Why festive sales alone won't be enough to lift auto stocks

Indeed, original equipment manufacturers (OEMs) reported lower-than-expected Ebitda margins in the June quarter (Q1FY22). Much of the hit has been due to rising covid-19 costs, salary revisions and higher input costs. Ebitda is earnings before interest, taxes, depreciation and amortization.

OEMs had to provide for covid-19 related staff expenses, including vaccination costs and higher insurance premiums. Analysts point out that much of this will persist in the coming quarters as well. Further, volume growth has been slow due to regional lockdowns.

Even as many OEMs raised average selling prices by about 1-3% during Q1, these have not been sufficient to absorb the higher costs. Besides, there may not be much room to raise prices further as it could hit sales recovery in the coming quarters, note analysts.

In addition, raw material costs have inched up by 3-4% on average, resulting in a sharp under-recovery for auto companies.

“Except for Eicher Motors and Ashok Leyland, all companies reported an under-recovery of commodity price increases and saw a gross margin de-growth of 40-200 basis points sequentially in Q1FY22," said analysts at Centrum Broking in a client note. One basis point is one-hundredth of a percentage point.

The industry is also going through a shortage in chip supply, which could hamper vehicle production. In fact, in the past few months, global chip shortages have intensified as rising covid-19 infections have hit production regions in Southeast Asia.

“The chip shortage is acute due to the covid-19 disruptions in countries such as Malaysia, Taiwan and Vietnam. It’s a big dampener as production ramp-ups for the coming festival season could be muted," said Abhishek Jain, auto analyst, Dolat Capital Market.

No doubt, domestic volume growth could see some perk-up on account of festive sales. The monsoon season is ending on a positive note, which should be good for the kharif crop, elevating rural incomes. Some urban demand due to the need for personal mobility will be seen.

However, since much of the covid-19 related pent-up demand has been exhausted, a sharp acceleration in volumes may not happen, note analysts.

Further, steel prices are still high. As a result, input costs will remain elevated. If volume growth remains tepid or if companies resort to high discounts to prop up festive sales, a squeeze in operating leverage can be ruled out.

“Operating margin challenges will persist as raw material prices have not softened materially yet," said Ashutosh Tiwari, head of research, Equirus Securities.

While some companies that have an export market should be able to weather the conditions, many others don’t have that luxury. Analysts have already cut back on earnings growth expectations for the full year after several companies disappointed in earnings growth.

Further, the valuations of most companies are still quite stiff and do not quite factor in the impact of any sluggish offtake. As such, the second half may leave some room for disappointment if margins don’t revive.