Home / Markets / Mark To Market /  Valuations of parts makers at risk amid uncertainty in auto industry

Shares of leading component makers such as Bharat Forge Ltd, Motherson Sumi Systems Ltd and Varroc Engineering Ltd have fallen 23%, 17% and 36%, respectively in the past year. This is sharper than the 10% drop in the Nifty Auto index.

With auto sales slowing across the globe, revenues and profits of parts makers, which rely on the export market, have taken a beating. Yet, their one-year forward valuations of 20-25 times are by no measure reasonable.

There is uncertainty over near-term demand for components given cautious commentary from the managements of leading original equipment manufacturers (OEMs). And analysts forecast subdued vehicle sales at least till calendar year 2021.

A report by Kotak Institutional Equities Research cites IHS Markit’s cut in the growth forecast for global light vehicles sales in CY19, from flattish growth earlier to a fall of 6-8% year-on-year (y-o-y). Barring Japan, South Korea and Brazil, all other countries are likely to post a contraction in sales. Light vehicles include passenger plus small commercial vehicles of up to six-tonne capacity.

In another forecast, Ferdinand Dudenhoeffer, director at Centre for Automotive Research in Germany, said, “World sales in 2019 will fall to 79.5 million from 83.7 million last year, and won’t recover to 2018’s levels until 2022, when sales will rise back to 84 million."

Indian component exporters’ revenue growth has already started falling in the last couple of quarters. Bharat Forge’s Q2 FY20 consolidated revenue fell 17% y-o-y, whereas growth rate slowed to 5% from double-digits for Motherson Sumi. Varroc Engineering clocked a 10% decline in revenue. Operating margin of these firms, too, contracted as a result of negative operating leverage. With the auto sales slowdown unlikely to reverse in the near term, cost-reduction efforts by OEMs will weigh on component makers’ margins.

Meanwhile, the Kotak report said valuation of global component peers is at a significant discount compared to their Indian counterparts. “For instance, Motherson Sumi (assuming fair multiple of 18 times for standalone operations) suggests that its overseas subsidiary, Samvardhan Motherson Automotive System Group BV, is trading at price-to-earnings multiple of 20 times, despite its global peers like Faurecia, Plastic Omnium and Magna International trading at 8-10 times estimated FY2021E earnings, with superior return ratios," it said.

That apart, there are risks from the overall economic downturn too. Some component makers such as Bharat Forge diversified into non-auto businesses such as oil and gas, which are also under pressure. Besides, some of the recent overseas acquisitions by Indian component firms would take time to scale up revenue and turn around. These factors will pose risks to upsides in component makers’ valuations in the quarters ahead.

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