Rally in auto stocks may pause for now, say analysts

Auto companies are now grappling with a slowdown in sales, triggered by pent up demand due to the COVID-led lockdown easing a bit and supply-side issues for raw material.

After a phenomenal rally since March 2020 low that saw the Nifty Auto index jump 132 per cent since then compared to a 93 per cent gain in the Nifty50, the rally in auto stocks may pause for now as demand cools off and companies grapple with supply-side issues, say analysts.

Valuation at which some of the auto stocks are trading at is another concern.

"PV manufacturers are trading at expensive valuation and I do not find much comfort there.

"Instead, investors can look at two-wheeler manufacturers and auto ancillaries. They are a better bet given the current industry dynamics.

"Overall, the blanket rally in auto stocks is likely to take a breather for now," says G Chokkalingam, founder and chief investment officer at Equinomics Research.

At the bourses, most auto stocks have done well since their March 2020 low.

Among the lot, commercial vehicle-maker Ashok Leyland and Tata Motors have surged 280 per cent and 374 per cent, respectively.

Mahindra & Mahindra (M&M), Motherson Sumi, Bharat Forge, Hero MotoCorp and Maruti Suzuki have gained between 70 per cent and 232 per cent during this period.

On their part, auto companies are now grappling with a slowdown in sales, triggered by pent up demand due to the COVID-led lockdown easing a bit and supply-side issues for raw material.

Retail sales of automobiles dropped nearly 10 per cent in January 2021 to 1,592,636 units (two-wheeler, three-wheeler, passenger vehicles or PVs, commercial vehicles or CVs, and tractors) from 1,763,011 units a year ago, data show.

This, reports suggest, was triggered by shortage of semiconductors, price hikes undertaken by companies and waning demand.

"The performance of auto stocks going ahead will be polarised.

"While there is demand, the waiting time for supply, especially select models of PVs, has gone up tremendously due to shortage of parts such as semiconductors etc.

"Companies that have a strong supply chain will continue to deliver. Stocks of such manufacturers will do well. The across-the-board run up is likely to pause," says A K Prabhakar, head of research at IDBI Capital.

On the regulatory front, the government has proposed a Green Tax, under which vehicles older than eight years would be charged additional 10 – 50 per cent of road tax annually, while PVs would bear higher costs on registration renewals after 15 years in age. However, electric vehicles (EVs), CNG vehicles and tractors are exempt.

The move, analysts say, will not meaningfully help increase vehicle sales, especially those of CVs due to the cost involved. A 10-ton truck, according to a Jefferies’ note, incurs an annual road tax of Rs 3,800 in Delhi and would now have to spend an additional 50 per cent, i.e. Rs 1,900, as Green Tax, which is just 10-20 basis points (bps) of the price of a new vehicle.

“The additional tax would also form just about 1-2 per cent of new vehicle price over the lifetime of a CV.

"We believe this might not be a sufficient trigger to switch away from older vehicles and additional incentives would be needed to promote replacement,” wrote Nitij Mangal and Sagar Sahu of Jefferies in a January 26 note.

The scrapping of government-owned vehicles older than 15 years likely to come into effect from April 2022 is another regulation with a good intent, but may not be able to meaningfully impact auto sales, say analysts.

“We believe that the number of vehicles owned by the government would be very small, and thus it would have a limited impact in its current form on demand for passenger vehicles (PVs) and Medium and Heavy Commercial Vehicles (MHCVs),” said Kapil Singh and Siddhartha Bera of Nomura in a recent report.