Best Auto & Ancillary Stocks To Buy Now: Report By ICICI-Direct

Covid-19 adds to sector woes…

The domestic auto industry is going through difficult times, with industry sales volumes down nearly 16% YTDFY20. The industry was already in a transitory phase for the upcoming switchover to BS-VI norms with effect from April 1, 2020 that needed intense deliberation and strategising in areas related to products, pricing, production & inventory management.

We were factoring in negative growth in Q1FY21, a neutral Q2FY21 and higher single digit growth in H2FY21 to finally end the year positive with ~5% industry growth for FY21. However, the recent outbreak of Covid-19 with associated nationwide lockdowns as well as plant closures of the entire ecosystem (auto OEM + auto ancillary) will meaningful change our estimates.

Rework estimates to build in delay in recovery…

As per SIAM estimates, the present suspension of production activities at OEMs and ancillaries would cost the industry ~₹ 2,300 crore/day in lost revenues. Q4FY20 (till March 15) was witness to production rationalisation at most OEMs as the focus remained firmly on rundown of BS-IV stock. With half of March slated to be a washout, the quarter is another poor one.

Going forward, we expect industry volumes to decline sharply (~40-50%) in Q1FY21E amid plant closures, accounting for at least two months of subnormal operations (one month of complete closure i.e. April 2020 and corresponding one month of gradual resumption of work i.e. May 2020).

Our reworked estimates bake in another year of de-growth at the industry level in FY21E (-5%), after adjusting for some pent up recovery in H2FY21E. We see meaningful growth returning to the industry only in FY22E post normalisation of BS-VI environment, expected uptick in economic activity and consumer spending and build in ~10% volume increase for that year.

Indian automobile industry leads by example!

The auto industry has stepped forward as a responsible stakeholder in this time of unprecedented crisis affecting the length and breadth of the country. The industry is one of the top tax contributors to the exchequer (our estimates suggest auto space accounts for ~8-10% of the total direct and indirect tax collected in India with GST collection itself pegged at ~₹ 1.5 lakh crore) and has assured commitment for supporting the most vulnerable section of its employees in the immediate future in aspects of job security and work compensation.

Several OEMs have offered to manufacture vital requirements like ventilators and masks. Recent announcements of voluntary salary cuts by some senior managements are a welcome gesture that expresses their solidarity during prevailing tough business conditions. Domestic auto OEMs possess healthy B/S with adequate capital to support its staff in the present difficult times.

Valuation & Outlook

In the present times of despair and unprecedented economic slowdown due a Black Swan event like Covid-19 outbreak, we reiterate our preference for business models that are capital efficient in nature (RoE, RoCE >15%), possess healthy balance sheet (debt: equity < 0.5x) and are more domestic (India) centric in nature. We maintain our view that these businesses remain better placed to navigate the current downturn effectively and emerge stronger from it, leaving themselves primed for eventual recovery down the road. Among OEMs, we have valuation comfort and assign BUY rating to Hero MotoCorp, M&M, Bajaj Auto & Ashok Leyland while assigning HOLD rating to the rest of the pack i.e. Maruti Suzuki, Tata Motors, Eicher Motors and Escorts. Among ancillaries, we assign BUY rating to Exide Industries and HOLD rating to Apollo Tyres and Bharat Forge.