Auto sector: Motilal Oswal prefers two-wheelers over PVs; here are its top picks
Domestic brokerage house Motilal Oswal stated that it has shifted focus towards 2Ws amid the initial PV slowdown. Moreover, MHCVs (medium and heavy commercial vehicles) remain stable, it added.
The auto sector witnessed a healthy rebound in terms of demand, supply chains, and operational costs after overcoming its numerous macro as well as sector-specific challenges. The Nifty Auto index has risen 31 percent in the last 1 year, outperforming the Nifty index, which has advanced 7 percent, reflecting the robust sectoral performance.
Meanwhile, in 2023 YTD as well, the trend has been the same; the auto index has risen 35 percent as against an over 9 percent gain in Nifty.
In a recent note, domestic brokerage house Motilal Oswal stated that it has shifted focus towards 2Ws amid the initial PV slowdown. Moreover, MHCVs (medium and heavy commercial vehicles) remain stable, it added.
"While volumes of passenger vehicles (PVs), and tractors reached new highs in FY23, those of commercial vehicles (CV) and two-wheelers (2W) have been relatively slower to approach their earlier peaks, suggesting that the extent of recovery differed between categories. Though growth in other sectors should stabilize, we are already witnessing a reversal in demand patterns, especially in the 2W segment, wherein we anticipate high growth potential, along with the MHCVs. We have modified our sector preferences in light of the same and now favor 2Ws above other sectors, followed by MHCVs, while we turn cautious on the PV outlook," said the brokerage.
Read here: Q2 earnings review: Topline growth slows further, margins improve
2W in focus as MHCVs remain stable
Positive on 2Ws and cautious on PVs: The brokerage noted that India is already witnessing a reversal in demand patterns, especially in the 2Ws wherein it anticipates high growth potential. As compared to other categories, 2Ws have a relatively better scope for growth over FY23-26E. On the other hand, the brokerage has turned cautious on the PV growth outlook due to a slowdown in demand trend and high base.
Positive view on MHCVs: As per the brokerage, growth momentum in MHCVs has been sustained, led by strong demand in all underlying industries. It anticipates MHCVs' volumes to register a CAGR of 7-9 percent from FY23 to FY26E. This keeps MHCVs as MOSL's second choice within the auto pack. Tractors reported their highest volumes in FY23. It also expects minimal space for growth in both LCV (light commercial vehicles) and tractors over the next three years, with expected CAGRs for both ranging from 3-5 percent.
Stock picks: The brokerage prefers Tata Motors and Hero Moto among OEMs (original equipment manufacturers) and Endurance Tech and Craftsman Automation among auto ancillaries.
"We reiterate Tata Motors as our top pick in the sector, while we have added Hero Moto as our second preferred pick among OEMs as it is a good proxy, especially on a rural market recovery, with its stronghold in the 100cc Motorcycle segment. Among ancillaries, we prefer Endurance, as it is a proxy play to domestic 2W industry and Craftsman, led by ongoing CV growth cycle coupled with expectations of strong growth and superior capital efficiency," it explained.
Read here: Five key trends in Q2 results revealed: Nuvama
Auto sector trends
Demand outlook for 2W improving: 2W demand recovery anticipated albeit at a slower pace. Demand sentiment improved in 1HFY24, as urban markets continued to do well, while rural markets are also showing signs of recovery, said the brokerage. It believes new model launches along with the lower base of the previous year and improved supplies should drive 9-11 percent volume CAGR over FY23-26E.
MHCV is better placed among all the sectors: The brokerage also noted that the fleet utilization level is expected to improve, led by growth in infra-led activities, and improving demand from ports. However, replacement demand has not yet picked up sharply and is going to be a key monitorable in the coming quarters. It expects MHCV volumes to register a CAGR of 7-9 percent over FY23-26E.
PVs see signs of growth moderating: MOSL also pointed out that PV dispatches continue to witness healthy growth, led by new model launches and improving supply chain. However, it cautioned that there are signs of a slowdown in the lower-end segment, along with a declining waiting period for SUVs (partially due to improved supplies). It expects volumes to register 5-7 percent CAGR over FY23-26E.
Read here: Auto sector sees better profitability in Q2 driven by soft raw material prices
Tractors to see growth in H2FY24: The brokerage also informed that volumes declined 4 percent YoY in H1FY24 due to festive mismatch, uneven distribution of rainfall, and elimination of subsidies in key states. While the demand is expected to improve in H2FY24, MOSL believes FY24 volumes should stay flat YoY
Exports: Gradual recovery expected from H2FY24
Receding headwinds across key global markets: While the challenges related to global macros continue, the situation seems better this year vis-à-vis FY23. This has been further supported by improving supply chain and improved availability of semiconductors, said MOSL.
Management commentaries indicate ramp-up from 2HFY24 onwards: The brokerage further pointed out that most of the management commentaries indicate that exports remained under pressure in Q1FY24 but that they sequentially recovered in the second quarter. Headwinds have now started moderating and exports should see a gradual recovery from H2FY24 onwards, it added.
Companies with high global exposure continue to trade at a discount: Within the MOSL coverage universe, several companies have material exposure in key geographies such as the EU, NA, China, Africa, and others. Most of these companies are trading (based on FY25E EPS) at a discount of 10-35 percent vs their 10-year LPA, informed MOSL.
Read Here: Tesla vs. Toyota Is the New Hot Battle in Cars
Q2FY24 margin
As per the brokerage, after a sharp increase in H1FY23, most of the raw materials have witnessed significant correction in their prices. Commodities such as steel/aluminum/rubber/polymer have corrected 10-25 percent from their peaks. In 2Ws, the mix for >125CC models has increased from 30 percent in FY22 to 33 percent in Q2FY24. Similarly, for PVs, the SUV mix has increased from 45 percent in FY22 to 53 percent in Q2FY24, it informed. MOSL estimates gross margin/EBITDA margin to improve 210bp/260bp over FY23-26E for its OEM universe (ex-JLR), led by operating leverage, cost control, and product mix.
However, MOSL sees limited scope of EBITDA margin expansion over Q2FY24 as the gross margin is expected to have peaked out.
Outlook
While the absolute capex is expected to increase over the next three years, it will be significantly lower than the revenue growth, said the brokerage. Also, the capex cycle looks more prudent now vs the previous growth cycle as the average capex for FY24-26 is expected to be 3.6 percent/4.6 percent of revenue for OEMs/ancillaries, it added.
Moreover, improved earnings visibility and lower capex intensity should help generate better free cash flows over the next few years, predicted the brokerage. It anticipates 36 percent/49 percent CAGR in FCF (free cash flow) for the OEM/ancillaries coverage universe over FY23-26E. This should result in an average FCF to sales of 6.6 percent each over FY24-26E vs 6.3 percent/1 percent over FY17-19 for OEMs/ancillaries coverage, respectively, it forecasted.
Read Here: Auto Dealers Find Savings by Buying Cars Off the Street
Stocks
Tata Motors: While the India CV and PV businesses would see some moderation in growth in H2FY24E, the focus shifts to margin expansion-led earnings growth. JLR is witnessing a recovery, led by improvement in chip supplies, a healthy order book, and a favorable product mix. This should aid TTMT becoming net cash by FY26 (from ₹437b in FY23). The stock trades at 14.7/14.6x each for FY24E/FY25E consolidated P/E and 4.1x/3.2x EV/EBITDA. TTMT continues to remain its preferred BUY among OEMs with Dec’25E SOTP-based TP of ₹750, said the brokerage.
Hero MotoCorp: MOSL has added HMCL as its second preferred pick among OEMs stating it is a good proxy, especially on a rural market recovery, with its stronghold in the 100cc motorcycle segment. It has low vulnerability to EVs, as it garners 8 percent volumes from scooters and its core 100cc motorcycle is less prone to EVs. MOSL expects market share gain, driven by rural recovery (peaking interest rates and inflation), and new product launches every quarter. It sees revenue/EBITDA/PAT CAGR of 10 percent/30 percent/21 percent over FY23-25E. The stock currently trades at 15.2x/14.3x FY24E/FY25E EPS. MOSL has a BUY rating with a TP of ₹3,850
Endurance Technologies: Given ENDU’s strong positioning in the 2W segment, it is the best proxy to play the India 2W opportunity, keeping in mind the underlying trends of premiumisation and an uptrend in scooters, said the brokerage. Due to its strong business franchisee and management, the stock should continue to command premium valuation multiples in comparison to most domestic auto ancillary companies, it added. MOSL estimates a consolidated revenue/EBITDA/PAT CAGR of 15 percent/24 percent/32 percent over FY23-25. It has a BUY rating with a TP of ₹2,000.
Craftsman Automation: As per the brokerage, its track record of creating and gaining market leadership organically is uncommon in the auto component industry. This has enabled it to deliver a good balance of strong growth and superior capital efficiency. It estimates a consolidated revenue/EBITDA/PAT CAGR of 31 percent/31 percent/38 percent over FY23-25. However, the same is yet to be fully reflected in its valuations of 27.9x/23.1x FY24E/FY25E consolidated EPS. MOSL has reiterated its BUY rating on the stock with a TP of ₹5,800.
Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before taking any investment decision.
Catch all the Business News , Market News , Breaking News Events and Latest News Updates on Live Mint. Download The Mint News App to get Daily Market Updates.
- Top Gainers
- Top Losers
- 52 Week High