Is Auto Sector Reviving? Stocks to bet on

The nationwide lockdown was a challenging period for the auto sector in India. As per the media articles, the domestic sales of all manufacturers dipped nearly 80%-90% in May 2020. However, the auto sector is now seeing a recovery as the Government is easing the lockdown restrictions in a phased manner. Secondly, the new realities of social distancing and the fear of contracting the virus is driving more and more individuals to buy their own vehicles who were earlier dependent upon public transport. However urban areas have been adversely impacted by Covid-19 and the lockdown, industry players say that rural India is seeing a faster recovery.

Source: Ace Equity

Nifty 50 have rallied 36% between the period March 25, 2020 – August 12, 2020. Whereas, Nifty auto index has jumped 57% in the same period.

We are bullish on the prospects of the Indian auto industry over the next 2-3 years. We expect multi-fold earnings growth in the recovery period. Hence, we have identified some of the stocks which are significantly cheaper than peers, have better growth prospects and hence can give superior returns in the coming years. We believe Hero, Ashok, Exide and Apollo Tyres can rerate from current levels, if they deliver on a few parameters.

Hero Motocorp:

Hero has held on to the 51-52% motorcycle market-share over the past 5-6 years. Its overall share came off due to loss in scooters, especially as scooters were gaining share in the overall 2W industry. Scooters now account for only 6% of its domestic volumes. We believe scooter share has bottomed out, and may not be a drag any more. High growth in rural markets would support motorcycles more than scooters; this would favour Hero. Further, success of new models can bring confidence in Hero’s R&D and be a re-rating catalyst.

Ashok Leyland (AL):

AL has low volume/earnings visibility at this point. If & when Covid-19 recedes and the economy becomes fully functional, we expect demand for trucks to pick-up quite sharply. Improvement in truck volumes should drive a re-rating. FY21 MHCV sales would be below FY09 levels (GFC) and, hence, may see a sharp rebound in FY22.  Further, AL plans to launch the new LCV platform ‘Phoenix’ within the next three months. Management expects it to double the addressable market and further reinforce AL’s growing traction in the LCV market. These products can be configured for both right- and left hand drive, which augurs well for expanding into export markets.

Exide Industries:

Replacement demand for batteries should bounce back fairly quickly, as it is less discretionary in nature (difficult to postpone). The OE segment should also normalise soon, going by sales volumes being reported by OEMs. Other segments are picking up gradually. We expect Ebitda margin to normalise in upcoming quarters, as volumes revert to pre-Covid levels and production ramps up in sync with sales. The other potential catalyst for Exide would be an exit from the Life Insurance business, which has needed periodic cash infusion from the core batteries business. The market seems to be assigning zero value to the insurance business at this point.

Apollo Tyres:

Apollo generated negative FCFF for four straight years (high capex phase). However, the capex phase is largely behind; we expect Apollo to be FCFF-positive over FY21-24. Revival in CV tyre demand (both OE and replacement) would drive up earnings from current cyclical lows. Sharp cost cuts in the European business (headcount cuts in the Netherlands) would push up EU margins, from high single-digit to mid-teens; this would be a big earnings driver starting FY22.

Nifty Auto Index Stock Performance: