Why auto stocks may be the best bet for next 2-3 years

• All the segments recorded growth in FY10 and FY11 due to government measures announced to aid recovery from the global financial crisis of 2008.

• During FY12-14, high interest rates and high fuel prices coupled with inflation dampened the business sentiments resulting in a slowdown.

• FY15-18 saw improvement in customer sentiments due to appointment of a stable government. The Government placed a lot of emphasis on manufacturing and introduced favorable policy decisions along with focus on ease of doing business, fiscal stability and managing inflation.

• In FY19, PV sales were impacted due to regulatory changes, hike in interest rate and high fuel prices. FY20 saw an economic slowdown globally as well as in India due to protectionist measures introduced by various countries. FY21 was a Covid impacted year.

(Source: Annual reports, Equitree Capital)

For making outsized returns, the best time to invest is when a sector is running out of favour and valuations are low. Currently auto sector is contributing just about 5% of the total market cap, which is in line with its long-term averages. However, we have seen in the past that as the economic growth comes about, the sector has a tendency to go up to 9% of the total market cap.

ET CONTRIBUTORS

India’s GDP growth is likely to grow by more than 7% in order to reach the ambitious target of becoming a $5 trillion economy set by the Government of India. This implies that the auto industry should also lead to a cumulative contribution of 9% of the total market cap thereby creating substantial value over 2 to 3-year period.

Demand picking pace
India’s leading 4-wheeler company, Maruti Suzuki said that they are seeing strong demand in terms of enquiries and bookings, but due to supply-side issues, a lot of bookings have turned pending. The only challenge that remains is the supply of semiconductors and commodity inflation. Looking at the waiting period for many models it is visible that the demand for cars is not a challenge. Some models like Mahindra XUV700 have a waiting period of 88 – 90 weeks while Mahindra Thar has a waiting period of 43 – 44 weeks. Also, Tata Motors Nexon EV has a waiting period of 12 – 16 weeks while Tata Punch has a waiting period of 12 weeks.

Demand for commercial vehicles is expected to pick up as the projects pick up pace. Government’s continued focus on infrastructure spending is leading to a surge in demand for commercial vehicles. The demand will be further boosted by replacement demand as fleet owners would now be looking to replace their ageing trucks. It is important to note that the rural demand has not picked up yet and will be a key monitorable factor for the overall recovery.

Export opportunity contributing to growth
Major passenger vehicles and 2-wheeler companies have seen their exports surge mainly on account of demand from Latin America, Africa, and South-East Asia. In addition to the above, global players are looking at India for sourcing parts and components as part of their China+1 strategy. We are already seeing prominent companies like Case New Holland Industrial, the world’s fourth largest tractor maker, looking to triple sourcing of parts and components from India in value terms over $300 million in the next three years.

Current disruption giving an opportunity to invest from a long-term perspective
Due to the supply side constraints from availability of semiconductor chips to price hikes in key raw materials, auto industry might continue to remain under pressure for a few quarters, but these quarters might also lend an opportunity to investors with a longer-term horizon.

Bottom-up investors always look for companies that have managed to not only keep their head above water during downturn but have delivered supernormal growth. Companies like these, which manage to outperform during a downside, end up firing on all cylinders once the cycle picks up.

Specifically, investors should look for companies which have diversified product offerings and cater to various sub segments of the industry along with a focus on export and replacement market.

(Pawan Bharaddia, is Co-founder, Equitree Capital)
(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of Economic Times)