Automobile firms, apart from Tata Motors Ltd, sprung a pleasant surprise in their December quarter financial results.
Operating margins topped forecasts and also inched up from the year-ago levels in some cases, in spite of subdued sales.
However, the tide seems to be reversing now.
Key input prices have steadily risen from their lows. Compared with a year ago, steel and rubber prices have almost doubled, while copper and aluminium are up 18-25%. This is certain to weigh on the operating margins in the March quarter. In fact, a margin correction was expected in the December quarter.
But it didn’t happen because most auto companies had a high inventory of finished goods that skewed raw material costs as a percentage to sales.
Finished goods stocks were high because demonetisation played spoilsport on vehicle sales, especially in the rural markets. Auto firms also have to comply with new emission norms that will add to costs, too.
For instance, brokerages have forecast a Rs600-1,000 per unit cost increase for two-wheelers on this count. It would be much higher for commercial vehicles. Therefore, the prospects for the next few quarters would hinge on the ability of auto companies to pass on the cost pressures to customers.
Through the December quarter, there were no price hikes as sales were punctured.
But many auto companies such as Maruti Suzuki India Ltd, Hero MotoCorp Ltd, Bajaj Auto Ltd and TVS Motor Co. Ltd reportedly raised prices in January. However, a report by Religare Capital Markets Ltd highlights that the price hikes may only partially offset cost pressures that would impact margins in the near term.
Meanwhile, sales may move up as the pent-up demand of the December quarter kicks in. Another trigger could come from pre-buying by customers (especially in commercial vehicles) because vehicles may be costlier after April, when the new emission norms apply.
Higher sales may then translate into operating leverage benefits such as margin improvement. This may take some time though.
For now, the stocks in the auto universe trade at optimum valuations—ranging between 18-23 times estimated earnings for the fiscal year ahead. The key things to watch out for in the next few months are sales growth and price hikes in vehicles.