Edelweiss analysis on auto stocks for the past 20 years’ demand cycle indicates that the sector is currently in the middle of a down cycle. High Goods and Services Tax (GST), low demand and various other macro concerns have dragged the auto sector to 5-year lows.
The Edelweiss report further points out that the current slowdown is different from earlier ones on four counts i.e. domestic factors, sharp regulatory cost pressure, stiff competition from pre-owned vehicle market and significant margin pressure.
The brokerage further said, "We are mid-way in the slowdown for 2W (two-wheelers) and PV (Passenger vehicles) with Q1FY20 being the first quarter of sharp sales dip. At the current juncture, we believe, volume recovery is unlikely to be as sharp as in the past, unless there is strong stimulus support. We do not expect any major pre-buying and hence do not expect significant sales dip in FY21."
Therefore, the winning formula behind the auto sector is to prefer stocks with the ability to capture market share, strong product cycle and power to pass on the cost pressure or a diversified revenue stream.
The report by Edelweiss said, "Empirical data indicates that market share gain is the key stock outperformance driver. Players with higher exports are better placed to absorb cost pressures compared to domestic players. In the current scenario, a strong product cycle will enable players to address the above two points.”
The report further added, “Given the sharper-than-expected slowdown, we revise down FY20E and FY21E EPS of companies under coverage in the 2-18 percent range. We do acknowledge that given the tepid demand and BSVI implementation, near-term volume outlook remains hazy with the risk of further earnings cut.”
The brokerage narrowed down the auto sector to ‘Top Picks’ which is Ashok Leyland and Eicher Motors. In case of Ashok Leyland, the report said that structural changes over the past three-four years like the implementation of GST and ban on overloading, the advent of 3PL players and new-age logistics companies, shortage of drivers, etc., have rendered a large chunk of older trucks unviable.”
We expect Ashok to report strong free cash flow (FCF) in FY21 at 9 percent of sales, the report added.
On Eicher Motors’ front, the brokerage said, "Royal Enfield’s product cycle will enter a new orbit post-transition to BSVI norms. Expect existing models to transition to the new platform along with BSVI, significantly improving their performance, which has largely remained unchanged over the decade. We expect the 650 twins to retail 100K units in FY21, thereby boosting average realisation as well as EBITDA per vehicle."
First Published: IST