FADA data also shows that inventory with dealers is rising
Two-wheeler inventory has increased to 55-60 days in May from 45-50 days in April
Sales of automobiles have been falling for sometime now, prompting manufacturers to cut production to align supply with retail demand and existing inventory with dealers.
Latest data shows that production cuts will continue as retail demand continues to falter. According to a report by the Federation of Automobile Dealers’ Associations (FADA), retail auto sales in May that fell 7.5% from a year ago show that the overall consumer sentiment is poor.
This worsens the prevailing gloom in the sector. After the high single-digit growth in January, auto sales growth has has declined every month. Crisil Research pegs FY20 growth at merely 3% for passenger vehicles (PVs) and two-wheelers and 6-8% for commercial vehicles (CVs). Along with this is the continuing earnings cut by brokerages, typical of a cyclical slowdown. The chart shows that the market has trimmed FY21 earnings per share estimates for Nifty auto index companies almost every month since April 2018, adding to a cumulative cut of 32% in FY21 earnings estimates.
Reliance Securities Ltd analyst Mitul Shah said in a report, “Going forward, we expect slowdown to continue as rural demand is not picking up due to liquidity crisis in non-banking finance companies and the rural market impact from monsoon deficit last year."
The writing on the wall is clear. Auto sales and company profits will be under pressure even after FY20. True, there is a ray of hope that advance buying by customers, who wish to avoid paying more for costlier BS VI-compliant vehicles beginning 1 April 2020, will push up sales in the third quarter of FY20. But demand is unlikely to come back in a jiffy.
The liquidity crisis holding back non-bank lenders from giving loans won’t ease quickly. Then, there is weakness among small and medium enterprises (SMEs) struggling with low capacity utilization and working capital constraints. Analysts reckon the stress in SMEs impacts sales of PVs and two-wheelers.
“Even after inventory destocking, existing inventory continues to remain at a higher-than-normal level for most players," Shah said in the Reliance Securities note.
FADA data also shows that inventory with dealers is rising. Two-wheeler inventory has increased to 55-60 days in May from 45-50 days in April. Even PV and CV inventory are high at 35-40 and 45-50 days, respectively. This is far above the normal 21 days that FADA has recommended.
Ergo, in the absence of demand revival, production cuts to the tune of 17-18% are likely in the June quarter and may continue thereafter, too. After all, auto firms would not want a repeat of last year when lack of demand revival during the festive season led to a huge inventory pileup.
On the CV front, there has been little cheer from macroeconomic indicators, be it the Index of Industrial Production, Purchasing Managers’ Index or capex across core sectors. Even with the help of a fiscal stimulus, sales would only improve with a lag effect as seen in earlier cycles.
That said, the silver lining is that the cost of ownership, which rose with higher interest rates and fuel prices through FY19, is now more stable.
From an investor’s standpoint, valuations of auto stocks have corrected. The Nifty auto index has plunged 28% in a year, registering the second-biggest sectoral index fall after media, even as the Nifty rose about 9%.
According to Jigar Shah, an analyst at Maybank Kim Eng: “Auto stocks trade at reasonable valuations now. Demand should be supported by normal monsoon, interest rate cut, GST rate cuts and any budgetary stimulus."
Be that as it may, industry and analysts are pinning hopes on advance buying as the cost of vehicles would increase by 10-15% once BS VI norms kick in. However, counting on that would be a gamble because in the absence of clear signs of economic revival, customers may defer purchase. That’s a risk to even the low single-digit growth pegged for FY20.