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Options galore; which ones to choose from the lot

We have analysed various auto ancillary businesses based on valuation multiples, likely earnings growth, RoE and several business risks. We believe there are some outliers in the list, on either side, in terms of valuation vs business fundamentals/risk led by fears of EV-led business disruption or EV-led opportunity driving higher growth. For long-term investment purpose, we prefer businesses with minimal exposure to CV cyclicality, minimal EV penetration led business risk, ability to manage capital structure/efficiency, and ability to innovate. Going by data analysis, our top picks in the space for long-term investment are CIE, Sansera, Sona, SAMIL, Craftsman and Balkrishna. We believe within our coverage universe Asahi India, CEAT, Bharat Forge and Bosch are trading higher than their fair value.

Avoid cyclical businesses with elevated multiples

Business cyclicality for India auto ancillary businesses is driven by either domestic CV cycle or input commodity cycle with rest growth and margin drivers being largely stable in nature. Thus, post domestic M&HCV market likely regaining FY19 highs by FY24 end in volume terms (~20% higher in tonnage carried terms), we see high probability of the cycle peaking out by FY25E. Thus, businesses dependent on domestic CVs can face ~15-20% segmental revenue decline in FY26E driven by market decline. Therefore, it would be better to avoid companies with higher exposure to this segment. Rising input commodity risk is another key risk that can swing earnings massively by impacting business profitability. Thus, avoid automotive tyre businesses with relatively low pricing power and high capital intensity, currently operating at elevated EBITDAM and trading at the higher end of valuation multiple trajectory

EV exposure is good, but needs to have sustainable + profitable growth rather than the risk of getting commoditised soon

With present EV penetration in 2Ws at ~5-6% and ~1% in PVs, the rising need for localisation of components is giving scope for ancillary makers to address the rising size of opportunity. We believe ~INR 30-40k/unit of e-2W is the addressable market size exclusively, other than parts common to both ICE/E2Ws. Components/systems like hub motors (BLDC/PMSM), controllers, ECUs, BMS, chargers, converters etc. would drive this demand. But we believe the entry barrier for any manufacturer to tap this opportunity is becoming lower with time, as access to M&As, JV formation and tech tie ups are allowing competition building up in the space, impacting the profitability potentially.

Avoid companies with volatile margin/cashflow + elevated valuation

We would recommend staying away from players with higher element of cyclicality in profitability, operating at higher end of margin currently along with trading at higher end of valuation multiple band. Thus, automotive tyre stocks, operating more than one standard deviation above long-term mean levels along with trading above long-term average forward P/E multiples should be avoided. We would rather prefer businesses that have the capability to execute and sustain operating margin across OEM cycles and withstand input commodity cost volatility seamlessly, thus, giving visibility to cashflow ahead. Therefore, we like CIE, Sona, Craftsman and Sansera.

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