Jun 3, 2004|
Auto: What should an investor do?
Here is yet another story in the stock market about expectations running ahead of fundamentals and trying to catch up with reality now. We are referring to the performance of the auto stocks on the bourses in the last one year and in the not-so-recent past. But is the worst over?
Just consider the table below. There are two columns that highlight the performance of auto stocks (one, the change in prices in the last one month and second, the change in stock prices from the 52-week highs). As is evident to retail investors, the change has been dramatic either way. Before analysing why stocks have tumbled now, a brief review of what happened prior to this decline will put things in perspective. The recovery in auto demand (barring motorcycle segment, which has been growing at a steady rate) started in September 2001, when both commercial vehicles (CVs) and car sales started gaining momentum. Led by various factors like favorable interest rates, new model introductions, road development projects, stringent emission norms and replacement cycle, demand for automobiles has been robust ever since.
Auto - Losing steam...
*one-month change, sorted by change from 52-week high
||As on May 3,
|As on Jun 2,
|% change from
||70 / 24
||496 / 114
||52 / 23
||113 / 45
||134 / 49
||600 / 145
||570 / 170
||311 / 112
||1,200 / 495
||275 / 110
||2,015 / 1,005
||6,250 / 3,170
||263 / 133
||506 / 125
Most of the auto stocks, barring tractor majors, benefited from this structural-cum-cyclical recovery. Just to back our argument with numbers, four-wheeler sales (excluding tractors) grew at a stellar rate of 29% in FY04 with buses and CVs leading the pack (46% growth YoY). While the passenger car segment grew by 27%, utility vehicle sales were higher by 35%. Such growth rates are at historically high levels. On the back of this performance, stock prices soared.
While part of this was justified due to fundamental improvement in industry fortunes, the concern at the start of this calender year was whether growth prospects were already reflected in the price or not? (our view on auto stocks in Jan'04). The performance of auto stocks in the recent past therefore, has to be viewed in this context. We indicated in January 2004 that auto stocks are trading at significantly higher valuations and expectations were high. But, given the decline in the last one month, the question is whether valuations are attractive now?
We do not think so, for the following reasons.
With interest rates expected to edge higher in the current fiscal, demand for automobiles could suffer. The fact that almost 80% of passenger cars are financed is a concerning figure for any investor. We expect this ratio to be higher for other segments like CVs, two-wheelers and UVs too. If interest rates were to go up, the cost of financing is likely to increase and to that extent, growth may slow down.
Secondly, considering the firm crude prices in the international markets, the possibility of petrol and diesel prices being hiked cannot be ruled out. As per Scania (the European CV player), in developing economies, fuel cost generally account for almost 60% of truck operators costs. If fuel costs were to increase, whether transport operators are in a position to pass on the rise to customers remains to be seen. Hike in petrol and diesel prices could also impact demand for cars and two-wheelers. The investor has to be cautious to that extent.
Thirdly, most of the auto majors have posted strong improvement in margins, working capital ratios and asset productivity in the last four years. We believe that there is limited scope for improvement from the current levels on all these facets in the future, given the intensity of competition. The borrowing and capital expenditure plans of auto companies are significant over the next three years. If volumes slow down, the rise in net profit could be much lower compared to the topline growth on account of aforesaid factors.
What is the conclusion? Despite the decline, we would continue to exercise caution when it comes to selecting auto stocks. Yes, the long-term prospect of the industry is good. But investors have to keep in mind that there is a price for this growth. Even current valuations do not offer comfort.
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