Volume growth likely to stay moderate in auto sector: IIFL Capital Services

21 Dec 2023 , 11:55 AM

In 2023, all Auto OEM stocks outperformed Nifty, despite the volume growth across auto segments coming off substantially vs FY23. FY24 will see average volume growth of 6% (excl. 3Ws, a low-value category) vs 26% average growth in FY23. 3Ws is the only segment that beat expectations with 42% growth in FY24 vs analysts of IIFL Capital Services estimate of 20% growth a year back. All other Auto segments saw 2-5% cut to FY24 volume estimates at the industry level. This moderation was offset by better-than expected margins, as commodities (especially aluminium, precious metals) continued to soften in 2023. In past cycles, deceleration in volume growth had been accompanied by de-rating in valuations. However, FY24 saw average Auto OEM PE go up by ~12%. This may be explained by the overall market exuberance as well as by the fact that the EPS estimate saw upgrades (margin-led), despite a cut to volume estimates. As analysts of IIFL Capital Services look at FY25, they expect volume growth to stay muted at mid single-digit (on an average), which should drive a 15% Ebitda growth in FY25. If commodities soften further, there may be upside risk to earnings, and vice versa. 

Volume growth across auto segments to stay moderate: 

In FY23, MHCV, LCV, PV and 2W grew 49%, 27%, 27% and 16% respectively. FY24 saw a sharp deceleration to 10%, 0%, 8% and 11%, respectively. Analysts of IIFL Capital Services expect FY25 to be similar to FY24, with industry volume growth of mid-to-high single digits. Amongst auto segments, PV industry in FY24 would be at 124% of FY19 levels (last auto cycle peak), while tractors would be at 119% of FY19. Incidentally, these two segments have seen softness in demand in recent times. PV industry has seen elevated inventory, dealer destocking and higher discounts. Tractors saw weakness in demand in the festive season following suboptimal rains. On the other hand, 2Ws in FY24 is at 82% of FY19 and has some room for recovery. 2W exports are also substantially below peak (23% below FY22), having seen sharp fall in volumes, as enddemand in export markets (especially Africa) took a tumble. 

Low-end categories still below pre-Covid levels: 

Recovery post Covid has been uneven. Car volumes in FY24 would be 24% higher vs FY19, while 2Ws would be 18% lower. Within Cars, hatchbacks in FY24 would be 35% below FY19, while higher-priced UVs are 2.0-2.5x of FY19 levels. If the economic recovery becomes broad-based, low-end demand should catch up and would benefit Hero and Maruti. 

Tailwind of commodity deflation may support earnings growth, but can also become a headwind: 

FY24 industry margins are slightly lower than FY16-FY19 levels, leaving some more room for margin improvement. ‘Operating leverage’ and ‘pricing power’ have already played out, especially given that most segments are seeing moderation in volume growth. Analysts of IIFL Capital Services expect input-cost-led margin improvement to continue for one more quarter, as current commodity prices are lower than the average prices reflected in 2QFY24 results (1- quarter lag). A large part of this benefit is already built into Street estimates. If global commodity prices inch up, margins/earnings may come under pressure. 

Can valuation multiples expand further? 

In the previous cycles, deceleration in volume growth had been accompanied by de-rating in valuations. In 2023, only Ashok Leyland saw de-rating in valuations. All other Auto OEM stocks held on to, or saw re-rating despite weaker volume trends. Analysts of IIFL Capital Services forecast Auto OEM Ebitda growth (ex JLR) to moderate from 63% in FY23 to 35% in FY24 and 15% in FY25. If multiples hold, sector returns should closely match earnings growth. 

Analysts of IIFL Capital Services retain BUY on Bajaj, Tata; Cut Eicher to ADD, TVS to REDUCE: 

Bajaj is a play on recovery in 2W volumes (domestic and exports), as well as strong execution in 2W EV. Analysts of IIFL Capital Services expect Tata Motors’ near-term stock performance to be driven by superior performance in JLR in H2FY24 (volumes, margins, FCF), with ramp-up in volumes of RR and RRS. Analysts of IIFL Capital Services cut Eicher from BUY to ADD, as the recent rally does not account for its volume under-performance vs 2W industry amid rise in competition. Besides, 15-20% of Eicher’s FY25 EPS would come from CV segment, where growth is peaking out. Analysts of IIFL Capital Services downgrade TVS from ADD to REDUCE after an 80% rally this year (despite no EPS upgrade). About 3/4th of the rally is explained by PE re-rating. Analysts of IIFL Capital Services expect TVS’ 2W mkt share gains to pause in 2024 and result in valuation de-rating.