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Geopolitical tensions inflict more downgrades

Headwinds loom in the form of cost pressure, chip shortage, fuel price hike

The ongoing geopolitical crisis is escalating the risks of commodity inflation, fuel price hikes and potential disruptions in supply chains globally, previously witnessed in 2HCY21. These headwinds arise against the backdrop of some stability in commodity prices and supply chain issues, which emerged in the last 3-4 months.

Based on these spot prices, we estimate the gross impact of RM cost inflation for 2Ws/PVs/CVs at 270bp/220bp/120bp, respectively, over 2HCY21 average. However, this does not include the impact of forex on imports/exports as well as any price hikes taken. The gross impact, albeit, may not fully reflect in 4QFY22 due to inventories, contracts and lag effects.

Sharp inflation in crude oil and rubber will further aggravate under-recoveries led by the commodity costs and delay in margin recovery for the tyre players. Based on the current spot prices, we estimate under-recoveries at 8-10pp

While all auto component players will see a transitory effect as well as a mathematical impact on margins, component players with sizeable EU operations (e.g., MSS, MACA, ENDU, and BHFC) will see the full impact of hyper-inflation in energy costs in 1HCY22.

While commodity cost inflation will hurt margins, probable increase in fuel prices (15- 20%) after the state elections can potentially lead to demand deferment across segments. This would particularly hurt the 2W segment where customers have been impacted by persistent inflation in the total cost of ownership over last three years.

Lastly, there are fears of semiconductor chip supplies getting adversely impacted as Russia and Ukraine are important sources of noble gases and precious metals used in manufacturing of semiconductors. This could potentially derail the improving chip supplies and continue to impact PVs, premium 2Ws and CVs, negatively.

We are revising our estimates to factor in some of these headwinds viz: a) the commodity inflation partly offset by price hikes, b) impact of forex on exports/ imports, and c) marginal impact on supply-side issues. The current under-recoveries due to RM cost are minimal for 2Ws/PVs/Tractor OEMs, as the price hikes until Jan’22 largely covered the commodity inflation witnessed until Dec’21. For CV OEMs, we estimate an under-recovery of 4-4.5pp before the impact of the recent inflation

For OEMs, this leads to substantial cuts in FY23E EPS for AL (-19%), TTMT (-14%), TVSL/HMCL/MSIL (-12% each). For auto component players, there are major cuts in FY23E EPS for CEAT (-32%), MSS/APTY (-20% each), MRF (-15%), ENDU (-12%) and EXID/BHFC (-11% each).

We prefer 4Ws over 2Ws as PV is the least-impacted segment currently and offers a stable competitive environment. We build in a strong recovery in FY23E and beyond, with FY23E growth at 12%/21%/27%/31%/-10% for 2W/PV/LCV/ M&HCV/Tractors, respectively. We prefer companies with: a) higher visibility in demand recovery, b) strong competitive positioning, c) margin drivers, and d) balance sheet strength. MSIL and AL are our top OEM picks. In auto components, we prefer BHFC and APTY.

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