Auto industry hits coronavirus, lockdown roadblock; here’s what will get it up to speed in two years

April 16, 2020 12:19 PM

The speed of recovery largely depends on the government’s push towards growth. Going by the time frame in which other countries were able to pull back from this scenario, we should at least give it time till H2FY 21 to see positive changes.

Auto sector, coronavirus, lockdownAs of March-end, auto industry volumes were down ~18%, and the spillover effect will be seen in FY21
  • By Ravi Singh

The auto sector has been witnessing one of the worst cyclical downturns over the past few quarters due to multiple factors, including lower demand, transition to BS-VI and NBFC liquidity crisis. This led to inventory pile up as volumes were hitting record lows month after month. During 9M FY20, net sales of the automobile OEMs witnessed a y-o-y decline of about 14%. The ongoing coronavirus pandemic and lockdown is set to hit the sector harder, which will take much longer to recover.  Going forward, it will also face supply-side issues due to dependency on China for various components. As of March-end, auto industry volumes were down ~18%, and the spillover effect will be seen in FY21. Although this will be short-lived as the situation is coming to normal in China.

Lockdown will lead to negative operating leverage coming into play which will have an impact on margins. FY21 is unlikely to witness volume growth as people will try to regain the lost ground due to lockdown before resuming the discretionary spending. We expect H1FY20 to be lackluster followed by a gradual recovery in the second half of the year. The segment is likely to remain under pressure in the near-term as the virus outbreak persists. We anticipate that, even if the pandemic is curtailed, the consumer sentiment is expected to be negative and demand is expected to remain muted during much of FY21 led by fluctuating and uncertain economic conditions. While this has resulted in significant wealth erosion in the sector, the sector is offering opportunities to buy good stocks at very attractive prices.

Some of the key factors to watch out for include – companies with lower BS-IV inventory and lesser exposure to segments that are expected to be hit hard in the short to medium term. We expect the recovery to drag on a few quarters. We expect the rural economy to be relatively less impacted. Also, the salaried class’ cash flows would be corrected fast once the lockdown ends as they address issues arising out of EMI moratorium. As a result, companies with larger exposure to farm equipment and 2W come into focus. Additionally, companies with good balance sheets, higher domestic sales will stand to benefit the earliest. Some of the companies that fall into this category include Maruti Suzuki (cleared BS-IV inventory, good balance sheet), Escorts (emphasis on farm equipment) and Hero MotoCorp (cleared BS-IV inventory prior to March and higher focus on rural India). Initially, larger discounts will need to be offered to drive up volumes but its impact on the margins will be cushioned by lower raw material prices.

Overall recovery in the sector is still a few quarters away. The speed of recovery largely depends on the government’s push towards growth. Going by the time frame in which other countries were able to pull back from this scenario, we should at least give it time till H2FY 21 to see positive changes and a larger scale recovery in the sector by FY22 on account of pent up demand and improved sentiments across rural (particularly) and urban India.

(Ravi Singh is VP- Head of Research, Karvy Stock Broking. Views expressed are the author’s own.)

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