Volume growth to decelerate, margin uptick key for auto companies: IIFL Capital Services

22 Dec 2022 , 11:06 AM

As we look into 2023 (overlapping with FY24), volume growth may stay positive, but rate of growth would come off substantially, believe analysts at IIFL Capital Services. In FY23, OEM EBITDA growth is 55% with revenue up 34%. In FY24 and FY25, EBITDA growth may taper to 32% and 15%, respectively. Since stocks are already discounting FY24 earnings, stock performance will depend on upgrades/downgrades to FY24 EPS and confidence on achievability of FY25 estimates. 

Analysts at IIFL Capital Services begin 2023 with the following top picks: Ashok (CV growth + margin), Motherson (fall in global inflation), Apollo (margin, FCF). Tata (JLR ramp up) can be a dark horse. 

They downgrade Eicher from Buy to Add as they find that EPS upgrade resulting from Hunter launch pales in comparison to the run up in the stock.

Volume growth to decelerate

In FY23, MHCV, LCV, PV and 2W could grow 44%, 27%, 27% and 18% respectively. In FY24, analysts at IIFL Capital Services expect growth rate to taper down to 15%, 5%, 10% and 12%, respectively. FY23 growth benefited from low base, pent-up demand and chip shortage in FY22. These effects would wane off in FY24. MHCV growth would be highest as volumes are still lower than FY19 peak and fleet age is above normal, which should drive replacement demand. Analysts at IIFL Capital Services expect LCV segment to be the slowest, at 5%.

Recovery in entry-level segments may benefit Maruti & Hero, but no visibility yet

Recovery post COVID has been uneven. Car volumes in FY23 would be 16% higher versus FY19, while 2Ws would be 25% lower. Within cars, low-end segments are 26% lower versus FY19, while higher priced cars are 1.6-2.0x of FY19. If economic recovery becomes broad-based, low-end demand should catch up. This would benefit the likes of Hero and Maruti. Hero would benefit, if rural demand, which has been weak recently, sees a recovery.

Sector margins to improve, but already built in estimates

Current industry margins are much lower than FY16-FY19 levels. The operating leverage story has largely played out, given strong volume recovery seen this year. However, the benefit of fall in commodity prices and INR depreciation benefit for exporters are yet to flow through fully. A large part of this benefit is already built into FY24 street estimates. If we do not see evidence of this benefit in Q3FY23 results, there may be downside risk to FY24 margin and EPS estimates.

CV industry margin may surprise positively, as Tata prioritizes margins over market-share

Despite sharp recovery in MHCV industry (+50% in FY22, +44% in FY23), EBITDA margins are still at mid-single digit versus ~10% in previous upcycles. While high input costs played a part, they have started easing. The bigger problem has been high discounting levels. Recently, Tata set a target of pushing up CV margins from 5% to 10%. Tata also announced plans to increase CV prices by up to 2% in January 2023. Overall, this may result in improvement in net pricing and lead to margin surprise versus expectations.

Valuation multiples unlikely to expand from current levels

The high earnings growth years (FY23/FY24) are already built in expectations and discounted by the market. Beyond FY24, sector earnings may taper off (IIFL Capital Services’ build 15% EBITDA growth in FY25). Although current valuations are not expensive and closer to mid-cycle multiples, it is unlikely that valuation multiples would expand from current levels. 

As a result, sector returns from here should closely match FY25 earnings growth, provided FY24 earnings estimates are met. 

Analysts at IIFL Capital Services like Ashok, Motherson and Apollo; Tata can be dark horse

Analysts at IIFL Capital Services like Ashok, as MHCV industry would see highest volume growth in FY24 as well as highest YoY margin expansion (not built in consensus estimates). Samvardhana Motherson under-performed in 2022, due to margin pressure and resultant EPS cuts. As negotiations with customers yield better pricing and inflation moderates, margins should normalize and drive multi-fold jump in earnings. Apollo Tyres should see strong margin and FCF performance, with upside potential to expectations. Tata Motors under-performed in 2022, but may recover if JLR’s production ramps up to reflect its strong order-book.

Most Auto stocks outperformed broad markets in 2022

In 2022, most Auto stocks (except the ones with global exposure) outperformed broad markets. Stock performance in 2022 has been driven by earnings growth, estimate upgrades and multiple re-rating. Stocks such as M&M, Apollo Tyres, CEAT and Craftsman, saw significant re-rating in valuation multiples.

Earnings growth to be strong in FY24, but led by margins

In FY23, aggregate EBITDA of Auto OEMs should grow 55% YoY, driven primarily by growth in volume and revenue. Analysts at IIFL Capital Services estimate EBITDA growth to taper down to 32% in FY24 and 15% in FY25. They expect revenue growth to come off from 34% in FY23 to 13% in FY24. Hence, earnings growth would need strong support from margin expansion.