The point to point returns on the NSE Auto Index for the fiscal year 2018-19 has been disappointing (-25.27%). These negative returns on the auto index stand out in contrast since the auto index had outperformed the Nifty and the Sensex in each of the 10 years post the global financial crisis of 2008. So, what exactly has led to this sharp fall in auto stocks?
Have autos gone into negative growth?
When Jaguar Land Rover (JLR) decided to temporarily shut its plant in Europe to match demand and supply, the reason was simple i.e. weak demand from China. A sharp fall in GDP growth in China coupled with the negative income effects of the trade war had led to Chinese consumers going slow on auto purchases. But that was a problem only for Tata Motors. What about the more India-oriented stocks? Maruti has been forced to cut production on its passenger cars by 20-25% to keep pace with the piling inventory with dealers. Interestingly, the weak growth in auto demand is visible across sub-segments of auto. In the month of February 2019, the overall dealer inventory was twice the historical average giving an inkling of the gravity of the demand problem in the auto sector. Two wheelers were supposed to be the direct beneficiaries of the rural thrust, but even there, the average growth dipped from 15% to 5%. While Bajaj had some shield due to its 50% exposure to exports, the fall was much sharper for Hero Moto. In the case of Eicher, despite its presence in premium bikes, Enfield saw fall in volumes to the tune of 20%. Further, the CSFB consumer survey hit the nail on the head, “Consumers in India are now willing to wait for double the period for purchasing durables like automobiles”. That is not great news for demand.
Funding options have become tighter
With the liquidity crunch in NBFCs post the IL&FS implosion last year, the average cost of funds for NBFCs has gone up between 100-150bps. That has obviously translated into higher auto loan rates. With NBFCs operating on thin margins, the entire cost hike has been passed on. Higher loan rates combined with higher fuel costs in the last six months have combined to dent retail demand for four wheelers and two wheelers. That is another reason for the underperformance of auto stocks.
Rich valuations, but they may be nearing comfort zone
With most of the large auto companies correcting sharply, the valuations as measured by P/E ratios are sharply lower. For example, Maruti used to quote at a P/E of over 40x a year ago is now quoting at a P/E of less than 28x. Similarly, Eicher’s P/E Ratio has fallen from above 50x levels to around the 31x levels. Whether these are attractive valuations or not will eventually depend on the growth rates that these companies can sustain. But for an economy with an annual GDP of $2.6 trillion and growing at over 7%, the middle class shift will be continuous. Weak auto demand, in such cases, is more an exception than a rule. That may be the good news!