Q2 preview: Auto Inc to report high revenue and profitability improved prices & margin 

Automobile manufacturers are likely to report good numbers for the September quarter of 2023-24 (Q2 FY24), on the backdrop of growth across segments and an  offset by a marginal drop in overall two-wheeler (2W) volumes. From a demand perspective, 2QFY24 was a mixed bag as PV and CV continued to expand on a year on year basis,  but 2W and tractors declined, say analysts. 

HDFC Securities Limited (HSL's) Q2FY24 preview stated that four-wheelers are expected to see margin boost on a quarter on quarter basis. Given that the festive season this time has been pushed by a month into November, Q2 volume growth appears lower YoY. In PVs, while UV demand has held up extremely well, car demand has further decelerated, driving a rich mix for most OEMs.

CV demand momentum continues to be healthy in Q2. However, 2W demand has failed to revive even in Q2. 2W industry is estimated to decline 1% YoY in Q2. While 2W exports seem to have bottomed out, recovery is likely to take a while given the adverse geopolitical trends. Within this, the entry-level commuter segment continues to underperform as rural recovery has remained elusive. Even the tractor segment has witnessed an estimated 3% YoY decline in volumes in Q2 due to sub-par monsoon.

2W makers likely to witness slower earnings growth QoQ

The report stated, two-wheeler OEMs are likely to post just a 3.5% earnings growth in Q2 on a QoQ basis (plus 23% YoY growth led by low input costs). Within 2Ws, TVS is expected to outperform peers with a 15% QoQ earnings growth, led by good volume growth and an improved mix.

Bajaj Auto net sales stood at Rs 10,838.24 crore in September 2023 up 6.23% from Rs. 10,202.71 crore in September 2022. Quarterly Net Profit at Rs. 2,020.05 crore in September 2023 up 17.48% from Rs. 1,719.44 crore in September 2022.

Experts attributed this due to improved export mix and favourable currency. However, HSL expect Hero MotoCorp to post a 2% QoQ earnings decline, as they expect margins to be impacted by higher promotion spending in Q2, given its recent launches. Even Eicher is expected to post a 7% earnings decline QoQ due to margin pressure, given the adverse mix.

Four-wheeler OEMs likely to post strong earnings growth

As highlighted above, CVs continue to see healthy demand even in Q2 with the industry expected to see 15% volume growth on a QoQ basis. Hence, the top 2 CV OEMs are expected to post healthy margin improvement QoQ. For Tata Motors, HSL expect JLR to see some margin decline QoQ due to adverse mix and gradual rise in marketing spending. "In PVs, we expect MSIL to post around 140bps margin improvement QoQ due to strong improvement in product mix in favour of UVs. However, M&M is likely to see margin pressure QoQ due to a lower tractor mix," said in the report.

Auto ancillary companies set to benefit from benign input costs

For Apollo Tyres, HSL expect both demand and margins to largely remain stable QoQ. For Balkrishna Industries, HSL expect margins to improve around 140bps QoQ, led by softening input costs and a gradual pick-up in demand QoQ over a low base. For Endurance, HSL expect a 2% earnings decline QoQ due to weak demand in Europe. For Bharat Forge, the standalone entity is expected to see margin improvement led by steady revenue growth driven by execution of its defense exports order and PV exports ramp-up. Performance of overseas subsidiaries is also expected to improve QoQ.

According to Motilal Oswal report, from a demand standpoint, 2QFY24 was a mixed bag as PV and CV continued to expand YoY but 2W and tractors declined. While MOSL anticipate a YoY decrease in 2W volume, the domestic and export markets appear to be recovering for 2W. Dispatches for SUV remained strong fueled by order book execution and improvement in supply chain situation. However, demand moderated for lower-end PVs. Among all the segments, MHCV appeared to be better placed despite a drop in discounts, driven by healthy demand across most of the underlying industries.

On a YoY basis, wholesale volumes are estimated to grow ~15% for MHCV, ~11% for PV, 20% for 3W and 1% for LCV. However, MOSL estimate 2QFY24 volumes to decline 2% YoY for 2W and 4% YoY for tractors. Domestic 2W volumes are expected to decline 3% YoY, whereas exports are likely to grow 3.5% YoY.

"We estimate the EBITDA margin of our Auto OEM Universe (ex-JLR) to expand for the sixth consecutive quarter on a YoY basis. EBITDA margin is likely to improve 200bp YoY (+50bp QoQ) driven by lower RM costs, favorable FX and operating leverage benefits. We are building our estimates based on stable commodity costs; however, we expect the benefits of favorable mix/FX and operating leverage to accrue and lead to sustained margin recovery. There has not been any material change in our FY24 earnings estimate for our coverage universe except for MRF (+5%)," according to MOSL.

Signs of demand moderation visible in PVs; 2W witnessing gradual recovery
From a demand perspective, 2QFY24 was a mixed bag as PV and CV continued to expand YoY but 2W and tractors declined. While MSOL anticipate a ~2% YoY drop in 2W volume in 2QFY24, it continues to see gradual recovery especially in the exports market, which is expected to grow ~3.5% YoY. Dispatches for SUV remained strong fueled by order book execution and improvement in supply chain situation. However, demand moderated for lower-end PVs. As a result, MOSL expect PV volumes to grow ~11% YoY in 2QFY24. CV wholesales are likely to grow ~6% YoY driven by better demand in underlying industries and healthy fleet utilization level. However, LCV volumes are projected to remain flat YoY due to high base. Tractor wholesales are anticipated to decline 4% YoY due to erratic monsoon across key regions and high base of last year. 3W volumes are likely to jump 20% YoY as demand is reverting to full normalcy.

Softening commodity costs to result in margin expansion

MOSL estimate the EBITDA margin of Auto OEM Universe (ex-JLR) to expand for the sixth consecutive quarter on a YoY basis. EBITDA margin is likely to improve 200bp YoY (+50bp QoQ) driven by lower RM costs, favorable FX and operating leverage benefits. Except for MM (weak tractor volumes) and HMCL/ EIM (flattish EBITDA margin), all other OEMs are likely to report margin expansion on QoQ basis. We are building our estimates based on stable commodity costs; however, we expect the benefits of favorable mix/FX and operating leverage to accrue and lead to sustained margin recovery.

Sector outlook stable; emerging concerns to be monitored closely
MOSL stated that the demand recovery is expected to sustain for 2W, M&HCV and 3W segments. Exports appear to have bottomed out, but broad-based recovery is not yet visible. On the other hand, new headwinds are emerging in the form of likely demand moderation in certain segments such as PVs, LCVs and tractors due to higher inflation/interest rates, and global macro uncertainties that are raising concerns for players having international exposure.

However, commodity prices have been favorable since the last few quarters. After witnessing inflationary pressure from the lows of 3QFY23, most of the commodity prices have corrected (especially precious metals). We expect a volume CAGR of 9-11%/5-7%/3-5% for 2W/PV/tractors over FY23-25. For 3W/LCV/MHCV, we expect a volume CAGR of 17-19%/3-5%/9-11% over FY23-25.

Valuation and view

The auto sector has underperformed the Nifty Index over the last six months due to concerns over rising inflationary pressures hurting the demand momentum. In this scenario, we believe companies with a strong product pipeline would be able to outperform the market and emerge as major beneficiaries of a softening commodity cycle. Our top picks for the sector are Mahindra & Mahindra, Maruti Suzuki and TVS Motors. In auto ancillaries, we like Bharat Forge, according to HSL.

"There has not been any material change in our FY24E earnings estimate for our coverage universe except for MRF (+5%). We prefer companies with higher visibility in terms of demand recovery, a strong competitive positioning, margin drivers, and balance sheet strength," added MOSL.

Festival cheer

August 2023 brought good news for passenger vehicle (PV) manufacturers, as wholesales trends turned favourable. Overall dispatches to dealers rose almost 10% in August, building up to a modest 5% rise in wholesales in Q2FY24. Leading the volume growth is Mahindra & Mahindra.

Commenting on September wholesales, Veejay Nakra, President of the Automotive Division at M&M, said, “We have achieved our highest ever sales of SUVs for the third month in a row. We are also keeping a close watch on semiconductor availability to meet strong festive season demand”.

Overall, PV makers anticipate a really good festive season, with strong new demand, and normalising chip supplies. The industry expects to sell over 10 lakh cars, sedans, and SUVs on the retail side, up by 12% from the 2022 season.

However, 2W makers continue to see weak demand due to a sluggish rural economy. With the monsoons ending at a deficit of nearly 6%, the outlook on rural demand is uncertain.