Auto: operating margins hold out in spite of odds
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Given the rally in commodity prices and the tepid sales growth across auto companies, auto manufacturers put up a decent operating performance for the June quarter.
On an average, the gross margin, after accounting for only raw material costs, declined. However, most firms contained staff costs and other expenses to sustain operating profitability at year-ago levels. Within the listed universe, Hero MotoCorp Ltd, the largest motorcycle manufacturer in the world, posted the highest operating margin in six years. Bajaj Auto Ltd, too, which makes two- and three-wheelers, excelled on profitability in spite of lower exports.
Disappointment came from the most unexpected quarters. Maruti Suzuki India Ltd, the country’s No. 1 carmaker, had a production setback due to a fire at a vendor’s plants. Lower sales, adverse currency movement and higher commodity prices together culminated in a contraction in operating margin.
Likewise, Tata Motors Ltd, contrary to its usual outperformance in the pack, hugely disappointed the Street, as a negative foreign exchange impact and lower sales incentives for its subsidiary Jaguar Land Rover Plc, along with tepid performance by commercial vehicles and cars in the domestic market, dragged consolidated profit down to about one-third the year-ago period.
However, investors are hopeful that these currency adversities won’t recur. Two-wheelers are likely to gain from rural offtake after a favourable monsoon and from urban demand—an offshoot of higher disposable income with consumers after the 7th pay commission’s award of salary and pension hikes to government employees and retirees.
The resulting sales boost will improve pricing power, enabling auto makers to pass on cost increases. Discounts, too, are likely to be lower than in the past few quarters.
These factors will, at least partially, offset the margin pressure on account of rising costs. Only premium product manufacturers such as Royal Enfield, from the Eicher Motors Ltd stable, would buck margin pressure, as the motorcycles are hardly price-sensitive.
Meanwhile, within auto firms, two-wheelers and utility vehicles manufacturers may post better margin traction, going by the July and August sales trend. The one segment that may drag earnings momentum in the sector is medium and heavy vehicles. Here, growth is slowing, given the high year-ago base and also since industrial activity has not picked up to the estimated levels.
That said, the Street is quick to discount positives in the auto sector. All the auto stocks have returned 25-60% from April till date and trade at near-peak valuation on estimated one-year forward earnings.
Investors should watch out for sales growth in the festive season and its sustainability thereafter, which is the key to the next round of upward earnings revision.