Auto and auto ancillaries constitute roughly 22 per cent of India’s manufacturing GDP, which is quite substantial. This sector is considered largely cyclical: when the economy is in the expansion mode, it performs well and when the economy slows down, it performs poorly. Just like housing finance has fuelled demand in the real estate sector, auto finance has spurred growth in the auto sector.
It is forecasted that automobile ownership in India will grow from 20 per 1,000 to 20 per 100 in the next two decades, which would be the fastest growth among all large economies. As India climbs the growth ladder, more and more people who own two-wheelers will migrate to four wheelers, which currently constitute 80 per cent of sales by number of vehicles. The number of two wheelers would also grow as more and more people enter the middle-class bracket. The government has initiated discussions to ban diesel vehicles older than ten years, which will ignite huge growth opportunities for the sector. The rapid speed with which the roads are being built—connecting villages, towns and cities—is good tidings for the sector. With interest rates expected to fall further, cheaper credit would further promote growth.
The geographic constraints in the form of high density of population compared with other developing countries would act as a long-term hurdle for bigger automobile penetration in India. Environment concerns are discouraging people from buying automobiles using non-renewable fuel. The revolution caused by digital technologies through taxi-hailing apps is radically changing the consumption patterns of automobiles, which could potentially threaten long-term growth by reducing the ownership of the vehicles. It would, however, bring in efficiency in utilisation and consumption of non-renewable energy resources.
Irrespective of the long term business dynamics on the ground level, markets have a different way of looking at stocks. There are sharp disparities in valuations based on the perception of growth and profitability of stocks. Since the economy is at the threshold of accelerated growth based on government spending on infrastructure and road sector, the heavy vehicles segment would see higher growth rates and therefore would attract increased demand on the stock market. The forecast of a good monsoon would drive rural consumption, which, in turn, would drive higher growth rates for the two-wheeler segment, given the fact that the base of previous year was low because of lacklustre demand caused by a subdued monsoon. This year, the reported growth will be much higher, propelling stocks of two-wheelers to new heights. Four-wheelers had great numbers in the year gone by on the back of huge incremental demand generated by people wanting to be part of taxi-hailing aggregators like Uber and Ola. This year could therefore witness a slump in demand in the four-wheeler sector because of the high-base effect.
Coming to major vehicle manufacturers, Mahindra & Mahindra posted muted annual numbers, but the fourth quarter result of 14 per cent revenue growth was slightly better than the street estimate, which gives the hope that a great monsoon ahead would actually translate into higher revenue growth on the back of rural demand revival. Because of the low-base effect, the growth numbers would be better, leading to handsome capital appreciation.
Tata Motors has delivered strong growth in the fourth quarter, as revenues grew by 19 per cent on healthy margin expansion, igniting hopes of solid growth in FY 17 on the back of strong JLR sales and turnaround in Indian operations. At P/E (price/earning) multiple of 14, it is reasonably priced compared with its peers. There exists enough margin of safety given the fact that it is estimated that the company may grow at 20 per cent CAGR (compound annual growth rate) for FY 17-18.
Maruti, the largest passenger vehicle manufacturer in India, is looking for 12-14 per cent revenue growth for the next two years, which could be a tall task. Given that valuations are on the higher side, and low revenue growth expected, the stocks will deliver returns in line with the market. The diesel ban could act as a positive surprise if implemented in many cities and towns.
Bajaj Auto came out with a good set of numbers by delivering a growth of 14 per cent in Q4, with higher realisations and margin expansions and with export headwinds settling down. With a strong monsoon and a revival in rural demand, the company is likely to post better numbers for FY 17, which would rerate the stock as it had gone through a phase of consolidation in the previous year. High average ROE (return on equity) of 35 per cent and higher incremental growth along with margin expansion would take the stock to new heights in the coming quarters.
Hero Motors came out with encouraging Q4 numbers by posting the strongest growth in the past six quarters consecutively. For the last three months, the company has been posting 12-14 per cent volume growth month-on-month, which makes the case for rerating after a lag of one year of consolidation. The stock can outperform the sector in FY 17.
TVS Motors has launched a slew of new products in the previous year to gain market share, which had slightly impacted the margins. For Q4 FY16, the company registered a healthy profit after tax growth of 30 per cent, but disappointed on the margin front, which declined to 6.3 per cent. The current valuation is on the higher side and the stock is expected to underperform in the general market.
Force Motors is racing ahead of its peers in growth and profitability matrix, registering 30 per cent top line growth on quarter-on-quarter and year-on-year basis. Pick up in economy commensurate with the e-commerce boom has been well-capitalised by the company. Going forward, the growth is expected to be maintained, making a compelling case for investing in this stock.
Ashok Leyland has posted strong Q4 numbers in heavy and medium vehicles on the back of increased infrastructure spending demand. High growth may not be sustained, especially since the previous year base has already been ballooned. The high valuation the stock commands leaves little margin of safety for conservative investors.
The author is chief executive officer, SAMCO Securities.