Automakers earnings still stuck in the slow lane
Premium- Q1 gross margins of automakers are likely to dip sequentially due to cost headwinds
- Margins in Q2 are expected to increase sequentially as prices of commodities are falling
The June quarter (Q1FY23) would be the first normal one after two years for Indian automakers. But, this does not mean that investors can expect companies to report stellar earnings for the quarter. Higher cost of commodities such as steel, aluminium and precious metals are likely to compress margins. Price hikes by companies can partly offset this.
Kotak Institutional Equities expects Q1 gross margins of most automakers to drop by 50-80 basis points (bps) sequentially. One basis point is 0.01%.
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There would also be a seasonality effect on revenue performance sequentially. In the two-wheeler segment, the wedding season in the last quarter drove volume growth, which in turn could aid revenues. For instance, Hero MotoCorp Ltd’s volumes in Q1 rose by 17% quarter-on-quarter.
On the other hand, the commercial vehicle (CV) segment had to bear the brunt of seasonality as the start of monsoon leads to a pause in the infrastructure activities. This is evident from the sequential drop in Q1 CV volumes. Ashok Leyland Ltd and Tata Motors Ltd’s Q1 volumes plunged sequentially by 18.6% and 15.8%, respectively. Consequently, Q1 revenue and margins are expected to decline.
“We expect Ashok Leyland to report 38% sequential decline in Ebitda (earnings before interest, tax, depreciation and amortization) mainly led by negative operating leverage, decline in average selling price due to higher mix of the light commercial vehicle segment and also raw material headwinds," said analysts at Kotak in a report on 5 July.
But, as the chart alongside shows, Q1FY23 volumes of CV makers were higher versus Q1FY20 indicating strong demand momentum. Note that a comparison with Q1FY21/FY22 would not be fair given that these quarters were impacted by the first and second wave of covid, respectively. While Mahindra & Mahindra Ltd’s CV volumes in Q1FY23 were higher by 14.3% vis-a-vis Q1FY20 levels, Tata Motors and Ashok Leyland’s volumes were up just slightly.
Coming to passenger vehicles, the segment’s sales volumes have dipped sequentially due to supply chain constraints. The lockdown in China would weigh on the sales of Tata Motors’ UK-based subsidiary, Jaguar Land Rover Automation PLC and could impact Tata Motors’ consolidated revenue.
However, the supply chain situation is expected to ease. Analysts do not foresee further incremental impact from geopolitical tensions and the China lockdown. “This should aid operating leverage in passenger vehicles/commercial vehicles, with significant ramp-up expected in premium variants across segments," said analysts at Yes Securities (India) in a report on 6 July.
The outlook for margins is also getting better. With the correction in prices of steel and aluminium, margins are expected to expand in Q2FY23. For perspective, domestic hot rolled coil price as on 6 July was Rs59,800 per tonne, according to SteelMint. This is a 21% fall from the average seen in April.
Analysts at Kotak expect 100-200bps sequential boost to the automakers’ gross margins in Q2, assuming there is no price hike.
As such, demand conditions are on a strong footing across segments.
“The auto industry is coming out of a slowdown after three years. Two-wheeler volumes have been picking up sequentially and are expected to maintain the momentum in view of expectations of higher kharif sowing. Demand in the passenger vehicle segment is robust and with supply chain issues easing, volumes are expected to improve," said Varun Baxi, analyst at Nirmal Bang Equities. Further, increased infrastructure activity bodes well for the commercial vehicle segment.
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The Nifty Auto index seems to reflect this optimism, appreciating by over 10% so far in CY22, making it the top gainer among NSE’s sectoral indices.