Home > Markets > Mark To Market > Tax cut won’t solve the real issue facing auto sector: weak demand

The Nifty Auto index has rallied 13%, surpassing the benchmark Nifty’s 8% rise, since the corporate tax rate was cut on 20 September. The investor euphoria is not surprising, given the immediate benefits of a lower tax outgo and the resultant profit expansion for FY20. After all, in the listed universe, auto and auto component makers are among the highest tax paying firms.

However, investors would do well to realize that such fiscal measures are temporary props. The need of the hour is consumer optimism and demand growth.

In a sense, the government’s corporate tax largesse masked the disappointment on the goods and services tax (GST) front, as the expected rate cut on vehicles was not entertained by the GST Council. In its report, Jefferies India Pvt. Ltd said: “The government did not go ahead with a 10% GST cut, which would have reduced on-road prices by 7-8%. As a result, the issue of pile-up of channel inventory ahead of the BS-6 transition in April persists, particularly for two-wheelers and MHCVs (medium and heavy commercial vehicles)."

The Indian auto industry is passing through the worst slowdown seen in the past two decades. Domestic inventory piles range between 45-60 days across vehicle categories. Exports are contracting on the back of a global slowdown. While fair weather winds are blowing in certain segments, such as utility vehicles and two-wheelers, overall sales are expected to be weak in September, too.

For now, hopes of a demand recovery are pegged on the festive season.

The bigger worry, however, is whether any sales expansion during the festivals will sustain. Edelweiss Securities Ltd said: “The nature of stimulus is more indirect or supply-side in nature and does not immediately address key reasons for the slowdown (slowing income, savings, financing). The previous stimulus had been more direct on the demand side (excise duty cut, pay commission, etc)." In other words, weak purchasing power with consumers will thwart a sustained sales uptick in vehicles.

Kotak Institutional Equities Research had a rather conservative view. In a report, it stated that income levels were likely to increase by mid-single digits and customers will likely defer purchases to FY22.

Therefore, auto companies may be forced to forego any gains, be it by way of lower tax outgo or technology, and commodity costs to the consumer. This leaves little scope for an earnings revision in the near term.

Meanwhile, cost increases and higher vehicle prices, as the BS-VI norms come into being (for new vehicles) just six months from now, remain an overhang on the sector.

Yet, there are optimists among analysts who have revised earnings forecasts for auto companies by 5-15% for FY20 and FY21. This may change if demand continues to be slack and dent sales growth leading to auto stocks shedding recent gains.

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