Demand looking up for autos; these stocks likely to gain the most

The auto sector has been passing through one of its worst phases brought on by a sustained decline in sales, shift in technology and regulatory norms and prolonged weakness in India's financial space.

Investors have been offloading their bets in auto stocks, causing most of them to suffer deep losses.

In November, the domestic passenger vehicle (PV) sales shrunk by about 9 percent YoY. Domestic commercial vehicle sales were down nearly 18 percent while those of two-wheelers (2Ws) declined by about 14 percent YoY.

However, overall three-wheeler (3W) segment sales grew by nearly 7 percent YoY, primarily led by improvement in export markets.

Though the sales numbers are still subdued, brokerages and industry experts are of the view that the auto sector is gearing up for an upward journey.

"Ongoing marriage season, higher discount to across diesel models and new launches may lead to the revival in auto sales in the coming months, especially within PV and 2W segments. The majority of automakers are anticipating pre-buying ahead of BS-VI implementation. Additionally, higher reservoir levels, adequate soil moisture condition and an improved MSP of rabi crop are expected to augur well for 2W demand in the next few months," Canara Bank Securities said in a report.

"Trends in the demand environment for two-wheelers and passenger vehicles are encouraging, particularly in the run-up to BS-VI transition. This was critical for justifying the outperformance of the auto sector," Motilal Oswal Financial Services said in a recent report.

"For the next 12-18 months, our preference remains for PVs over CVs and 2Ws as the segment is likely to be least impacted by BS-VI transition and face less risk of EVs and competition, in turn reflecting better earnings growth."

While the sector is expected to gain strength in the coming months, some auto stocks may give good returns in the next one year. Let's take a look at them:

The analyst expects lower deterioration for medium and heavy commercial vehicle (M&HCV) segment, though YoY decline will continue till mid-FY21E.

"We believe the industry would observe its down-cycle over FY20-H1FY21 and would strongly rebound in 2HFY21-FY22E. Therefore, it is more sensible to consider FY22 for the CV industry to judge the right scenario and fair valuation," the analyst says.

Shah says the likely up-cycle in FY22E will bring back high earning growth and valuation expansion, which will transform into a strong potential upside from the current level. "Pent-up demand of previous 1.5-2 years would be the single biggest catalyst for the strong revival by mid-FY21E," he says.

Excess rainfall is expected to help the rabi crop and its positive effect will benefit the rural economy for the next 1-1.5 years. Any demand recovery in the rural market will benefit the company.

Moreover, it has many launches lined up for FY21 after the BS-VI transition. The company’s regular price hike will help it on the margins front to some extent.

"We believe that BS-VI implementation would remain a challenge for the industry over the near-term, while we expect a revival in the rural volume by mid-FY21. We expect Hero MotoCorp’s BS6 products at most competitive pricing levels, which would help it on volumes front in FY21E," Shah says.

Tata Motors’ management attributed the steady improvement in JLR’s volume to better traction in all major markets, particularly in China. However, it raised concern over Brexit uncertainty. It outlined several measures to improve financials, increase profitability, reduction in capex, lower working capital, cash flow improvement, debt reduction and cost-cutting for JLR as well as India business.

The management is confident of maintaining a double-digit margin at JLR, with better volume and lower commodity cost. It expects RM cost to go down further in H2FY20, as lower commodity prices-related negotiations with the vendors are underway. Its target is to record a similar operating margin at JLR.

"We believe that the initiatives towards cost-saving and cash flow improvement would help Tata Motors, albeit gradually, which would keep its net automotive debt under control," says the analyst.

"In view of better traction at JLR, China revival, better margins ahead and control on debt and capex, we consider stock at an attractive valuation at the current level and reiterate our buy recommendation on Tata Motors, with a SOTP-based target price of Rs 205 valuing the standalone business at Rs 119, JLR at Rs 264 and other subsidiaries at Rs 36, based on FY22E EBITDA, post excluding net debt of Rs 214 per share."

After a significant decline in volume over the last 10 months, the domestic tractor industry started witnessing moderation at the start of the festival season, which is expected to continue.

Based on changing dynamics of the industry and fundamental favourable triggers like strong monsoons, likely subsidies in 2HFY20 and increasing non-agri usage, the tractor industry is expected to recover in FY21 as against our earlier estimate of downcycling in FY21. Moreover, likely pick-up in construction activity, higher water levels at reservoirs and low YoY base are the key positive factors.

Improving cost structure in construction equipment and better traction in the high margin railway segment with its high order book would further expand its margins.

"We reiterate our buy recommendation on Escorts with a target price of Rs 925, valuing it at 13.5 times FY21E EPS," said the analyst.

RK Forging derives more than 85 percent of its revenue from the automotive segment (including exports). Its management cited strong momentum in export business on the back of new products, new clients and new markets.

The company’s focus on exports will help it record growth despite an expected downturn in truck sales in CY20. The management expects export contribution from Europe to increase to 30 percent from the current 10 percent.

Domestic M&HCV industry is going through a bottoming-out phase of the downcycle and will remain sluggish till Q1FY21. However, a strong recovery is expected by mid-FY21E and Q4FY20 may be better due to pre-buying ahead of BS-VI implementation.

"We expect its EBIDTA margin to improve by 270bps from current level to 20.8 percent in FY21E, due to better operating leverage and higher contribution of exports business," says Shah.

"In view of industry bottoming out soon and attractive valuation at 9.8 times FY22E, we reiterate our buy rating on RK Forging with a target price of Rs 355, valuing the stock at 12 times FY22E EPS."