Earnings upgrade cycle for auto sector gathering pace: IIFL Capital Services

7 Jul 2022 , 01:06 PM

Nifty Auto outperformed the Nifty by 15% in the first half of 2022. IIFL Capital Services expect the outperformance to continue in the second half, led by upgrades to consensus estimates.

Auto volumes well placed for strong growth in FY23

Analysts at IIFL Capital Services expect MHCV/LCV to grow 35%/25%, PV to be up 17% and 2Ws to grow 15%. CV and PV are on track to meet or beat their estimates based on recent volume trends. In 2Ws, wholesales were below the required rate in Q1 (inventory correction). However, retails are holding strong; wholesales should catch up from Q2. Tractors saw a strong 40% YoY industry growth in April and May (base effect, wheat exports). Their FY23 estimate of 5% growth implies very little growth for the rest of FY23. Analysts at IIFL Capital Services sees risk to ‘2W/3W exports’ due to weakening macro and currencies of export markets. Hence, they cut volume growth estimate, from 10% earlier to 5%. Tractors and ‘2W/3W exports’ are low on their preference list.

Multiple tailwinds for margins

Sharp rise in commodity prices in Q1 of 2022 (Russia-Ukraine conflict) created a scare for margins. However, metal prices have corrected 25-35% from the peak and are now even lower than the Q4 2021 levels. This would be a significant tailwind for the industry. As this is a reversal of margin pressures seen in 2021 and given no history of ‘price cuts’, analysts at IIFL Capital Services expect most of this benefit to be retained. INR depreciation would be a tailwind for exporters (subject to ability to hold USD prices). Weakness in JPY would benefit Maruti.

Upgrade EPS by up to 20%

IIFL Capital Services has upgraded EPS estimates of companies in its OEM coverage universe by up to 20%, primarily driven by upgrade to margin assumptions. Based on current metal prices, IIFL Capital Services’ margins assumptions build in 100-200 bps margin of safety. EPS upgrades (%), led by margins, are higher in case of low-margin companies such as TVS and lower in high-margin companies such as Eicher. In case of Bajaj, EPS estimates are largely unchanged as higher margins are offset by significant downgrades to volume estimates (both export and domestic).

Prefer Maruti, Hero, Ashok and Tata at current prices

TVS and M&M are both up 37% since IIFL Capital Services upgraded them in December 2021 and February 2022, respectively. They now prefer Maruti, Hero, Ashok and Tata Motors.