Graphic: Mint
Graphic: Mint

Automobile sector shares trip on rising risks to earnings growth

Rising prices of rubber and metals such as steel, aluminium and copper; higher interest rates and galloping crude oil prices; along with a depreciating rupee, pose risks to earnings growth

Automobile sales are racing ahead but share prices are struggling to keep pace. Since January, the BSE Auto index has underperformed the benchmark Sensex. Perhaps the Street perceives strong headwinds being faced by auto companies as potential growth spoilers. Despite double-digit sales growth, while the Sensex rose 10%, the Auto index fell 12% since January.

After about 12 quarters of impressive sales growth and margin expansion, the challenges are mounting. Rising prices of rubber and metals such as steel, aluminium and copper; higher interest rates and galloping crude oil prices; along with a depreciating rupee, pose risks to earnings growth.

But the moot point is whether rising interest rates and high fuel prices will puncture sales growth in the near term.

Analysts are still hoping that strong demand will hold out, given that the forthcoming festive season is good for retail segments such as cars and two-wheelers. Rural incomes are pegged to improve due to the relatively normal monsoon and higher support prices for agricultural products.

The commercial vehicle segment is holding out hopes of growth. According to Girish Wagh, president (commercial vehicle business unit) at Tata Motors Ltd, “Strong economic fundamentals are driven primarily by infrastructure growth. Therefore, we see momentum continuing in key sectors like cement and mining. Good monsoons are also likely to supplement the growth after the harvesting season in October."

So far, the rise in truck rentals has outpaced surging diesel price, a sign of strong freight demand.

Analysts too echo this optimism and have pencilled an annual sales growth of 10-15% between FY18-20 across various sub-segments.

However, cut to profitability and there is some concern. High sales can only partially mitigate the impact of high commodity prices that weigh on profitability. After all, raw material costs account for nearly 60-70% of sales in auto firms. Further, the tumbling rupee will add to margin pressures for firms which import raw materials.

A report by IIFL Ltd says, “While most OEs have limited exposure to imports of raw materials, the domestic price of most commodities is closely linked to international prices and hence suffer the impact of currency depreciation. Further, customer acquisition in the wake of intense competition in the OE sector is exerting additional margin pressure." OE stands for original equipment, a term used to describe auto companies here.

Some companies such as Maruti Suzuki India Ltd have direct and indirect exposure to currency fluctuations because it imports parts from and pays royalty to Suzuki Motor Co. in yen.

While these pressures on costs will play out in the coming quarters, steadily rising demand across segments will also bring operating leverage benefits. Companies have also hiked prices, which will soften the blow of rising costs. But they agree that rising lending rates, higher input costs and rupee pressures are inflationary and can slow the pace of growth in consumer and retail sectors, even if with a lag.

The Street is factoring these risks in how it values these stocks, which is why the BSE Auto index is underperforming the broad market. Auto stocks may be range-bound unless their earnings growth turns out better than expected.

Close