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The auto sector is accelerating ahead due to a decent festive season show in Q3. Volumes were steady in Q3 across segments. However, passenger vehicle (PV) and tractor sales stood out while rural growth remained healthy. That should see the auto sector post revenue growth in the mid-teens.

In fact, the third quarter will also be driven by the low base of last year. The BS-VI transition led to a marginal de-growth in auto sales. Higher auto volumes will lead to better operating leverage and profitability in Q3.

This will help the sector post sizeable growth in profits. “We expect aggregate recurring net profit for our covered original equipment manufacturers to rise 18% year-on-year (y-o-y) in Q3—first y-o-y growth after two years of decline," said analysts at Jefferies India Pvt. Ltd in a client note.

Registrations for two-wheelers, passenger vehicles and tractors showed an improving trend in December 2020
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Registrations for two-wheelers, passenger vehicles and tractors showed an improving trend in December 2020

Notably, most segments are firing well except commercial vehicles, where sales volumes have been lacklustre. However, demand for commercial vehicles has been improving lately, and is expected to track the economic recovery, going forward.

PV sales are on the fast lane as the need for personal mobility remains high. This should benefit the likes of Maruti Suzuki India Ltd. While two-wheeler volumes tapered marginally, revenue and operating margin trend is likely to remain upbeat on improved operating leverage. Tractor volumes have remained decent, too, which should reflect in the Q3 numbers of tractor companies.

“The automobile sector remains a key beneficiary of economic recovery and low interest rates," said analysts at Emkay Global Financial Services Ltd in a note.

That said, the sector faces headwinds in the form of higher input costs due to the sharp increase in steel prices. This could impede margin expansion despite higher operating leverage.

“The sharp rise in commodity costs in H2CY20 will start affecting auto sector’s gross margins in Q3, although the full impact is likely to come through in H1CY21," said analysts at Jefferies India.

Part of the rising costs could be mitigated. Auto companies have been cutting back costs through reduced marketing spends. Discounts were also lower during the year-end, unlike in earlier years. Companies also cut back on travelling and other expenses, added analysts.

However, note that auto stocks have been a step ahead due to the market’s rise and seem to be pricing the revival quite well.

“Valuation multiples for auto companies are now trading at +1 standard deviation above mean as the Nifty Auto index is up another 16% in the December quarter. We believe returns from here on will be more stock specific," said analysts at HDFC Securities Ltd in a client note. Standard deviation expresses the difference from the mean value.

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