Auto sector woes to continue as downgrades loom under Covid shadow

Steep rise in input costs cited as the key reason for the revision

The BSE Auto index has been underperforming the benchmarks over the past three months amid multiple headwinds, including weak retails, rising commodity prices, and supply disruptions. The auto index, after outperforming the benchmarks for most of FY21, is down about 9 per cent, as compared to the 2 per cent decline in the Sensex during the last three months. The derating on the one-year forward price to earnings ratio has been higher, about 18 per cent since January. Most analysts believe these headwinds will remain in the near term.

Mitul Shah, head of research at Reliance Securities, says: “Due to the ongoing economic slowdown amid the second wave of Covid, the turbulence (demand woes) the sector is facing for over a month and a half is expected to continue into May, as well. On the other hand, higher commodity prices and other cost inflation would impact operating margins of these companies in the June quarter of FY22 and beyond.”

Prices of key inputs — such as steel, aluminium, copper, natural rubber, and precious metals — have been trending up. To tide over the rise in costs, auto companies had hiked prices in the December and March quarters, with the latest round of hikes effective from April 1. However, these hikes are not enough to offset the surge in costs and can lead to further downgrades. Analysts at IIFL Securities believe management commentary on incremental pressure in the first half of FY22 may lead to earnings downgrades.

In this context, the margin commentary by passenger vehicle market leader Maruti Suzuki, which will declare its March quarter on Tuesday, will be critical from the sector’s point of view. Among the various segments, tractors, exports, and replacement markets are expected to be more resilient, given higher rural volumes, improving Covid situation in key exports markets, and steady demand for parts. In the replacement market, batteries (Amara Raja/Exide) form the only segment which will report improvement in margins both on sequential and YoY bases.

Given the near-term overhang, investors should await clear signals on the margin movement and more importantly, demand improvement before considering an investment.