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Realigning MOdel Portfolio as new headwinds emerge

Overweight on PVs, global plays; remain Underweight on 2Ws MOFSL Auto MOdel Portfolio has delivered a moderate outperformance of 160bp since its inception in Dec’20 in an operating environment challenged by relentless headwinds. With more headwinds on the anvil, we realign our MOdel Portfolio to navigate the near-term headwinds. In terms of major changes, we are Overweight on MSIL, companies with global exposure (BHFC, TTMT, MSS), and APTY, whereas we reduce weight on MM (to Neutral) and remove BOS, BIL, and CEAT.

Auto underperforms Nifty 50 in CY21YTD

* The Auto sector (NSE Auto Index) has underperformed Nifty sharply by ~13% in CY21YTD, with a broad-based underperformance across stocks. This is attributable to several factors impacting the Auto sector. The NSE Auto index has delivered just ~6.5% returns in CY21YTD, against the Nifty 50’s ~19.5% returns.

* Further analysis of this underperformance reveals broad-based underperformance across stocks, with only a handful of stocks outperforming – TTMT (+34% outperformance over NSE 50), ENDU (+17%), BIL (+15%), MSS (+13%), and BHFC (+12%).

* The broad-based underperformance has been due to relentless headwinds in the form of a) high commodity cost inflation, b) weaker demand recovery post the second wave led lockdown, c) higher fuel prices, d) the semi-conductor shortage, and e) the increasing threat from EVs (particularly in 2Ws).

Auto MOdel Portfolio delivers marginally outperforms NSE Auto

* Since the introduction of our MOFSL Auto MOdel Portfolio in Dec’20, it has delivered a small outperformance of 160bp in an environment challenged by incessant headwinds across segments.

* This outperformance of the MOdel Portfolio was driven by our Overweight stance on four of the five above-mentioned outperformers (TTMT, MSS, ENDU, and BIL). Our Underweight stance on key underperformers (MSIL and AMRJ) also aided our performance.

* However, our Overweight stance on HMCL (underperformance by 60bp) and no weight on BHFC (underperformance by 100bp) restricted our overall outperformance to 120bp.

Headwinds persist, with chip shortage getting more widespread

* Post the lifting of the second lockdown in Jun’21, demand recovery has been weaker than expected. While PVs continue to witness good recovery, 2Ws and CVs are subdued. The outlook for Tractors is also muted, especially considering the high base of 2HFY21.

* Additionally, the semi-conductor shortage is intensifying, with 2QFY22 likely to see the worst impact. While there is hope that semi-conductor supplies would improve in 2HFY22, OEMs and vendors are currently living by the day.

* Furthermore, financing has been getting stringent for CVs (for single truck and small fleet owners) and 2Ws.

* Lastly, commodity prices seem to be stabilizing for now. Coupled with price increases taken and cost-cutting initiatives, EBITDA margins should start looking up from 2HFY22.

Realign MOdel Portfolio to reflect new headwinds

* We tweak our MOdel Portfolio to reflect the headwinds on demand, supply-side issues, financing dynamics, and the increasing threat from EVs.

* We are Overweight on MSIL by 2.2% (from Underweight by 4.3pp) to reflect PV recovery and the product lifecycle turning favorable.

* We increase our Overweight stance on TTMT (from 50bp to 230bp) and MSS – as we expect normalcy to return in JLR and continued traction in the India business.

* For BHFC, we are Overweight by 3pp (from 3pp Underweight), led by cyclical recovery in all the key businesses.

* We introduce APTY in the MOdel Portfolio with 5% weight, as it offers the best blend of earnings growth and cheap valuations. APTY is our only allocation in the Tyre segment – implying 2.5pp Underweight on Tyre (from 0.7% Underweight) – as we remove BIL and CEAT from the portfolio.

* For MM, we reduce our weight to Neutral (from +700bp) due to a change in the outlook for Tractors. Although, we see the LCV cycle improving as well as the SUV product lifecycle being supportive.

* We reduce weight on HMCL (from Overweight of 3.8% to Underweight of 1.7%) as demand recovery has been slower than expected.

Valuation and view

* Demand momentum is building up gradually post the re-opening in Jun’21, with varied recovery across segments. Current valuations largely factor in sustained recovery (our base case), leaving a limited margin for safety for any negative surprises.

* We prefer 4Ws over 2Ws as PVs is the least impacted segment currently and offers a stable competitive environment. We expect the CV cycle to recover and gain momentum towards 2HFY22. In our estimates, we build in strong recovery in 2HFY22 and beyond, with FY22 growth at 16%/28%/28%/55%/4% for 2W/PV/LCV/M&HCV/Tractors.

* We prefer companies with: a) higher visibility in terms of demand recovery, b) a strong competitive positioning, c) margin drivers, and d) balance sheet strength.

* MSIL and MM are our top OEM picks. In auto components, we prefer BHFC and APTY. TTMT is our preferred global play.

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