Domestic vehicle sales may moderate over the next one year

HDFC Institutional Equities’ Research Analyst (Strategy), Aryan Singh Dalal, shares his views on the auto sector.

Auto sector is seeing some headwinds given the economic slowdown in many parts of India. What is your outlook for the sector over the next one year?

We expect domestic vehicle sales to moderate over the next one year, with a back-ended recovery as the interest rate cut transmission flows through to the consumers with a lag, benefits from tax savings (based on the tax cut that was announced in the union budget) starts lifting consumer sentiment, and the upcoming 8th Pay Commission. Rural growth continues to outpace urban growth, and we expect this to continue on the back of a good monsoon season forecast and moderating inflation.

 EV sales have slowed down. Do you think they will pick up and make a bigger portion of auto sales in the next 1-2 years?

EV sales benefitted from the first wave of customers who have mainly bought the EV as their second vehicle, and for the want to differentiate themselves in society. Reduction and withdrawal of central Government incentives, as well as most state Government incentives has moderated the growth rate. However, with expanding EV portfolios and reducing battery prices that are being partially passed on to consumers, it is helping the industry target a larger customer base, and especially those who would evaluate the benefits of total cost of ownership closely. While 2W and 3W will continue to see higher penetration of EVs, we expect the penetration in the PV segment to be gradual as it faces tough competition from the more convenient hybrid vehicles that do not create any range anxiety.

 Domestic sales for the sector slowed down in the June quarter. But export demand was strong. What is your view regarding export demand for the sector over the next three quarters, given the scenario of higher tariffs?

Exports continue to be weak on the back of a global demand slowdown, which is now seeing higher tariffs impacting business sentiments further. What has benefitted the export segment of a few players recently is their expansion into newer export markets as well as expansion within the existing markets. However, like to like sales in the exports market continue to be impacted. We expect exports to continue facing demand headwinds over the near term on the back of a challenging business environment which has only been exacerbated by geopolitical trade tensions that could lead to further supply chain disruption and recalibration.

Which companies in the sector are in positions of strength?

TVS Motors and M&M are bucking the domestic growth trend, by continuing to grow double digits, capitalizing on the successful product launches. However, valuations are factoring that to a certain extent. Our top picks are domestic facing OEMs are Ather Energy and Ashok Leyand, that are in the midst of a strong medium to long term structural growth story.

Stocks of Indian auto companies are currently trading at a P/E ratio of around 25.06. Do you think this ratio is justified, given their growth prospects in the near future?

If we were to evaluate on a 2 year forward P/E basis, the NSE Auto Index is trading at close to plus one standard deviation of the 3-year mean. Hence, valuations do look expensive at the moment, considering the global tariff uncertainty and the rare earth magnet shortage, if left unresolved, could lead to a production impact over the near term. Therefore, we believe that it is time to be selective in the auto sector.

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Source: HDFC Securities Institutional Equities