Auto sales have been booming for three consecutive months ended June in fiscal year 2019. Reports from industry and analysts give a sense of underlying confidence that the year will be one of bumper auto sales across most segments.
Yet, barring random spurts, the shares of auto firms have been southbound. Some explain this in the context of an overall weak sentiment on the Street over the last few weeks. In any case, the Nifty Auto index has fallen by 10.3% since January, underperforming the benchmark Nifty 50 that has risen during the period.
What gives?
The macroeconomic headwinds in the road ahead pose a risk to earnings growth. Foremost among all is the incessant rise in fuel cost. Both petrol and diesel prices that account for a significant part of vehicle maintenance costs have jumped 7% and 13%, respectively, in the current calendar year.
That’s not all. The interest rate spike after four long years will increase the cost of finance for vehicle owners. Both these factors are unlikely to change course in the near term. These will affect the cost of ownership and may lead to demand moderation after a few quarters.
The Street is unsure whether higher sales are translating into higher profitability. Commodity prices that ruled high throughout FY17 and FY18 are likely to impact Ebitda (earnings before interest, tax, depreciation and amortization) margins in the quarters ahead.
This was partly mirrored even in the quarter ended March 2018. In its report, brokerage firm Prabhudas Lilladher Pvt. Ltd while analysing the sector’s performance stated, “With commodity prices being around 15% higher year-on-year and 2% higher quarter-on-quarter, operating margins for most companies failed to meet our expectations despite significant operating leverage, given the strong volume growth.”
A similar situation in the coming quarters may limit earnings expansion.
Besides, June sales were on a low base of the year-ago period, when the new goods and services tax roll-out led to cutback in despatches.
These imponderables are currently weighing on valuations. Note that one-year forward valuations of passenger vehicles market leader Maruti Suzuki India Ltd and two-wheeler firms Hero MotoCorp Ltd and TVS Motor Co. Ltd have come off from the highs scaled a year ago.
That said, demand for vehicles remains robust and is likely to continue into the forthcoming festive season. If auto firms have pricing power and can increase vehicle prices to match cost pressures, perhaps valuations will catch up again.