in 2008 (nearly 12 years) and in the case of certain stocks have fallen below the 2008 levels.” He also highlights that barring a few names such as Tata Motors and Motherson Sumi, the balance sheets of most auto makers are deleveraged.
 
While valuations are attractive and demand is expected to bounce back, analysts say it is difficult to predict a bottom for the sector. In addition to an early withdrawal of the outbreak, what could help  the sector is stimulus package to boost overall consumption and a scrappage policy for the sector.