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Investment Guide: Is the demand revival in auto sector sustainable? Experts discuss

Updated : September 23, 2020 11:06 PM IST

The auto sector has seen a demand pick-up recently, but it remains to be seen whether it is because of pent-up demand post the lockdown, or is it a sustainable recovery.

To track the auto sector, one needs to understand the company's basic strengths - what are key products they sell - whether cars, two wheelers or tractors? Is there any USP of the company? The four important things to track is product, technology, scale, distribution. For example the unique selling proposition of Maruti is value for money offering and strong distribution.

For the commercial vehicles (CV) segment, one needs to track e-way bill data and truck freight rates. Truck freight rate is to understand truck operator profitability and utilization rates. Truck freight rates are tracked on Indian Foundation of Transport Research and Training or IFTRT website.

For understanding rural demand, one needs to track government investment in rural India, crop prices, monsoons to try and get a understanding of both agri and non-agri income in rural India.

So what are the key numbers to monitor in the auto sector? The first thing to track is wholesale and retail sales. In simple terms , wholesale sales is the number of units auto companies sell to dealers and this parameter is used to calculate the revenues of the auto company. This data is provided every month by companies. Retail sales is simply the number of units dealers sell to a customer. Retail sales helps understand consumer sentiment and demand trends.

Another important parameter is current dealer inventory to help track future demand scenario. The comfortable level for companies to keep inventory is 30-45 days.

If you want to understand the pricing power of a company, you have to calculate the net realisations, net realisations in simple terms is total sales divided by total volumes. Net realisations in simple terms is the average selling price of a product in a company. Net realisations indicate how pricing power and product mix is moving for the company.

Finally valuations, what is the most important ratio to track? The most used valuation metric in market is price to earnings ratio. P/E ratio varies in a band depending on the auto demand cycle. The idea for investors is to catch the stock when demand is depressed and valuations are at rock bottom. 2 wheelers trade at average PE ratio of 15-18x for Hero and Bajaj, TVS trades at 20-22x and Eicher at 25x. Maruti trades at 25x one year forward PE, tier 1 auto ancillaries trade at 18-20x one year forward PE. So to discuss the trends and potential in the auto sector, Anuj Singhal and Sonia Shenoy spoke to Rajesh Kothari MD of AlfAccurate Advisors and Hitesh Goel Assoc Director of Kotak Institutional Equities.

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