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Commodity inflation impact transient; healthy demand to support price increases with a lag

* Lately, amid a healthy recovery, rising commodity price inflation has caused automobile prices to rise. In the last three quarters, net price increases, factoring in discounts, stood at 4-5% across segments, with another ~2% increase expected in Q1FY22. OEMs expect price increases to cover a major chunk of commodity inflation, and the rest will be gradually offset through cost savings and better mix.

* Historically, in the auto market, there is a poor inverse correlation between price increases and volume growth as there are other factors influencing demand, such as economic growth, customer sentiment and interest rates. Our recent channel checks indicate that price increases have not significantly impacted demand across segments, except for the demand pressure seen in entry-level 2Ws.

* The impact of price increases has been partly neutralized by tapering interest rates and some shift toward longer-tenure loans. Let’s take the example of best-selling models: for Maruti Baleno hatchback, in the last two years, monthly EMIs have increased by only ~Rs450 to Rs11,100 for a fiveyear loan, and for Hero Splendor motorcycle, EMIs have increased by ~Rs230 to Rs1,500 for a fouryear loan. Monthly EMIs can reduce by 13-14% by increasing loan tenures by one year.

* We expect demand growth to be robu

* There has always been a reasonable inverse correlation between commodity price inflation and margins for automakers, due to the lagged effect of price increases. Gross margins were impacted in Q3FY21 and the pressure on margins is expected to continue in Q4FY21 as well. However, we expect a gradual recovery from H1FY22. Our current FY22 gross margin estimates factor in these commodity price pressures and are lower than FY18 levels by 200-300bps for most OEMs.

* Cost-reduction efforts and some improvement in product mix are offsetting commodity inflation to some extent. 2W product mix is on an improving trend, with higher share of executive/premium motorcycles. PV product mix is also improving, with higher share of UVs. In addition, the share of midtop variants is increasing within models for both 2Ws and PVs. In MHCVs, we expect mix improvement in FY22E, with robust growth in the higher-tonnage segments.

* Our positive view on the Automobile sector is underpinned by expectations of a strong cyclical upturn, which is expected to last for at least three years. Our top picks among OEMs include Tata Motors (TP:Rs375), Ashok Leyland (TP:Rs155), Maruti Suzuki (TP:Rs9,000) and Eicher Motors (TP:Rs3,300). In Ancillaries, we like Bharat Forge (TP:Rs760) and Apollo Tyres (TP:Rs306).

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