What must investors look for beyond a weak Sep quarter in auto sector?2 min read . Updated: 04 Oct 2019, 07:20 AM IST
- Retail sales may continue to grow in October on the back of festive season cheer
- Of course, the story for commercial vehicles hinges on economic revival and a sustained rise in freight rates.
September auto sales failed to impress. Barring three-wheelers and tractors, all other segments’ sales fell more than 20% year-on-year in the month. This marks the worst sales performance in the last four quarters. It also sets the stage for another round of earnings cut in auto companies across segments.
However, the one-year forward price-earnings multiple is up from a year ago, showing a flicker of hope that things may be getting better. Optimism comes from the slight improvement in sentiment in the last few days of September. Sales rose sequentially when compared to August. For example, Maruti Suzuki India Ltd’s month-on-month sales rose 17%, while those of Hero MotoCorp Ltd were up 14%.
Is the worst behind for the auto sector? Are there green shoots of revival? To answer these questions, here are a few things investors could look for in the coming months.
No doubt, the 10% year-on-year increase in vehicle registrations in September is a positive sign. But, it is not sufficient to indicate firm demand recovery.
Analysts feel that after the recent corporate tax cuts, there is clarity there will be no near-term change in the goods and services tax for autos. “This factor, along with all-time high discounts in passenger vehicles and two wheelers, led to sequential improvement in these segments during early days of the festive season (in Sep’19)," JM Financial Services Ltd said in a report.
Retail sales may continue to grow in October on the back of festive season cheer. So far, dealers are optimistic due to higher customer footfalls. However, this must translate into sales.
Importantly, a sustained recovery in November, when the festive season euphoria recedes, is necessary to confirm that the green shoots of revival in the auto sector will stay.
Besides sales, other positive indicators of revival are lower inventory levels. At the beginning of the festive season, manufacturers had flooded distribution channels with stock. Two-wheeler and passenger vehicle inventory is at 55-60 days and 40-45 days, respectively, which is high. Meanwhile, improvement in sales will slowly but surely translate into lower discounts and incentives.
“An uptick in festive period sales is critical to assess genuine demand and clear inventory backlog ahead of the transition to BS-VI (emission norms)," said Edelweiss Securities Ltd.
Of course, the story for commercial vehicles hinges on economic revival and a sustained rise in freight rates.
Until then, negative operating leverage, higher discounts, and incentives to push festive season sales and clear the BS-IV inventory will continue to dent profitability of auto firms.
Analysts concede that September quarter’s operating margin will contract by 200-400 basis points from the year-ago period across listed automobile companies. “Given the sharp volume decline across segments in 2Q, we expect significant cuts to FY20E consensus estimates in the upcoming earnings season," said Arya Sen, analyst at Jefferies India Pvt. Ltd.