Auto and Auto Anciliaries Sector Update - Input cost rise like to wipe operating leverage gains By ICICI Securities
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Input cost rise like to wipe operating leverage gains
* Wholesale despatch momentum moderates on supply chain issues and delayed marriage season: The auto industry has witnessed wholesale despatches taper off post a strong festive season. As states opened up further to reach normalcy, component shortages (e.g. semiconductors) has led to OEMs focussing on raising channel inventory (e.g. 2W at ~4-6 weeks) to manage potential production issues. On the consumer side, 2W dispatches fared worse (~-8% decline QoQ) than PVs (~-1% decline QoQ) due to delay in wedding season (relevant for North India). Tractors demand moderated due to seasonality. On the commercial side, CVs have started to witness moderate improvement (up ~10% QoQ).
* Consumer sentiment remains weak in mass-market segments; OEM’s continue new launches but hike prices too: During the quarter: a) retail demand trends (Link) remained modest even with relaxed consumer credit norms as OEMs undertook multiple price hikes and discounts/incentives tapered off post festive season; and b) OEMs launched new models (e.g. 4 new SUV launches in 3Q) and variants while working to increasing inventory levels.
* Operating leverage supports EBITDA margins as gross margins slide: Weaker product mix, higher commodity prices is likely to impact operating margins in 4Q. Across I-Sec OEM coverage higher input costs is likely to drag gross margins by ~80-180 bps QoQ. We also expect better earnings resilience from companies with: a) higher export mix, b) replacement revenue share, and c) better pricing power.
* Key factors to watch out: 1) Sustenance of demand recovery and customer sentiment in Q1 as Covid second wave emerges, and 2) extent of price increases undertaken to protect margins.
* Our view: We expect demand to sustain primarily on the back of strong rural incomes, which have higher income visibility due to better outlook on farm incomes due to higher kharif acreage, better MSPs and strong monsoon. Also, we expect the normalisation of economic activity across regions to help economy facing segments; hence we prefer tractors, CVs vis-a-vis consumer segments.
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