Component firms in for a smooth ride on improving auto sales
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Auto component firms are cranking up to meet the rising demand from the sector’s original equipment manufacturers (OEMs). Fiscal year 2018 (FY18) prospects look more promising, what with passenger vehicle (PV) and two-wheeler sales set to gain momentum.
After a blip for a couple of months on account of the cash crunch created by the note ban, domestic auto sales are firmly back on track. The Society of Indian Automobiles data until February shows an increase of around 5.3% in total auto sales for FY17, led by a 7.3% jump in domestic numbers. This is good news for component makers as even at a time when the auto industry clocked a subdued 2.6% growth in annual sales during FY16, component makers’ revenue grew by about 8.6%.
More importantly, PVs, which account for 45% of their revenue, are on a roll. Multiple forces like lower interest rates, higher salaries driven by the 7th pay commission and a slew of new models to drive customer interest are likely to drive PV sales higher by 10-12% during FY18 when compared to the previous year. Even two-wheelers, which are the second largest contributors and accounting for about 22% of the auto component revenues, are likely to clock robust sales.
If this is so on domestic ground, Indian component exports too are likely to improve as the global economy is slowly but surely moving out of recession. A recent report by CARE Ratings says that region-wise, Europe is the largest destination with a share of 36% in India’s component exports. This is followed by North America and Asia, which account for almost 25% each. While PV registrations are looking up in Europe, North America’s auto industry is seeing a revival in truck sales too.
That said, raw material costs for component firms have risen sharply on the back of rising commodity prices during the last 12 months. However, a report by Crisil Ltd says that this will not stunt profitability, as the organized sector with its strong relationship with OEMs would be able to pass on cost increases to the customers. Besides, growth in volumes should also offset cost pressures through economies of scale. Data from Capitaline on 83 listed auto component firms shows that average revenue growth has gained traction in the last three quarters. The average operating margin has remained stable between 12% and 13.5% in the last 10-12 quarters. Investors should note that firms, which are higher up in the value chain of component supplies like engine parts and transmission systems, would boast higher profitability.
Benefits from higher volumes and operating efficiency should trickle down to robust net profit growth in the forthcoming quarters. Investors must, however, be cautious about firms with a higher exposure to trucks mainly in the domestic market, which are likely to post lower revenue growth, as sales may moderate in the near term. The fate of tractors too is linked to the monsoon.
On the whole, there is optimism on the Street towards this sector. The recent rally in some component firms’ stock prices mirror the same, but still leaves headroom for higher valuation as earnings are likely to expand for a few quarters.