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Six trends stemming from 2Q; signs of rural upturn visible

Exports moderation getting broad based | OEM capex accelerating

Our analysis of the 2QFY23 performance and management commentaries of automotive companies predominantly indicates the emergence of six key trends. Among these trends, the signs of rural recovery coupled with accelerating OEM capex are highly encouraging. Further, easing of supply chain constraints and commodity cost reduction will drive working capital release. While exports moderation has gathered momentum in 2QFY23, there has been a divergence in management commentaries on demand, surging order books in developed markets and macro headwinds.

* Trend # 1: Signs of rural upturn visible, driving reduction in channel inventory – Retails, in the recently concluded festive season, recorded the best ever performance across automotive segments. This was the first normal festive season in the last three years, with the economy opening up fully. Urban pockets performed relatively better than rural markets, which did catch up during the latter part of the festive period. This rural recovery resulted in a healthy 26%/30% YoY growth in 2W/tractor retails during festive season, respectively, even as secondary 2W dealers (mainly non-urban) saw strong demand revival.

* Trend # 2: Contrast between macros and micros (new orders) in developed markets –The global environment continued to remain severely affected by numerous headwinds, though supply-side pressures started to ebb. OEMs cautioned on demand slow-down as macro environment deteriorated. However, underlying demand continued to be strong for PVs/CVs, resulting in expansion in the order backlogs. This coupled with substantially lower channel inventory lends healthy medium-term demand visibility.

* Trend # 3: Exports moderation gets broad based in 2QFY23 – Signs of exports moderation, which were visible in 1QFY23, gathered momentum in 2Q with almost all exporters flagging weakness in exports in most of the geographies. This was partly due to weak underlying demand (in 2W exports) and inventory destocking (on weakening macros and reduction in transit time). However, 2W OEMs are witnessing signs of stability in retails in Africa, though they do not forecast wholesales to improve before 4QFY23.

* Trend # 4: Full benefit of softening RM costs to reflect in 2HFY23E, but to be diluted by FX impact and other cost inflation – Management commentaries in 2QFY23 indicated that the full benefit of softening commodity prices will be visible with one-quarter lag and in 2HFY23. While spot prices of most of the commodities have seen sharp correction, the benefits realized by the OEMs will be offset by: a) unfavorable FX impact on imports, and b) other cost inflation.

* Trend # 5: Working capital increases leading to mounting debt – Supply chain disruptions and input cost inflation have resulted in material increases in inventory and working capital for the entire auto supply chain. These coupled with weaker operating performance have led to a surge in net debt, particularly for auto component companies, by over 60% in Sep’22 (over Mar’22), despite capex moderation. This trend is likely to be reversed aided by normalization of supply chain disruption and overall improvement in exports.

* Trend # 6: Capex of OEMs seeing a step-up; that of component players wanes – Capex of the OEM Universe increased to INR70b in 1HFY23 (~3.6% of sales), the highest in many years. Conversely, capex of auto component players declined to INR48b (~4.6% of sales v/s 6.3% of sales in 2HFY22), as they had elevated capex cycles over FY20-22 (avg. of 6.5% of sales).

* Valuation & views: MSIL and AL are our top OEM picks. Among auto component stocks, we prefer BHFC and APTY. We also like HMCL as a pure play on domestic 2W recovery.

Signs of rural upturn visible, driving reduction in channel inventory

* Retails, in the recently concluded festive season, recorded the best ever performance across automotive segments. This was the first normal festive season in the last three years, with the economy opening up fully.

*Urban pockets performed relatively better than rural markets, which did catch up during the latter part of the festive period. This rural recovery resulted in a healthy 26%/30% YoY growth in 2W/tractor retails during festive season, respectively, even as secondary 2W dealers (mainly non-urban) saw strong demand revival.

*The 2W segment, which had been lagging, also revived during the festival period (2% growth in retail sales v/s CY19 festive season) though full normalcy is yet to be achieved.

* Our channel checks suggest inventory built up in anticipation of good festive season has largely been liquidated for 2Ws and PVs. We expect the post-festival demand to sustain for PVs (due to pending order backlog), while 2W demand environment needs to be monitored. CV demand is projected to remain stable while demand for tractors is likely to be muted in 2HFY23E.

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