Home >Market >Mark-to-market >Keeping excise duty unchanged in Union Budget will cheer auto stocks

The BSE Auto Index has outperformed the broader market on the hope that there will be a gradual improvement in demand after an excise duty cut was announced in the interim budget in February. From 1 February until end of March the index rose 15% on expectations that the four percentage point cut in excise on automobiles would improve sales. During that time, the benchmark Sensex moved up by only 9%.

What does the street expect for the sector in the budget? Simply put, no change in excise duty. The hope is that if the basic excise duty remains at 8%, demand may improve in the festive season between September and December. Any rollback from the current 8% will be a dampener. Leading auto stocks could then react adversely.

The picture, however, is far from rosy as discounts continue to be doled out by most automakers, barring for two-wheelers, keeping margins low. Also, competition is rising across auto segments, which will hinder automakers’ ability to increase price in a sluggish economy. Besides, price increase arising from higher excise duties will turn investors away.

That said, auto companies have been trimming costs in the last few quarters. March-quarter operating margins improved from the year-ago period but were driven by export earnings. The rupee’s depreciation helped profitability.

If excise duties are unchanged, auto stocks may be euphoric for some time. But, this must be backed by robust sales growth, which will boost earnings growth and help sustain interest in auto stocks on the street.

At current market prices, shares of Maruti Suzuki India Ltd and Hero MotoCorp Ltd trade at 16 times 2014-15 earnings. This is a fair valuation, a tad higher than a 10-year historical average. Valuations will expand if unchanged excise duties propel customer purchases in the coming months. Analysts expect a sales growth of 8-10% for passenger cars and a higher 10-12% for two-wheelers in the current fiscal year.

“In a market where demand is recovering, stock valuation on market leaders will expand," said Surjit Arora, analyst, Prabhudas Lilladher Pvt. Ltd.

Meanwhile, commercial vehicle leader Tata Motors Ltd will not be impacted by the national budget in the near term given that the domestic entity has been clocking losses for the past few quarters. Even during the best period, domestic sales accounted for only a tenth of the consolidated net profit. Ashok Leyland Ltd, however, is better placed as its performance has improved in the past two quarters. On the whole, commercial vehicle sales are more sensitive to truck rentals and diesel price changes.

Apart from the direct excise duty measures, the budget may offer some indirect sops such as reduced import duties on components, steel or other commodities. Further, any change in direct taxes that fuel discretionary spending or a thrust on infrastructure augurs well for the auto sector.

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