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Final quarter of profitability consolidation

We believe, Q1FY23E would be the last quarter where profitability of our coverage universe would remain impacted due to either scale disadvantage or elevated input commodity costs in the current business cycle. Retails in PVs, 2Ws and M&HCVs were up 1.7%, 11.8% and 0.5% QoQ in an otherwise weak quarter seasonally, with inventory being sub-par across segments. We believe operating leverage is not going to impact margin this quarter, though lag in impact of input commodity prices peaking in Mar-Apr’22 would get reflected in the gross margin. China lockdown for a large part of Q1FY23 would impact OEMs dependent on the global supply chain, i.e. JLR. With price hikes having come into effect across Q1FY23 to pass on input cost inflation, and spot commodity prices cooling off in latter part of the quarter, we are building-in a gross margin reduction of ~50-100bps QoQ. From Q2FY23E, we believe wholesales would rise on the back of improving chip supply and the lagged impact of input commodity price decline would come into effect. This would start pushing profitability to pre-covid levels by end of FY23E. Our top picks continue to be Tata Motors, TVS Motors, Maruti Suzuki, and Ashok Leyland.

Flattish volume growth coupled with lag in RM basket benefit could hurt margins:

With moderate volume growth across segments in a seasonally weak quarter, we expect stable to slight moderation in profitability. Input cost inflation and price hikes taken in the first half of Q1FY23 amidst steady operating leverage is likely to impact gross margins by 50-100bps. This would be even as commodity price correction benefit becomes visible Q2FY23E onward as contracts have 1-6 month revision cycles.

Key factors to watch out:

1) Capability to gradually improve production in coming months depending on chip supplies and supply chain issues getting resolved with Chinese ports opening up; 2) shift in commodity contracts to lower rates amidst product prices remaining unchanged; and 3) new-launch pipeline and timelines.

Our view: 

We expect Q1FY23E results to sail through smoothly (QoQ) despite it being a seasonally weak quarter. This would be because there was no QoQ decline in volumes across segments and price hikes effected would take care of input commodity inflation in the first half of the quarter.

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