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Why auto stocks might be the best bet for the next 2-3 years

Why auto stocks might be the best bet for the next 2-3 years
The automotive industry has been yearning for growth for more than 10 years. The various sub-segments of the industry have only grown at a CAGR of 3-6% over FY10 to FY20 compared to 10-12% CAGR over FY00 to FY10. Industry growth has been impacted because the fortunes of the auto industry are closely linked to the growth rate of the economy.

  • All segments posted growth in FY10 and FY11 as a result of announced government measures to help recover from the 2008 global financial crisis.
  • During FY12-14, high interest rates and high fuel prices combined with inflation dampened business sentiment, leading to a slowdown.
  • In FY15-18, customer sentiment improved thanks to the appointment of a stable government. The government placed great emphasis on manufacturing and introduced favorable policy decisions, along with an emphasis on ease of doing business, fiscal stability and controlling inflation.
  • In FY19, solar panel sales were impacted by regulatory changes, interest rate hikes and high fuel prices. FY20 saw an economic slowdown, both globally and in India, due to protectionist measures introduced by several countries. FY21 was a Covid-hit year.

Year Grow GDP growth Year Grow GDP growth
PV 2W resume PV 2W resume
FY10 26.00% 24.00% 38.00% 7.40% FY16 7.30% -0.40% 12.00% 7.60%
FY11 29.00% 24.00% 27.00% 8.50% FY17 9.20% 3.70% 4.00% 7.00%
FY12 4.70% 13.00% 18.00% 6.20% FY18 7.90% 13.70% 28.00% 7.20%
FY13 2.20% 0.10% -2.00% 4.50% FY19 2.70% 6.34% 18.00% 6.80%
FY14 -6.00% 3.90% -20.00% 4.70% FY20 -18.00% -18.00% -28.00% 5.00%
FY15 3.90% 2.50% -3.00% 7.20% FY21 -2.24% -10.70% -21.00% -7.30%

(Source: Annual Reports, Equitree Capital)

To earn outrageous returns, the best time to invest is when an industry is falling out of favor and valuations are low. Currently, the auto sector contributes only about 5% of the total market capitalization, which is in line with its long-term averages. However, we have seen in the past that as economic growth develops, the industry tends to rise to 9% of total market capitalization.

ET CONTRIBUTORS

India’s GDP growth is likely to grow by more than 7% to meet the ambitious goal of becoming a $5 trillion economy set by the Indian government. This means that the auto industry should also lead to a cumulative contribution of 9% of the total market capitalization, creating substantial value over a period of 2 to 3 years.

Rate of question selection
India’s leading four-wheeler company, Maruti Suzuki, said they are seeing strong demand in terms of inquiries and bookings, but due to supply-side issues, many bookings are pending. The only challenge left is the supply of semiconductors and the inflation of commodities. Looking at the waiting time for many models, it can be seen that the demand for cars is not a challenge. Some models like Mahindra XUV700 have a waiting time of 88 – 90 weeks while Mahindra Thar has a waiting time of 43 – 44 weeks. Also, Tata Motors Nexon EV has a waiting time of 12 – 16 weeks, while Tata Punch has a waiting period of 12 weeks.

Demand for commercial vehicles is expected to increase as the projects accelerate. The government’s continued focus on infrastructure spending is fueling a surge in demand for commercial vehicles. Demand will be further boosted by replacement demand as fleet owners are now looking to replace their aging trucks. It is important to note that rural demand has not yet picked up and will be an important controllable factor for the overall recovery.

Export opportunity contributing to growth
Major passenger car and two-wheeler companies saw their exports increase, mainly due to demand from Latin America, Africa and Southeast Asia. In addition to the above, global players are looking to India to source parts and components as part of their China+1 strategy. We are already seeing prominent companies such as Case New Holland Industrial, the world’s fourth largest tractor manufacturer, looking to source three times as many parts and components from India over the next three years, worth more than $300 million.

Current disruption offering the opportunity to invest from a long-term perspective
From supply-side constraints, from the availability of semiconductor chips to price increases in key commodities, the auto industry may remain under pressure for a few quarters, but these quarters may also present opportunities for investors with longer-term horizons.

Bottom-up investors are always looking for companies that have managed not only to survive a recession, but have also delivered supernormal growth. Companies like this, which manage to outperform during a setback, are firing on all cylinders once the cycle picks up.

In particular, investors should look for companies with diversified product offerings and target different sub-segments of the industry, along with a focus on the export and replacement market.

(Pawan Bharaddia, is Co-Founder, Equitree Capital)
(Disclaimer: Recommendations, suggestions, views and opinions of the experts are their own. They do not represent the views of Economic Times)