Pick auto stocks with lower COVID-19 impact, strong balance sheets, say brokerages

Most auto companies, for the first time, reported zero sales in April, due to the nationwide lockdown.

With factories and dealerships shut during the month, original equipment manufacturers (OEMs) Mahindra & Mahindra (automotive segment), Bajaj Auto, TVS Motor, Hero MotoCorp and Maruti Suzuki reported almost no business.

However, as the government allowed agricultural activities (except in the containment zones), M&M and Escorts sold a few tractors. M&M, TVS Motor, Bajaj Auto and Eicher Motors managed to export some vehicles.

As it announced the third phase of lockdown that began on May 4, the Centre has allowed companies to start operations and dealers to reopen business, with the permission of state governments, in the areas that are coronavirus-free.

In an interaction with brokerage houses, OEMs indicated they were evaluating the possibility of restarting operations and waiting for permissions from state governments. Most of them have inventories of three to eight weeks.

Even after recommencing operations in some plants with a minimum manpower due to social distancing, getting spare parts would be difficult as most auto ancillary plants are in red zones or the coronavirus hot spots.

For instance, Bajaj Auto's two plants, including in one in Pantnagar, are operational. "30 percent of Bajaj Auto's dealers are located in the green zone and 50 percent are in green/orange zone. Hardly 2-3 percent of its dealerships have reopened for business, and hence, there is near-zero demand for vehicles or spares. Hence, the Pantnagar plant being operational does not help," Motilal Oswal said after talking to Bajaj Auto.

M&M told the brokerage that tractor plants have not restarted yet, as the company had enough inventories (for around eight weeks) in the system, even at the plant level. "Auto plants have started at Nashik, Haridwar and Igatpuri (engines). Chakan plant is yet to start," it said.

Hence, given the uncertainty due to COVID-19 crisis, brokerages expect the recovery to take longer time and all companies to see negative growth in FY21 against FY20 but there could be recovery in FY20 on low base of FY21.

"The COVID-19 pandemic has not only put the brakes on the initial signs of recovery seen in 2Ws/PVs but has also brought in uncertainty considering the several unknowns associated with its impact. This potentially deepens the impact of BS6 related price increase on FY21 demand," Motilal Oswal said.

Given the lockdown of nearly two months, the economy will likely take time to reach normalcy, say brokerages.

Leading agencies such as CRISIL and the World Bank have slashed India's FY21 economic growth forecast to 1.5-2.8 percent from 4.8-5.2 percent.

"Slower economic growth is likely to impact discretionary purchases such as automobiles and we expect the demand to remain under pressure in the near term. We expect recovery from FY2022 as long-term growth triggers, such as lower vehicle penetration and favourable demographics, are intact," Sharekhan said.

Moreover, pent-up demand (automotive volumes have been under pressure for the past six quarters) and pick-up in economic growth (post normalisation) would lead to a recovery from FY2022, it feels.

The Nifty Auto Index has corrected by about 21 percent in the past two months (compared to a correction of 18 percent in the Nifty) after the COVID-19 outbreak and the lockdown.

Most automotive stocks have also corrected sharply and are trading at 15-45 percent below their historical long-term average multiples.

Given the weak demand going ahead and attractive valuations, brokerages prefer to pick quality names less impacted by COVID-19 and have strong balance-sheet position.

"The demand is expected to remain under pressure in the near term on account of a slowdown in economic growth. Further, dealer support from auto companies may also impact their margins in the near term. Hence, we stay neutral on the automobile sector and prefer a selective approach," Sharekhan said.

The brokerage likes companies that are relatively less impacted by COVID-19 such as Balkrishna Industries and M&M (67 percent and 35 percent revenue from agriculture, respectively).

It also prefers companies that have a strong balance sheet and cash position and are leaders in their segments such as Hero MotoCorp, Exide Industries and Mayur Uniquoters.

Motilal Oswal also said valuations appeared attractive across companies but given the uncertain macro environment and threat of a possible prolonged impact of the coronavirus, it preferred stocks offering higher visibility of demand recovery, better competitive positioning, scope of higher operating leverage and strong balance sheet.

Eicher Motors and Maruti Suzuki are its top largecap picks, among mid-caps, it preferred Endurance Technologies.

Disclaimer: The above report is compiled from information available on public platforms. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.