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Beyond the festive season: recovery sustains

The demand for automobiles has been resilient even post the traditional festive season. Sales for PVs and tractors continue to grow in healthy doubledigits and we expect this trend to sustain. As the country emerges from COVID (with vaccine rollout expected shortly), the economic recovery will further benefit auto sales, in our view. We expect margins to be range-bound (vs 2QFY21). While the utilisation levels are elevated (car, tractor utilization is upwards of 80%) and discounts are lower, commodity prices have risen sharply over the past quarter. Valuation multiples for auto companies are now trading at +1 standard deviation above mean. We believe that returns from hereon will be more stock specific as growth rates are likely to differ across segments. We upgrade Bajaj Auto to BUY to factor in an improving export outlook/expected pick-up in domestic 3W sales. We are also positive on Maruti, Tata Motors, and Subros in the autos space.

* Demand revival sustains post-festive season: The demand for automobiles has been resilient even post the traditional Diwali season. Sales for passenger vehicles and tractors continue to grow in healthy double digits and we expect the trends to sustain over 4Q as well. However, sales for 2Ws have moderated (refer our note: Divergent Trends in PVs and 2Ws). CV sales are improving QoQ and are expected to witness an uptrend (aided by a low base). As the country emerges from COVID (with vaccine rollout expected shortly), the economic recovery will further benefit auto sales.

* 3QFY21 margin outlook – differing elements: We expect margins to be range-bound (as compared to 2QFY21). While utilisation levels are elevated (car, tractor utilisation is upwards of 80%) and discounts are lower due to encouraging demand trends, commodity prices have risen sharply over the past quarter. The increase will be felt over 3-6 months as contracts typically rollover with a lag, we believe the cost increases will weigh on margins. OEMs have taken price hikes to partially offset the impact of the above.

* Stock valuations are elevated: Valuation multiples for auto companies are now trading at +1 standard deviation above mean as the NIFTY Auto index is up another 16% in the Dec-20 quarter (it has doubled since the COVID lows). We believe that returns from hereon will be more stock specific as growth rates are likely to differ across segments. Any announcements in the upcoming budget will benefit the sector.

* Upgrade Bajaj Auto to a BUY: We are upgrading Bajaj Auto to a buy as (1) exports (~50% of volumes) are reviving across frontier markets as crude prices and other commodities are firming up; (2) 3W sales are expected to revive, particularly after the vaccine rollout and (3) after Bajaj has firmed up its agreement with Triumph, it is building a new facility in Chakan to increase production. We raise our earnings by ~3% over FY22/23E and set a revised TP of Rs 4,000 at 20x FY23E EPS (vs 18x earlier). We value the stock at a 10% premium to its long-term average trading multiple to factor in the improving outlook.

* Key recommendations: We are positive on Maruti, Tata Motors, Bajaj Auto and Subros in the auto/auto ancs sector. These companies will benefit from improving demand trends as well as improving prospects in overseas markets.

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