Will Auto Stocks Outperform In 2019?

Auto stocks have long been investors' favourites. Indeed, some of the quality stocks in the auto sector have created huge amount of wealth for investors. But the moot question now is: Will the auto stocks outperform in 2019? Yogesh Supekar, along with the DSIJ research team, take a look at how auto stocks have performed historically to ascertain whether auto stocks will outperform key benchmark indices in 2019.

Auto stocks have long been a part of the diversified portfolios of majority of investors. After all, auto industry accounts for almost 7 per cent of India’s GDP and contributes to nearly 22 per cent of the country’s manufacturing GDP. Apart from being the world’s sixth largest car market in the world, Indian car market is all set to be among the fastest growing car markets in the world. 

The dynamism in the auto industry, customer-centric approach of auto manufacturers and demanding customers have ensured that the Indian car market is buzzing with new innovative and competitive products. Looking at the size of the Indian car market, more and more car makers are striving to optimise their product portfolio mix that will maximise their company’s revenue. While the car makers fight it out in the markets for improving their market shares, equity investors have created wealth by opting to take exposure in some of the auto stocks over the long term. 

If any long-term investor had invested Rs.1,00,000 in TVS Motors 5 years ago, i.e on February 1, 2014, his money would have grown to a whopping Rs.6,28,517 (by January 25, 2019). Here’s a look at how much Rs.1,00,000 would have grown in five years:-

Trading close to their respective 52-week Lows 

The fact that majority of the auto stocks are trading close to their respective 52-week lows indicates the stress in the industry. The competitive nature of the industry is leading to margin erosion for several of the auto makers and that is getting reflected in the stock prices. The table below highlights how the automakers stock prices are precariously trading close to their respective 52-week lows.

"There is no clear up trend emerging for electric vehicles because a) high cost of battery and overall price of an EV being 2.5x the internal combustion based vehicle; b) no explicit subsidy from the Government except lesser rate of GST; c) lack of charging infrastructure; and d) lack of ancillary industry developing electronics within India."        
                     -Maybank Kim Eng

Commercial Vehicle Segment:- 

Booming e-commerce and last mile delivery of grains and other food products has ensured that the demand for commercial vehicles remains intact. The commercial vehicles segment is historically cyclical in nature. In all probability, commercial vehicle segment is in an up-cycle. 

"According to the forecasts made at the SIAM conclave by CRISIL, Frost and Sullivan (F&S), the growth in commercial vehicles will be the highest due to the pre-buying ahead of BS-VI roll-out in FY21"

Auto Financing 

The recent meltdown in the NBFC sector has caused a temporary blip in financing the purchases of automobiles. However, going forward, the meltdown in NBFC sector is not expected to be a major issue impacting auto sales. The bigger NBFCs do have enough capital and distribution network to service the needs of the industry. Also, in view of the recent poor performance of the NBFC sector, the demand for finance is expected to shift to private banks from the small NBFCs. Some of the major auto finance companies such as Shriram Transport Finance, Mahindra Financial Services, Cholamandalam Finance, etc. may grow their market share. 

BS-VI emission norms 

As per the Supreme Court order, the BS-VI emission norms have to be implemented in three years in India and will be effective in all new vehicles on sale from April 1, 2020. It is expected that these emission norms would reduce the PM2 pollution by 68 per cent and Nox levels by 25 per cent. To meet the norms, a change in engine design would be required, which requires usage of complex electronics and use of diesel particulate filter (DPF), select catalytic reduction (SCR) technology, as well as exhaust gas recirculation (EGR). All these changes have to be implemented within three years by the automakers. An investment of approximately Rs.75 crore to Rs.110 crore is required for each platform by the automaker to shift from BS-IV to BS-VI, while it is estimated that, on an average, each automaker has 10 to 50 platforms. These investments can put a break on the growth rate for the automakers in three years from now. 

Large automakers such as Mahindra and Mahindra, Tata Motors and Ashok Leyland may have an edge when it comes to their readiness to shift to BS-VI. Also, Bajaj Auto stands out in its preparedness for BS-VI norms. 

"According to a SIAM forecast, the trucks business can grow by 12 - 14 per cent, while cars/2-W business is expected to grow by 8 - 10 per cent"

Mustafa Nadeem
CEO, Epic Research
  
What is the outlook for the auto sector?

We are bearish on auto stocks for quite some time and, if we look at the current state, we think what was an Injury may further bleed in the coming few months. When we look at commercial vehicle sales, these are down by almost 30% while the passenger vehicles and motorcycles sales and passenger cars in the last few quarters have dropped nearly 30 to 40% and the light commercial vehicles sales are down 25%. There is already a factor of cyclicality to this particular space and when we look at this space in an environment with rising interest rates, 50 bps in 2018 in India, and across the globe, the pressure on margin is likely to be the factor for these companies. This trend has continued from early 2018 and we believe it is going to worsen in 2019.

All this can be seen in a medium-term perspective of the last two years as these companies have enjoyed a low interest rate environment from 2013 to 2017. We are not seeing a bottoming out signal soon since the leaders, along with the overall sector, are in a tight bearish grip. And with volatility kicking in, we believe this can further put some pressure on this sector.

Will auto stocks outperform in 2019?

It is very unlikely that we may see out performance from a medium to short term perspective since the technical set-up is pointing otherwise. There is a reversal H&S pattern formation on Nifty auto space, and when we do the math, it is pointing to another double-digit cut in the space. Hence we are not seeing out performance from this space. There may be some short term bounces which may lure the biases of prices being too low, but it will take a lot of revival in breadth to call in an out performance from this space. In fact, today, when we see a stock like Maruti shedding almost 8% in a day, we can simply put it as the damage is further escalated. We are bearish in most of the blue-chips from this space.

Conclusion

With several auto stocks trading close to their respective 52-week lows, the time is ripe to buy the stocks of the large automakers in India. While the growth story remains intact for the sector, there are visible headwinds for the sector in the form of BS-VI implementation. It is estimated that BS-VI implementation will also increase the product prices by 8 to 10 per cent and one will have to wait and see how the BS-VI implementation will impact the sales. Indian consumers are price-conscious and only time will tell whether the customers would be willing to pay 10 per cent extra just for the new emission norms.

In the near term though, the expected improvement in demand may ensure that the next quarter earnings will show an uptick in earnings. The headwinds in the long run may limit the upside for the auto stocks. Interest rate will play a key role, as will liquidity for the auto car makers as it may impact auto sales this year.

Segment-wise, the outlook looks best for the heavy commercial vehicles, followed by passenger vehicles. Two-wheeler companies may see a flattish growth in CY19.

In a challenging growth environment, investors ought to construct a diversified portfolio which is not overweight on auto sectors. The auto sector exposure in the context of a diversified portfolio can be skewed towards leading players in heavy commercial vehicles such as Mahindra and Mahindra, Ashok Leyland and Tata Motors. Auto stocks may not outperform Sensex; however, the stocks from this sector may perform in line with major index such as Sensex.