Auto companies facing multiple headwinds

Auto companies facing multiple headwinds

After a strong run in the past two years, share prices of automobile companies are taking a breather. In the past month, BSE’s auto index has underperformed the BSE 100 index by about 6%. In the two years prior to that, the auto index had outperformed the broader market index by over 100%.

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But this doesn’t merely seem to be a case of profit taking. After strong growth in the past two years, the momentum is expected to slow in 2011. This is because the industry is facing multiple headwinds, such as an increase in interest rates, higher fuel prices and an increase in vehicle prices to mitigate higher raw material costs. The rise in the overall cost of owning a vehicle, coupled with a high base effect, will hit growth. Already brokerages such as CLSA and Kotak have released reports estimating lower growth for two-wheeler companies.

Of course, none of these will be reflected in the results of auto companies for the quarter ended December 2010. Revenue growth is expected to be strong across categories, on the back of healthy volume growth. According to an earnings preview report by Motilal Oswal Securities Ltd, “Two-wheeler sales are expected to have grown by 25.7% year-on-year, cars 20%, commercial vehicles 21.1% and UVs (utility vehicles) 27%. Volume growth was supported by improvement in economic activity, easy availability of credit and new product launches."

However, raw material costs are estimated to rise by about 300 basis points (bps) as a percentage of sales for the sector owing to a rise in prices of most commodities.

One basis point is one-hundredth of a percentage point.

Motilal Oswal’s auto analysts estimate that on an aggregate basis, the profit margin of Bajaj Auto Ltd, Hero Honda Ltd, MarutiSuzuki India Ltd, Mahindra and Mahindra Ltd and Tata Motors Ltd (standalone) will likely decline by 300 bps on a year-on-year basis. If one were to consider the performance of Tata Motors’ Jaguar Land Rover unit, sector-wide margins may be constant because of a low base effect in the previous year.

Analysts and investors would be watching out for the impact on profit margins in the December quarter, and a higher-than-expected decline may lead to a further correction in auto shares.

Graphic by Ahmed Raza Khan/Mint