Operating performance may bottom out in Q3

The automobile segments faced demand headwinds in Q3FY19 on account of increased cost of ownership due to rising fuel costs, an increase in insurance cost and higher cost of financing. Moreover, stress at the farm level and consequent weak rural sentiment led to lowest festive sales in 4-5 years, particularly two-wheelers and other private vehicles.

Ebitda margin for our original equipment manufacturers (OEM) (ex-JLR) universe is likely to contract by 140 bps YoY (-70 bps QoQ) to 12.6 per cent due to inflation, currency depreciation and higher variable marketing expenses. All OEMs – except Mahindra & Mahindra (20 bps YoY / 50 bps QoQ) – are likely to see YoY margin contraction – Bajaj Auto (- 330 bps), Maruti (-260 bps), Ashok Lyland (-250 bps), HeroMotor Corp (-160 bps), Eisher Motors (-140 bps) and TTMT S/A (-90 bps).

We have lowered our FY19/20 EPS estimates for Ashok Leyland (by 11 per cent each), EIM (6 per cent /9 per cent), TVSL (7 per cent /4 per cent), HMCL (5 per cent /6 per cent) and MM (4 per cent /7 per cent).

Increased ownership cost hurts demand, particularly in private vehicles and two-wheelers. All auto segments faced demand pressure in Q3FY19, as cost of ownership increased due to higher fuel, insurance and financing costs. Moreover, sales in the festive season were the worst in 4-5 years, particularly in the private vehicles and two-wheelers segments, as lower farm income dampened rural demand. Commercial vehicles demand momentum faced hurdles in the form of an increase in axle load and financing issues.

Margins are likely to contract for second consecutive quarter due to RM inflation, forex depreciation and an increase in variable marketing expenses.

We expect MM’s margin to expand by 20 bps YoY (+50 bps QoQ), but all other companies to report margin contraction on a YoY basis – Bajaj Auto (-330 bps), MSIL (-260 bps), Ashok Leyland (- 250bp), HMCL (-160 bps), EIM (-140 bps) and TTMT S/A (-90 bps). Consequently, PAT is expected to decline for the first time in six quarters by 5.6 per cent YoY (-23.7 per cent QoQ).

We expect the operating performance for most auto OEMs to bottom out in Q3FY19, led by demand normalisation due to softening fuel prices, improving liquidity and new product launches.

More support is likely over the longer term from healthy rural sales and pick-up in economic activity. We estimate 8-10 per cent CAGR for two-wheelers, 6-7 per cent for four-wheelers, 16-18 per cent for commercial vehicles and 10-12 per cent for tractors over FY18-20. Margins for all companies are expected to recover from Q4FY19 (except for Bajaj Auto and MM), resulting in aggregate PAT growth of ~12 per cent QoQ.

Near-term headwinds notwithstanding, our preference remains for personal vehicles over commercial vehicles/two-wheelers due to their stronger volume growth and a stable competitive environment. Our top picks in autos are MSIL and MSS among large caps, and ENDU and EXID among midcaps. We also consider MM as the best proxy to play the rural theme.

—Motilal Oswal Securities