Q2FY19 Preview: Speed bumps ahead for the auto sector

Second quarter of the financial year 2018-19 (Q2FY19) has been a roller coaster ride for most of the auto companies.  Several macro headwinds like rising fuel prices, increasing finance cost and hike in insurance premium have acted as speed breakers. However, while the speed of growth has definitely slowed down over last two months especially in the passenger vehicle (PV) segment (-0.7% YoY), high base effect, too, has had an impact on the volume.

Two-wheelers (2W) have been a consistent performer (+8.3% YoY), thanks to the robust demand from rural areas and high discounts offered by the original equipment manufacturers (OEMs). However, 2Ws as a space for OEMs is getting highly competitive as most OEMs fight to get an extra piece of the pie of market share. Loyalty programs, accessories and extended warranties are also likely to have a bearing on OEMs margins.

Commercial vehicle (CV) manufacturers, on the other hand, have been in the Goldilocks zone with Q2FY19 volumes growing 24% YoY. Growth for the CV segment has been on the back of various factors like Infrastructure, construction and improving the logistics network.   

In coming months, we believe PV sales to remain subdued on account of high base effect and no major launches. Secondly, 2Ws are expected to grow radically owing to normal monsoons in most parts of India giving the further push to rural demand. Lastly, unclear axle norms and truckers strike will act as a headwind for CVs which should result into muted growth in the coming month. 

Most of the auto stocks over the past month has corrected significantly and is off their peak valuations. We believe Maruti Suzuki India (MSIL) is a sweet spot when it comes to valuation. Back to back successful launches, a healthy waiting period for Baleno and Brezza, and unabated market leadership makes it a value buy for long-term investors. However, the decrease in margins on account of higher discounts and failure to pass the increase in commodity prices remains a concern for the company’s financials. We expect a steady quarter for MSIL with the margin being a key point of trigger.

Amongst 2Ws, Bajaj Auto is our preferred pick in space. Rupee depreciation, improving exports, improving volumes in domestic dispatches followed by robust three-wheeler sales is likely to drive record revenue. However, the company’s shift in policy of entering the entry-level segment will be margin dilutive and an important parameter for investors to watch out.

CVs have been a clear out-performer this year and Ashok Leyland has been on a dream journey thanks to its improving network supported by improving macros for CV players.  

In order of preference in automobile space, CV remains on top followed by 2Ws and PV.

(Ankit Merchant is research analyst - institutional equities at SMC Global Securities)